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US Venture Capital Sector Expecting Tough Ride In 2009

by Mike Godfrey,, Washington

29 December 2008

A group representing venture capitalists in Ohio has urged the US authorities to hold back on tax plans that may undermine the sector on a nationwide level.

In a position paper published this month, the Ohio Venture Association argued that Congress should not raise the tax rate on venture capital carried interest, as this would undermine support for entrepreneurship, particularly in states like Ohio with fragile economies, warning that:

"Several proposals to either treat carried interest as ordinary income, raise the tax rate on carried interest capital gains, or both have been discussed and circulated on Capital Hill."

The Association went on to observe that:

"Venture capital, particularly early stage venture capital, is just beginning to penetrate traditionally late adopting markets across the Midwest. Early stage venture capital is generally managed locally by smaller, risk-taking venture capital firms that expect to manage investments in companies for five to nine years. A large part of their compensation is carried interest, which is the share the firms earn in the equity gain of the businesses in which they invest."

"The presence of locally managed early stage venture capital is critical to supporting the transition of mature economies into entrepreneurial economics. An increase in tax rates borne by venture capital will slow or arrest the significant progress that has been made."

Meanwhile, the third annual National Venture Capital Association (NVCA) Predictions Survey revealed this month that US venture capitalists are forecasting a difficult 2009 for the country’s economy, the capital markets, and the venture industry as the global financial crisis takes its toll.

According to respondents, the coming year will be met with a slowdown in investing across most sectors and a continued weakened exit market. However, most VCs surveyed by the NVCA predicted a recovery in 2010, when the IPO market is expected to re-open and those companies and venture firms that weathered the storm will emerge strongly.

"2009 will be a year of anticipation for the venture capital industry as the economic turmoil will engender a fair amount of Darwinian change,” suggested NVCA President Mark Heesen, continuing:

“The recession and shuttered IPO market will place tremendous pressure on portfolio companies to tighten their belts and re-tool where necessary. We will likely see a marked slowdown of new investments as venture capitalists turn their attention to supporting these existing companies. That said, most venture capitalists will say that a down market is the best time to invest when valuations and competition are lower. There is no recession on innovation and great ideas will still get funded, especially in sectors that have more insulated demand such as clean technology and life sciences.”

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