Venture Capital and the U.S

President’s Advisory Panel on Federal Tax Reform Robert E. Grady Managing Director The Carlyle Group March 31, 2005 About the NVCA  460 member firms  Majority of all professionally managed venture capital in the United States  American Entrepreneurs for Economic Growth: 14,000 growth company CEOs  United States = 72% of all venture capital professionally managed worldwide About the Carlyle Group  $24.8 billion under management in 26 funds  24 offices in 14 countries  $1.8 billion in 5 venture capital funds  377 portfolio company investments Total of 151,000 employees Annual sales = $31 billion  34.2% gross internal rate of return on realized investments since founding Agenda The Role of Venture Capital and Entrepreneurial Start-ups in The U.S. Economy Venture Capital Investing Suggestions for Tax Policy The Role of Venture Capital and Entrepreneurial Start-ups in the U.S. Economy Venture Capital: America’s Job-Creating Engine  Companies backed by venture capital since 1970: – Provide 10.1 million US jobs – Had 2003 sales of $1.8 trillion  10% of US GDP on under 2% of capital invested  Venture-backed companies outperform others: Between 2000 and 2003: – US private sector jobs down 2.3%; – Venture backed companies grew jobs by 6.5%. – Sales nationally up 6.5%; – Sales at venture backed companies up 11.6%.  Venture backed wages grow faster than national average Source: Venture Impact 2004 by Global Insight (Wharton/DRI) The Increasing Role of Startups in U.S.-Led Innovation  Venture backed firms spend twice as much on R&D as non-venture backed firms  Share of US R&D performed by firms with <500 employees: – 1984: 5.9% ($4.4B) – 2003: 20.7% ($40.1B)  Major source of productivity growth – CAD/CAM, JIT, Auto-ID, payments, POS, e-Tailing, internet travel  Major source of U.S. Competitiveness: – 72% of all venture capital worldwide is in the US Source: Venture Impact 2004 by Global Insight; National Science Foundation Whole New Sectors Have Been Created…And Will Be Created        Biotechnology Network Security Package Delivery OnLine Retail Health Care Devices CRM Intelligent Merchandising  ERP Software  Medical Devices  Auto ID  WiFi Networks  Genomics  Wireless Messaging  Security Technology  Web Services The US Venture Industry Has Grown At Year End 1970 1980 1990 2001 2003 # Venture Capital Under Firms Mgt 28 $1B 89 $4B 399 $31B 943 $257B 919 $257B Source: 2004 NVCA Yearbook,/Venture Economics Venture Capital Investing The Venture Capital Investment Cycle  Investment: – Series A, B, C Preferred Stock – Expansion, Pre-IPO Capital – Use of Proceeds: • R&D, Product Development • Expansion of Sales Force  Realization – M&A, IPO – Valuation Metrics: • Price/Net Income Ratio • Price/Revenue Ratio (More Prevalent in Late 1990s Bubble) • Control Premium to Shareholders (in M&A Transactions) Characteristics of the Start Up Sector  Higher Proportion of Ownership/Options – Attractiveness of Opportunity Tied to Potential Gain in the Stock – NVCA Survey: 70% of Member Firms Portfolio Companies Award Options to 100% of Employees  Prior to IPO, M&A Transaction, or Institutional Financing, Many Firms Are Flow Through “S” Corps Carlyle Venture Partners Example  Fund I: 1997 – – – – – – – – – 31 Investments 6 Trade Sales 6 IPOs (3 Unrealized) 7 Write Downs 12 Remaining Private Unrealized Investments 29 Investments 4 Trade Sales 2 Write Downs 23 Remaining Private Unrealized Investments  Fund II: 2001/2002  Employees at 38 Active Companies: 4,100 Suggestions for Tax Policy Key US VC Building Blocks  Capital formation       – Prudent man rule – enabled pension investment – 1978 Steiger capital gains tax cut – Capital gains tax reductions Empowered entrepreneurs – Stock options/team building tools – Reasonable bankruptcy laws Protection of intellectual property Abundant customers willing to do business with small and medium enterprises Exit markets – the NASDAQ Face-to-face investing/proximity Cultural acceptance Tax Reform Objectives: The Entrepreneurial Sector  Policies Friendly to Capital Formation – Availability of Risk Capital Has Driven Innovation and Job Creation – Make Permanent Low Capital Gains Tax Rate  Simplicity – Complex Provisions Distort Capital Flows – Most Entrepreneurial Companies Have Modest Finance Departments  Low Rates – Corporate Tax Rates Largely Left Out of Debate – Most Small Companies Valued on Multiples of Net After Tax Income Conclusion  Low Rates Enhance U.S. Competitiveness – Attract Capital – Attract Companies – Attract People  Job-Creating Sector Decision-making is Growth-Driven Not Tax-Driven – Complex Provisions Create More Annoyance Than Value  Technology and Capital Flows Increasingly Global – U.S. Will Have to Compete to Remain the Home of Innovation, Growth and Job Creation www.nvca.org