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Helping Startups Cross the 'Valley of Death'

Mark Marich

A proposed permanent exemption to capital gains taxes on investments in startups could help new high-growth firms thrive and create jobs. According to a new report from the Kauffman Foundation, an exemption on investments in startups held for at least five years could spur $750 million in additional seed investment and help them survive the ‘Valley of Death’—moving from concept to prototype.

This idea is embodied in the Startup Act proposed by the Kauffman Foundation in July 2011, in Startup legislation proposed by the Administration, the Startup Act legislation recently introduced in the Senate by Senators Moran and Warner and in a Small Business Tax Extenders Bill introduced this week by Senators Snowe and Landrieu.

In "A Market-Based Approach for Crossing the Valley of Death: The Benefits of a Capital Gains Exemption for Investments in Startups," authors Robert Litan, Kauffman Foundation vice president of research and policy, and Alicia Robb, Kauffman Foundation senior research fellow, argue that this approach would reduce risk and enhance after-tax rewards for long-term investment in these important startups.

"The administration has proposed making permanent the 100 percent exclusion for investments in C corporations held for at least five years," Litan said. "Making this exemption permanent would generate, conservatively, $7.5 billion in additional investment over a 10-year period in startups, which contribute the vast majority of net new jobs created in the U.S. economy."

Litan and Robb drew on estimates from the National Venture Capital Association, the Center for Venture Research and the Kauffman Foundation to calculate a total baseline investment eligible for the capital gains preference of $10 billion in 2010. Assuming that a permanent capital gains tax exemption would generate a 15 percent increase in the real return of startup investments (relative to the current capital gains tax), this should conservatively lead to a 7.5 percent increase in investment volume: $0.75 billion in additional investments in new companies per year.

While it is difficult to directly estimate the number of incremental new jobs this additional investment could create, the report offers ample indirect evidence that the amount would be significant.

"Young companies – those five years old or younger – accounted for virtually all net job growth from the late 1970s until the Great Recession," Robb said. "Measures that would channel substantially more investment in startups should lead to the launch of more high-growth firms and boost the odds that they will reach the growth phase and create jobs that will support economic recovery."

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