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President’s Advisory Panel on Federal Tax Reform

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  1. President’s Advisory Panel on Federal Tax Reform Robert E. Grady Managing Director The Carlyle Group March 31, 2005

  2. 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

  3. 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

  4. Agenda • The Role of Venture Capital and Entrepreneurial Start-ups in The U.S. Economy • Venture Capital Investing • Suggestions for Tax Policy

  5. The Role of Venture Capital and Entrepreneurial Start-ups in the U.S. Economy

  6. 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 Venture Capital: America’s Job-Creating Engine Source: Venture Impact 2004 by Global Insight (Wharton/DRI)

  7. 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

  8. 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 Whole New Sectors Have Been Created…And Will Be Created

  9. The US Venture Industry Has Grown Source: 2004 NVCA Yearbook,/Venture Economics

  10. Venture Capital Investing

  11. 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)

  12. 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

  13. Carlyle Venture Partners Example • Fund I: 1997 • 31 Investments • 6 Trade Sales • 6 IPOs (3 Unrealized) • 7 Write Downs • 12 Remaining Private Unrealized Investments • Fund II: 2001/2002 • 29 Investments • 4 Trade Sales • 2 Write Downs • 23 Remaining Private Unrealized Investments • Employees at 38 Active Companies: 4,100

  14. Suggestions for Tax Policy

  15. 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

  16. 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

  17. 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

  18. www.nvca.org