From the December 2010 issue of Investment Advisor • Subscribe!

One Hundred Days of Job Growth

In the State of the Union address earlier this year, Obama acknowledged that “the true engine of job creation in this country will always be America’s businesses,” and that to spur the economy and job creation “we should start where most new jobs do—in small businesses” prior to declaring that we should “eliminate all capital gains taxes on small business investment.”

The result of this effervescent, yet evanescent evangelism? Our lawmakers deliberated and subsequently concocted a legislative scheme to incentivize private investment and job creation that lasted all of 100 days.

That’s right. On Sept. 27, 2010, President Obama signed the Small Business Jobs Act that provided for 100% relief from capital gains taxes for investments in qualified startups and small business that are held more than five years.

The exemption expires on Jan. 1, 2011, coincident with capital gains taxes at the highest bracket rising from 15% to 20%.

Most private investors take at least 100 days to evaluate an opportunity. Few angel investors I have spoken with are even aware of the exemption and not a single offering out of a couple of dozen that I evaluated during this period pointed out the perk.

Policy penchants and partisan politics aside, politicians have extolled upon the virtues of no taxes on capital gains for the past 50 years. Prior to his tax cuts, President John Kennedy accurately noted that “the tax on capital gains directly affects investment decisions, the mobility and the flow of risk capital…the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy.” Most of our politicians know intuitively that small business is the primary and most reliable engine of job creation. Irrefutably, two-thirds of net new jobs are created by companies with fewer than 500 employees.

This past August, a research study entitled, “Who Creates Jobs? Small vs. Large vs. Young” further clarified that there is more to the equation than merely size. “Business startups contribute substantially to both gross and net job creation,” says John Haltiwanger, who co-authored the study along with two economists from the Census Bureau, but, “it’s all age—startups are where the job creation really occurs.” Most job creation occurs in the early years of new companies.

Yet, government “stimulus” programs spend more resources attempting to promote bank lending (more of a benefit to existing business) than spurring private investment in risk-taking and entrepreneurialism.

Tactically, our tax policies need to do more today (and certainly beyond this coming Jan. 1) to incentivize angel investors to fund early-stage ventures than presently contemplated by our legislative class.

To its credit, Obama’s Small Business Jobs Act provided investors considering a qualifying venture investment with a significant opportunity as the result of the full 100% capital gains tax moratorium which also excluded 100% of the capital gains from alternative minimum tax (AMT) considerations.

Alas, the three-month window was unconscionable. Moreover, the Act included such archaic prescriptions as a five-year minimum required holding period; requirements that the business be a C-corporation; a greater of 10 times or $10 million cap; and, unnecessarily excluded certain labor-needy business categories such as hotels and restaurants.

In short, the disappearing Jobs Act mirrored the myriad of noncommittal, ill-conceived and insincere initiatives of prior administrations.

Rather, tax policy designed to promote private investment in startups to stimulate job creation and the economy must be meaningful and immutable to the estimated 225,000 angel investors.  

During the economic downturn in the mid-1990s entrepreneurs created 3.8 million new jobs. To encourage more risk-taking by entrepreneurs and to stimulate more individuals to invest in early-stage private ventures, I would propose that;

  • There be no capital gains taxes on investments in early-stage, pre-revenue companies—to encourage more early-stage private investment.
  • Shares of common stock issued to founders and key employees of early-stage companies should be exempt from capital gains taxation—to reward entrepreneurs for their risk-taking and create the currency (stock options) that would encourage entrepreneurial activity.
  • Investors who contribute the first $5 million of equity financing to any new company should get a dollar-for-dollar tax deduction for the year the investment was made—that critical first $5 million is the hardest for any new company to raise.
  • Assuming appropriate disclosure of all of the risks entailed, any investor regardless of their income should be eligible to invest in private ventures—our current securities laws are restrictive and discriminatory.

For these policies to effectively  stimulate sustainable job creation they need to be enacted permanently so that entrepreneurship is embraced by the best and the brightest.

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