Presidents Advisory Panel on Federal Tax Reform

1
Presidents 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

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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
Venture Capital Americas 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)
7
The Increasing Role of Startups in U.S.-Led
Innovation

• Venture backed firms spend twice as much on RD
  as non-venture backed firms
• Share of US RD performed by firms with lt500
  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
Whole New Sectors Have Been CreatedAnd 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

9
The US Venture Industry Has Grown
Source 2004 NVCA Yearbook,/Venture Economics
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• Venture Capital Investing

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The Venture Capital Investment Cycle

• Investment
• Series A, B, C Preferred Stock
• Expansion, Pre-IPO Capital
• Use of Proceeds
• RD, Product Development
• Expansion of Sales Force
• Realization
• MA, IPO
• Valuation Metrics
• Price/Net Income Ratio
• Price/Revenue Ratio (More Prevalent in Late 1990s
  Bubble)
• Control Premium to Shareholders (in MA
  Transactions)

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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, MA 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

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• Suggestions for Tax Policy

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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

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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

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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

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• www.nvca.org