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President Biden is increasingly unlikely to get his corporate or individual tax hikes, at least without reconciliation, and most venture capital firms are keeping their fingers crossed instead of prepping tax avoidance strategies.
Behind the scenes: VC lawyers and CFOs have spent the past couple of months discussing new fund structures that could offset the elimination of carried interest's beneficial tax treatment, as proposed last month by the U.S. Treasury Department.
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The most popular suggestion is to create special purpose vehicles for a fund's nonmarketable securities, contributed in-kind via general partners, thus effectively locking in the carried interest.
This would essentially be a tax deferral scheme, with the hope that a future president would reverse the carried interest move and/or lower capital gains rates.
But this is a big ask of limited partners, which is why VC firms are doing more talk than action. It involves added audit risk, new clawback complications and the potential of distributing nonmarketable securities to LPs (who are paying GPs to do that job).
In the spotlight: A lot of this came to light after a recent Bloomberg story that Sequoia Capital asked its LPs to make two key changes to existing fund structures, including the movement of nonmarketable and marketable securities into an SPV. As one fund formation lawyer told me: “That story caused a lot of firms to call us, but it caused a lot of firms who were thinking about this to walk away… It was like a giant flashing light for the IRS.”
I’m confused about the story’s argument that Sequoia’s rationale is to lock in 2021-era carried interest rules. Again, this seems more about tax deferral rather than acceleration. Were Sequoia to want to tie in 2021 rules, why also include marketable securities (companies like Airbnb and Unity) in the SPV, rather than just distribute those now?
It appears Sequoia is viewing this as the first step toward a massive overhaul of its entire fund structure – one source called it a “radical” plan – which is set to be unveiled in Q4 or Q1 2022. Long-term tax strategy may be a factor, but short-term tax strategy doesn’t seem to be.
Sequoia isn’t commenting, but my understanding is that its limited partners have already approved the changes (despite not knowing the master plan, which is a fiduciary duty-scratching display of faith).
Word also is that if Sequoia does get audited, the firm’s partners will cover that expense, rather than passing it onto LPs via management fee income.
The bottom line: Sequoia, per usual, is one step ahead of most of its peers. But they may not be running the same sort of race.
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