5 ms·

Dilution vs. Risk taking: Capital gains taxes and entrepreneurs

56 points by hhs 11mo ago

only-one1701 11mo ago
Waiting for the comments to roll in so I can see if most hackernews commenters view themselves on team Exception or team Rule.
- ares623 11mo ago
  It’s a useful lagging indicator. Most here still think they have a shot at being the next unicorn like in the ZIRP era.
- Nevermark 11mo ago
  I have worked about half time over three decades on a problem which I recently solved and am developing for a new venture. "Simple" conceptual solution - which took a long trail of reframing to get to. The complete solution is a layered series (actually a cycle) of partial solutions. Each partial solution except one from fields I never expected to be involved. Lots of work left to implement well, but this is the "easy" part. Getting taxed on any increases in value early would feel very unfair. I have already put in so much value, for nothing in liquid/credible valuation yet, that things would have to go very well to compare equitably with what could sensibly have been expected if I had accrued half-time earnings, continuously saving and investing that income in its entirety, for over three decades. Further worries: If I don't want to accept any venture capital, and at least for the foreseeable future bootstrap, would I somehow be forced into needing to liquidate ownership based on some accrued wealth rule anyway? Hopefully not. But if capital raises are the trigger for accrued wealth taxes, even a small raise after bootstrapped success gets ugly. Imagine raising capital after achieving bootstrapped success, by selling 1%, only to have to pay taxes on 99% of the company's new valuation! That would create a severe disincentive to take any capital ever, after bootstrapped success. My suggestion: Only tax valuation gains on the sold shares. The realized valuation gain on capital raising shares passes (indirectly) to owners. The realized gains on any owners shares sold to cover those taxes would also pass (directly) to owners, as usual. That would bring corporate capital raises into exact tax parity with normal owner stock sales. The only difference is practical: The cash from an indirect sale (capital raise), goes to the owners indirectly (into the company), and is taxed indirectly (pass through). The cash from a direct sale (same sale percentage, but by each owner independently), goes directly to the owners, and taxes are assigned directly. Either way, taxes are now identical. (A third case, where all owners sell the same percentage of stock, and agree to all inject the funds into the company, might be a circuitous way to operate, but again, taxes are identical. Taxes on realized gains become sale path and cash purpose neutral.)
- deleted 11mo ago
  [deleted]
- fragmede 11mo ago
  I'm on team "I wanna get rich" and also team "I want you to get rich". I'm also on team "I'm a programmer and not a CPA and definitely not your CPA". I pay a money person so I don't have to deal with this stuff because it's not interesting to me, but for those who do find it interesting, game on! I will say though, that the most important thing someone ever pointed out to me was 100% of $0 is $0. Even just 65% of $really big number is still > $0
- ikiris 11mo ago
  Everyone's on team "temporarily embarrassed billionaire founder"
dshuang 11mo ago
Doesn't seem fair to tax someone on appreciated stock if they haven't sold and haven't taken any loans against it.
- odie5533 11mo ago
  The taxes would be refundable.
  - anonymousiam 11mo ago
    Would they pay interest?
  - ENGNR 11mo ago
    How does that work in practice? If you're bootstrapped, borrow a bunch of money to pay tax because your company got to $10M val. But then the market shifts and it goes back down to $0 in later years, do you get the money back? Even if you do, it sounds weird taxing someone for the right to create something, especially when they're still in the middle of creating it.
    - jjmarr 11mo ago
      Yes, you do get the money back, that's the point of the paper. This is better for many founders that otherwise wouldn't cash out at all. VCs will be forced to cover your unrealized capital gains taxes.
  - robocat 11mo ago
    Refundable taxes are often gamed? See Cum-Ex: Dividend Withholding Tax (WHT) Fraud and Missing Trader Intra-Community (MTIC) Fraud.
- NewJazz 11mo ago
  Yeah I'm in favor of leverage == taxable event. I think the meaningful difference between leveraged and unleveraged capital gains is that when you take a loan, you access liquidity via your ownership in the asset. If you had gotten a dividend, that would have been taxable. A loan with a stock backing it isn't the same thing, but it does have a somewhat similar effect.
ur-whale 11mo ago
Quite funny that half of the team who wrote this hail from Switzerland, a country where there are no taxes on realized capital gains, much less unrealized ones.
- greyw 11mo ago
  Switzerland has a wealth tax. That is a tax on unrealized gains fyi.
  - Pooge 11mo ago
    No, because they are not exactly correlated with your gains. For what it's worth, you could have an unrealized deficit but still owe taxes. That's why it's a wealth tax and not unrealized gains tax. Real estate is included in that wealth, of course. And it has a different tax treatment than "usual" stock market gains.
  - ur-whale 11mo ago
    > Switzerland has a wealth tax. If the wealth tax rate is close to zero, who the hell cares? The wealth tax in e.g. Kanton Zürich is 0.025% (not the cheapest Kanton). If you are able to grow your capital at - say - inflation corrected 4%, which shouldn't be overly hard, and you pay no taxes whatsoever on cap gains while paying 0.025% on the total accumulated wealth. I'll let you do the math as to how good you have it there.
    - greyw 11mo ago
      The highest marginal wealth tax rate in Zurich is 0.47% and 0.9% in Geneva starting at 2-3mn CHF. It's not irrelevant at all If you now earn 4% on your capital and pay 0.9% wealth taxes that is like a 25% tax rate on your unrealized gains. Inflation is close to zero anyway and interest rates are negative. Obviously I prefer that system because we can compound essentially tax free to a couple of 100k before having to think about taxes.
- lambchoppers 11mo ago
  Sure but tax on wealth is a tax on the integral of gains and trying to imagine a tax only on realized wealth seems like it would interest Switzerland but is difficult with real estate and stock markets.
jjmarr 11mo ago
The paper spots that this pseudo-wealth tax would be better for more founders. > Moving from current realization-based to accrual-based taxation would reduce founder ownership at exit by 25% on average but would also increase the fraction receiving positive payoffs from 16% to 47% when tax credits are refunded. Founders would use VC money to pay the tax and get a refund if the startup fails, since the capital gains were never realized. Therefore "pre-paying" capital gains would be a good thing for most founders since otherwise a liquidity event wouldn't happen for 84% of them. This only happens with a tax on unrealized capital gains, though, not a normal wealth tax. Another corollary is that "zombie startups" would be heavily discouraged, since "failing fast" could result in a payout.
- NewJazz 11mo ago
  It is basically forcing them to dilute more, which is better for them on average because the shares expire worthless so often anyway. That said a higher percentage of positive outcomes does not mean much when the majority of significant wealth is in that small percentage of high value firms founded.
  - skybrian 11mo ago
    That's how progressive taxes work? It's generally considered a better outcome when the taxes are paid by people who can more easily afford them.
  - jjmarr 11mo ago
    > It is basically forcing them to dilute more, which is better for them on average because the shares expire worthless so often anyway. Well no, because VCs might not give you money to buy chunks of the business as they want the money to go into the business. An unrealized capital gains tax forces VCs to give founders money during funding rounds to cover taxes, money that is refunded to the founder in the event of the business going under. This means you no longer lose everything in an unsuccessful exit, because you get a refund on the capital gains that you didn't end up having.
    - 11mo ago
hexeater 11mo ago
The conversations around taxation and gov finance in the USA are absolutely delulu. I'm in California. Not including sales and property taxes, high earners are paying over 50% in taxes. Whereas the overall expenditures are unsustainable and in many cases just not working anyway. Notable examples are that we are paying more in Interest than for military at the federal level, and we are burning cash on failed homeless policies without any hope of actual change. Any rational conversation has to cut spending.
- reppap 11mo ago
  > Notable examples are that we are paying more in Interest than for military at the federal level, It is interesting to me that the party that runs on fiscal responsibility is the one that runs the highest deficits despite having a lower amount of GDP growth.
- NewJazz 11mo ago
  And revenue, right?
- mimir 11mo ago
  100%, This is the uncomfortable fact of taxes in the US right now. If you are a high earning W2 worker, you are likely paying close to if not above 50% income tax rate. Pretty much on par with all the "high tax" European socialist countries you always hear people complaining about. There is basically no good way to lower this w2 tax burden. I'm generally a "liberal" and support fair taxation and goverment spending, but the current level, based on the worldwide tax rates I've found, doesn't have much room to grow, especially when it does seem like goverment services are actually supbpar for many, and these taxes don't support some sort of universal health care/cheap university like they do in many European countries. I truly believe that goverment can and should be a force for good in people's lives, but I don't think that means we should give it a blank check. It does feel delulu that so many democrats seems to blindly support raising taxes on the "rich". I do think a wealth tax is very much the wrong approach. It's pretty frustrating to when folks talk about taxing the rich, since it seems like the policies that get passed often just add even more burden onto the "working" rich vs the capital based rich. Even the long terms capital gains rate is close to 30+% in high tax states + top bracket, but there is way more room for deductions.
Todd 11mo ago
An alternative is graduated capital gains rates based on total assets owned (ideally skewed higher, like 10, 50, 100MM, …). Exemptions like QSBS could still be applied. This would allow shareholder control issues to remain unaffected, which wealth taxes never seem to address. Not sure how to apply it on the corporate side. There are also multi entity workarounds to consider. Just an idea.
- phil21 11mo ago
  I’ve always been of the opinion tax brackets should be “lifetime earnings” based regardless of income source. Your first $1M should be taxed differently than your next $10M and so forth.
ashu1461 11mo ago
This theory seems to be BS, If let us say a founder is raising a seed round of 2m at 20m valuation, then according to hypothetical accrual tax rate, they would need to pay a tax of ~ 3-4m.
bix6 11mo ago
> Using comprehensive new data on U.S. venture capital deals, we find that founder returns remain extremely skewed, with 84% receiving zero exit value while the top 2% capture 80% of total value. Where is this data from?

56 points by hhs 11mo ago

Waiting for the comments to roll in so I can see if most hackernews commenters view themselves on team Exception or team Rule.

ares623 11mo ago
It’s a useful lagging indicator. Most here still think they have a shot at being the next unicorn like in the ZIRP era.
Nevermark 11mo ago
I have worked about half time over three decades on a problem which I recently solved and am developing for a new venture. "Simple" conceptual solution - which took a long trail of reframing to get to. The complete solution is a layered series (actually a cycle) of partial solutions. Each partial solution except one from fields I never expected to be involved. Lots of work left to implement well, but this is the "easy" part. Getting taxed on any increases in value early would feel very unfair. I have already put in so much value, for nothing in liquid/credible valuation yet, that things would have to go very well to compare equitably with what could sensibly have been expected if I had accrued half-time earnings, continuously saving and investing that income in its entirety, for over three decades. Further worries: If I don't want to accept any venture capital, and at least for the foreseeable future bootstrap, would I somehow be forced into needing to liquidate ownership based on some accrued wealth rule anyway? Hopefully not. But if capital raises are the trigger for accrued wealth taxes, even a small raise after bootstrapped success gets ugly. Imagine raising capital after achieving bootstrapped success, by selling 1%, only to have to pay taxes on 99% of the company's new valuation! That would create a severe disincentive to take any capital ever, after bootstrapped success. My suggestion: Only tax valuation gains on the sold shares. The realized valuation gain on capital raising shares passes (indirectly) to owners. The realized gains on any owners shares sold to cover those taxes would also pass (directly) to owners, as usual. That would bring corporate capital raises into exact tax parity with normal owner stock sales. The only difference is practical: The cash from an indirect sale (capital raise), goes to the owners indirectly (into the company), and is taxed indirectly (pass through). The cash from a direct sale (same sale percentage, but by each owner independently), goes directly to the owners, and taxes are assigned directly. Either way, taxes are now identical. (A third case, where all owners sell the same percentage of stock, and agree to all inject the funds into the company, might be a circuitous way to operate, but again, taxes are identical. Taxes on realized gains become sale path and cash purpose neutral.)
deleted 11mo ago
[deleted]
fragmede 11mo ago
I'm on team "I wanna get rich" and also team "I want you to get rich". I'm also on team "I'm a programmer and not a CPA and definitely not your CPA". I pay a money person so I don't have to deal with this stuff because it's not interesting to me, but for those who do find it interesting, game on! I will say though, that the most important thing someone ever pointed out to me was 100% of $0 is $0. Even just 65% of $really big number is still > $0
ikiris 11mo ago
Everyone's on team "temporarily embarrassed billionaire founder"

dshuang 11mo ago

Doesn't seem fair to tax someone on appreciated stock if they haven't sold and haven't taken any loans against it.

odie5533 11mo ago
The taxes would be refundable.
- anonymousiam 11mo ago
  Would they pay interest?
- ENGNR 11mo ago
  How does that work in practice? If you're bootstrapped, borrow a bunch of money to pay tax because your company got to $10M val. But then the market shifts and it goes back down to $0 in later years, do you get the money back? Even if you do, it sounds weird taxing someone for the right to create something, especially when they're still in the middle of creating it.
  - jjmarr 11mo ago
    Yes, you do get the money back, that's the point of the paper. This is better for many founders that otherwise wouldn't cash out at all. VCs will be forced to cover your unrealized capital gains taxes.
- robocat 11mo ago
  Refundable taxes are often gamed? See Cum-Ex: Dividend Withholding Tax (WHT) Fraud and Missing Trader Intra-Community (MTIC) Fraud.
NewJazz 11mo ago
Yeah I'm in favor of leverage == taxable event. I think the meaningful difference between leveraged and unleveraged capital gains is that when you take a loan, you access liquidity via your ownership in the asset. If you had gotten a dividend, that would have been taxable. A loan with a stock backing it isn't the same thing, but it does have a somewhat similar effect.

ur-whale 11mo ago

Quite funny that half of the team who wrote this hail from Switzerland, a country where there are no taxes on realized capital gains, much less unrealized ones.

greyw 11mo ago
Switzerland has a wealth tax. That is a tax on unrealized gains fyi.
- Pooge 11mo ago
  No, because they are not exactly correlated with your gains. For what it's worth, you could have an unrealized deficit but still owe taxes. That's why it's a wealth tax and not unrealized gains tax. Real estate is included in that wealth, of course. And it has a different tax treatment than "usual" stock market gains.
- ur-whale 11mo ago
  > Switzerland has a wealth tax. If the wealth tax rate is close to zero, who the hell cares? The wealth tax in e.g. Kanton Zürich is 0.025% (not the cheapest Kanton). If you are able to grow your capital at - say - inflation corrected 4%, which shouldn't be overly hard, and you pay no taxes whatsoever on cap gains while paying 0.025% on the total accumulated wealth. I'll let you do the math as to how good you have it there.
  - greyw 11mo ago
    The highest marginal wealth tax rate in Zurich is 0.47% and 0.9% in Geneva starting at 2-3mn CHF. It's not irrelevant at all If you now earn 4% on your capital and pay 0.9% wealth taxes that is like a 25% tax rate on your unrealized gains. Inflation is close to zero anyway and interest rates are negative. Obviously I prefer that system because we can compound essentially tax free to a couple of 100k before having to think about taxes.
lambchoppers 11mo ago
Sure but tax on wealth is a tax on the integral of gains and trying to imagine a tax only on realized wealth seems like it would interest Switzerland but is difficult with real estate and stock markets.

jjmarr 11mo ago

The paper spots that this pseudo-wealth tax would be better for more founders. > Moving from current realization-based to accrual-based taxation would reduce founder ownership at exit by 25% on average but would also increase the fraction receiving positive payoffs from 16% to 47% when tax credits are refunded. Founders would use VC money to pay the tax and get a refund if the startup fails, since the capital gains were never realized. Therefore "pre-paying" capital gains would be a good thing for most founders since otherwise a liquidity event wouldn't happen for 84% of them. This only happens with a tax on unrealized capital gains, though, not a normal wealth tax. Another corollary is that "zombie startups" would be heavily discouraged, since "failing fast" could result in a payout.

NewJazz 11mo ago
It is basically forcing them to dilute more, which is better for them on average because the shares expire worthless so often anyway. That said a higher percentage of positive outcomes does not mean much when the majority of significant wealth is in that small percentage of high value firms founded.
- skybrian 11mo ago
  That's how progressive taxes work? It's generally considered a better outcome when the taxes are paid by people who can more easily afford them.
- jjmarr 11mo ago
  > It is basically forcing them to dilute more, which is better for them on average because the shares expire worthless so often anyway. Well no, because VCs might not give you money to buy chunks of the business as they want the money to go into the business. An unrealized capital gains tax forces VCs to give founders money during funding rounds to cover taxes, money that is refunded to the founder in the event of the business going under. This means you no longer lose everything in an unsuccessful exit, because you get a refund on the capital gains that you didn't end up having.
  - 11mo ago

hexeater 11mo ago

The conversations around taxation and gov finance in the USA are absolutely delulu. I'm in California. Not including sales and property taxes, high earners are paying over 50% in taxes. Whereas the overall expenditures are unsustainable and in many cases just not working anyway. Notable examples are that we are paying more in Interest than for military at the federal level, and we are burning cash on failed homeless policies without any hope of actual change. Any rational conversation has to cut spending.

reppap 11mo ago
> Notable examples are that we are paying more in Interest than for military at the federal level, It is interesting to me that the party that runs on fiscal responsibility is the one that runs the highest deficits despite having a lower amount of GDP growth.
NewJazz 11mo ago
And revenue, right?
mimir 11mo ago
100%, This is the uncomfortable fact of taxes in the US right now. If you are a high earning W2 worker, you are likely paying close to if not above 50% income tax rate. Pretty much on par with all the "high tax" European socialist countries you always hear people complaining about. There is basically no good way to lower this w2 tax burden. I'm generally a "liberal" and support fair taxation and goverment spending, but the current level, based on the worldwide tax rates I've found, doesn't have much room to grow, especially when it does seem like goverment services are actually supbpar for many, and these taxes don't support some sort of universal health care/cheap university like they do in many European countries. I truly believe that goverment can and should be a force for good in people's lives, but I don't think that means we should give it a blank check. It does feel delulu that so many democrats seems to blindly support raising taxes on the "rich". I do think a wealth tax is very much the wrong approach. It's pretty frustrating to when folks talk about taxing the rich, since it seems like the policies that get passed often just add even more burden onto the "working" rich vs the capital based rich. Even the long terms capital gains rate is close to 30+% in high tax states + top bracket, but there is way more room for deductions.

Todd 11mo ago

An alternative is graduated capital gains rates based on total assets owned (ideally skewed higher, like 10, 50, 100MM, …). Exemptions like QSBS could still be applied. This would allow shareholder control issues to remain unaffected, which wealth taxes never seem to address. Not sure how to apply it on the corporate side. There are also multi entity workarounds to consider. Just an idea.

phil21 11mo ago
I’ve always been of the opinion tax brackets should be “lifetime earnings” based regardless of income source. Your first $1M should be taxed differently than your next $10M and so forth.

ashu1461 11mo ago

This theory seems to be BS, If let us say a founder is raising a seed round of 2m at 20m valuation, then according to hypothetical accrual tax rate, they would need to pay a tax of ~ 3-4m.

bix6 11mo ago

> Using comprehensive new data on U.S. venture capital deals, we find that founder returns remain extremely skewed, with 84% receiving zero exit value while the top 2% capture 80% of total value. Where is this data from?