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Stimulus Package For Entrepreneurs?

Posted on Wednesday, Feb 18th 2009

I wrote a Forbes column before the elections called Stimulus Package For Entrepreneurs. As we have started discussing bootstrapping as a weapon for mass reconstruction, we should also revisit the tax policy and stimulus issues. Here are the nuggets.

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My very strong recommendation to entrepreneurs is to learn the tricks of bootstrapped entrepreneurship so that they can keep maximum control over their destiny. This recommendation assumes that entrepreneurs would be putting their savings into their ventures. Thus, we need a tax policy that makes it as attractive as possible for entrepreneurs to “invest” in their own ventures, especially at the early stages.

For example, an aspiring entrepreneur ought to be allowed to create a tax-free pool of income for use as personal venture capital. Such a pool of capital would go a long way to help kick-start new ventures.

The next constituency is angel investors. These days, traditional venture capitalists hardly participate in early stage investments. The bulk of the responsibility of early stage investment is shouldered by angels, who are usually not the Bill Gates and Warren Buffetts of the world. More often than not, an angel turns out to be the entrepreneur’s uncle, who is a doctor making $400,000 a year and can afford to invest in the nephew’s audacious dream and unproven idea.

The misconception that the angels are the very rich people worth hundreds of millions leads people to think that these guys would invest anyway, tax or not. But most entrepreneurs–especially first-time entrepreneurs–don’t have access to such high net-worth people.

Thus, the government should be very careful how these $400,000-a-year uncles are treated from a tax policy point of view. The choice may well be between $250,000 being invested in a start-up, versus that $250,000 going into the government’s pocket as income tax.

Angels should also be allowed to create pools of tax-free capital for investing in start-ups–especially in unknown, unproven entrepreneurs who often don’t have access to venture capital. It is not so different from a tax-free account set aside for a child’s education. It is also similar to allocating money to “foundations” to fund nonprofit “causes.”

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Let’s discuss.

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Sramana:

If I read this right, you are suggesting that I should be able to put away a pool, say 100K for investing in startups and not pay taxes on what I put into this pool. Now if I invest this 100K and lose it will I still get to take it as a loss on my taxes?

Jagdambha Bilasia Wednesday, February 18, 2009 at 4:56 PM PT

Yes, that’s what I am suggesting. To create a conditional incentive to have entrepreneurs and investors start/fund more companies.

But no, I don’t think it makes sense to allow you to write that off on your taxes again, right? You got to already take the tax right-off in the beginning, can’t get it twice.

If you make money, on the other hand, you pay regular capital gains taxes on your investment.

But the government has just given you an incentive to invest in / start a company by offering you free cash flow which you’d otherwise be paying as income tax.

Sramana Mitra Wednesday, February 18, 2009 at 5:28 PM PT

You are right that I get the tax right off earlier rather than when I lose the money. This is something but probably not a big win for the rich uncle.

On the other hand if I make money I get a tax write off on the 100K and then I pay taxes only my gains so I do come out ahead. This is more of a win as I just got 100K of income, tax free.

Today you are allowed to roll over gains from a small business into another small biz and defer taxes. Under your plan would these taxes be eliminated?

So if I invest 100K in company 1, I write that off my taxes. Company 1 is a success and my investment returns 300K. Now I invest 300K into company 2. So can I write off 300K from my taxes? Now if company 2 returns 700K. I just pay taxes on 400K. Which means that I got 400K tax free and 400k on which I pay cap gains.

Jagdambha Bilasia Wednesday, February 18, 2009 at 6:16 PM PT

Not necessarily. I think you are thinking of the professional Angel investor category. A lot of first-time entrepreneurs are funding businesses out of their own pockets, or their rich uncle’s post-income-tax (not post-capital gains tax) money.

That’s the pool I am trying to unlock.

Professional Angel investors have the incentive you mention above.

Sramana Mitra Wednesday, February 18, 2009 at 8:01 PM PT

Agreed 100%. The idea creates jobs, but primarily opens the doors to future and better technologies and companies ran by people who are fitting to stay alive, thus producing the best product-technology outcome they could generate.
Tax the future of their fruits, not their roots of birth.

Frank Friday, February 20, 2009 at 7:36 AM PT

great ideas here. i’m the entreprenuer working with my “rich uncle” to get my audacious, unproven dream off the ground. honestly, i can say that bootstrapping is the only way to do it. SO MUCH can get done on a MINISCULE budget, it’s rediculous. just have to watch what you spend your money on. just so you know there IS a tax incentive for being an entrepreneur: “expenditure write off of income”–i.e. writing down your income liabilities as a result of operational costs. it may not be as glamorous as what you’re suggesting but it’s always been a reason for me to get started on my own businesses. “corp directive to pay for my housing as a stipend for work.” = “rent paid by the company but written off as a business expense.” pretty sweet deal. can do it for all kinds of things, insurance, car, internet, etc. just have to be creative–something all entrepreneurs are good at anyway! 🙂

james Friday, February 20, 2009 at 12:35 PM PT

Sramona,
I think you and Friedman have terrific ideas. How can this
get more publicity so it gets attention of Obama. I am
sure he would go for it.
Also I would mention on Global Warming that web video
conferencing needs more publicity because for years it has saved tons of CO2 and is cheap now and could be applied world wide right now.

john lynch Monday, February 23, 2009 at 11:36 AM PT

The best policy is not special favors but an efficient system for everyone. That would be to reduce income taxes for all and replace them with pollution charges (instead of cap and trade) and a national tax on the rent or value of land. A tax on land value would be a fixed cost, with a zero tax on any additional profits or investment returns. See my booklet
“The Ultimate Tax Reform”.

Fred Foldvary Friday, February 27, 2009 at 4:29 AM PT

The goal: Stabilize the housing market and stimulate the economy without bankrupting the country.

The solution: Due to the collapse of the financial system, everyone is fleeing to safe investments. The Government can now fund its debt by paying 2% interest. It should continue to borrow as much as it can and then lend that money to QUALIFIED new and existing home owners to allow them to buy or refinance property at a rate of about 4%. The Government actually makes money in this deal; the housing market stops its free fall in most places, and millions of homeowners have thousands more in their pockets each month to stimulate the economy. Congress does not get to pick the economic winners and losers or hand out goodies. The market decides how the stimulus is spent. The impact is felt immediately. Future generations are not left holding the tab.

LAurin Mills Friday, February 27, 2009 at 6:40 AM PT

Your take is right on. In a city like Roanoke, Virginia we cannot compete with larger metro. I see our long-term prosperity will be a result of our entrepreneurial spirit. Small micro-businesses must form and it’s about numbers…

We currently have an incentive program to get more business started as a pilot. We are working out the kinks, but I am hopeful it will be mainstay.

Additionally, we are working on an idea of creating an incentive to graduate college students (we have 60,000 in a 50 mile radius) and offering them a package of tangible and non-tangible incentives to move to Roanoke, setup a business and work on making it grow. It’s programs like this that’s needed now for the long-term prosperity of a region like Roanoke, Virginia

Stuart Mease Friday, February 27, 2009 at 6:49 AM PT

Dear Mitra:
I am thrilled to receive your email and am captivated by the concept. More than once, I’ve commented, “Well if you ask me…,” but nobody does, until now.
I have spent nearly 40 years intimately involved in small business entrepreneurship. I have worked in it, consulted on it and have been published on it. I have serious words about any Stimulus Package for Entrepreneurs.

First…
Entrepreneurship is the ultimate expression of the manifestation of ideas. To encourage the conversion of thought into entrepreneurial concepts, and then into a viable business model, there needs to be a platform to launch. Success will be dependent on resources available to non-business professional who take a leap of faith to follow their dream, but lack the toolbox to succeed. This is where the stimulus package needs to fund an increase to the small business technical service providers at the Small Business Development Centers. As the most effective, efficient and responsive use of taxpayer dollars, the SBDC continues to meet the need of start enterprises, hands down. The government should add $68M to the SBA budget specifically to fund Certified Business Advisers nationwide to ensure the best possible outcome of any venture attempt. Otherwise, retirement money, savings and loans could be jeopardized. Inexperienced would be entrepreneurs lack understanding of the business start-up journey. Providing free and confidential counseling, as SBDCs do now, ensures a safer approach to the start-up. Business plan development, cash flow projections, etc…

Next, understand that baby-boomers will experience the largest transfer of wealth in the history of the country as the Bob-Hope generation expires and wills their savings since the depression , to their children. Imagine if that wealth could be utilized to fund new venture, tech transfer or expansion. Providing a tax exemption on any capital gains from private investment for economic stimulus. Here’s how it could work.
Aunt Sarah, Uncle Jim and Sister Sally have money in the bank. Grandson Joshua wants to open an IT Audit and consulting business in California. Joshua and his relatives establish a joint certificate of deposit at a local (not N.A.) community bank.
Aunt Sarah $50,000
Uncle Jim $20,000
Sister Sally $30,000
Aggregate of the Certificate of Deposit $100,000. The Interest rate is 6.25% for five years. The CoD then is used as cash collateral for a business loan to Joushua from the bank to start the business. This releaves preassure on the SBA to guarantee all the start-up loans which are complicated.

Joshua establishes a Limited Liability company with his relatives as members, he puts the equivalent of three loan payments on deposit with the bank as back up, agrees to use the SBDC for support, education and guidance, and agrees to set up the BAIL team, Banker, Accountant, Insurance, Legal professional, as an advisory board.

In return, none of the interest in these transactions are taxed. The bank does not pay tax on the interest revenue and the relatives don’t pay tax on the interest earned. Safeguards are built in. If Joshua can’t make a loan payment one month because of slow sales, the bank automatically deducts it from his savings. If the venture fails within three years, (on or before 36 months) all interest becomes taxable, unless reinvested. This holds Joshua accountable to the members of the LLC, (the family), the bank is secured from default at 100% of Loan value, and it productively puts resources to work to stimulate the economy with minimal government intervention.

America needs to get government out of the capital system. Karl Marx has no place here. Much of the financial crisis is due to the Community Reinvestment Act that required banks to make mortgage and small business loans to people who had no business receiving those loans. When government holds a gun to the head of the banks, disaster is sure to follow. Let Americans have their role in this recovery as we have during previous times of economic challenges.

Other small business initiatives should include exemption on sales tax for any business books on start-up, expansion or advice. This will stimulate the best professional to get busy on producing viable learning tools. SBA should sponsor speakers for new business owners and only charge $10.00 per person. People like Jim Collins, Michael E. Gerber, and people like Laurie Joslin, a corporate trainer who moves mountains, should be assembled to speak on what breeds success in small business. Fund learning and proficiency.

I have more, but won’t impose.
Thank you for sending me this email.
Wishing you success and prosperity always,
Gina Marie Mangiamele
Author: Streetwise, Start Your Own Business Workbook; Adams Media Incorporated, 2002

Gina Marie Mangiamele Friday, February 27, 2009 at 7:22 AM PT

Sramana Mitra

If I understand correctly your proposal is that an angel would be able to tax shelter money that was invested in a start up firm in a vehicle analogous to a 401k. Presumably, any returns would be taxed as ordinary income, again analogous to a 401k.

For this to be practical there would need to be a uniform and easily recognized legal definition of ‘start up’ that could be approved by the IRS. I recommend that you keep this as simple as possible to start.

I agree that we need to find ways of funneling money into the growth plate of the economy but I’m not sure why we should discriminate against established firms who have innovative ideas. I am also not sure that the already obscenely complicated tax code needs an additional tweak. The biggest problem will be in selling this idea to an ultra liberal Obama administration. For him the choice between $250,000 in tax revenues or the same amount invested in a start up firm is a no-brainer. Take the tax revenues. But Obama will find it increasingly difficult to explain the continuing recession as his administration progresses so it is possible that he may become so desperate that he is willing to look for ways to grow the economy the rely on private sector initiatives.

Mark Bayless Friday, February 27, 2009 at 7:30 AM PT

THIS IS A GREAT IDEA. TAXPAYERS FUND A “VENTURE CAPITAL FUND” WITH CEO AND EXECUTIVE COMMITTEE COMPRISED OF WELL-KNOWN SENIOR ENTREPRENEURS AND PAUL VOLKER FOR THE PUBLIC.

JOHN A HASLEM Friday, February 27, 2009 at 10:11 AM PT

Speaking from experience trying to run my own startup venture through bootstrapping, I would say that a big “non value added” time sink is due to the number of complex forms that have to be filed with various government agencies, federal, state and local. So my suggestion is SIMPLICATION of (tax) regulations across the board, for startup ventures, and also for large companies as well as individuals. If changing tax incentives leads to simpler forms, less forms, to be filed less often, I’m all for it. Both the government and my company would be better off if taxes went up a bit and if it would cost me less time to deal with all the forms, filings, appeals, etc. I could then redirect the hours saved to more useful purposes such as improving my services, business development, etc.

Gezinus Hidding Friday, February 27, 2009 at 10:43 AM PT

Nice idea indeed! Why not allow individuals to put into venture fund – tax free – each month? This fund can be managed by professionals just like mutual fund. This is akin to 401K but meant for start-up only. That way people who earn even $50K a year can participate. Collectively this amount can be large enough and lets everyone participate. As structured only rich people can participate in this endeavor.

P. Dev Friday, February 27, 2009 at 12:04 PM PT

I like the concept, but tax laws are already over-complicated, and badly ‘abused’ by the wealthiest individuals who can afford to spend time or tax accounting money to get the tax breaks. For all the good this change would do, it could also lead to further abuses. Oversight on this change could be too expensive to manage – I could easily see new ‘travel’ start-ups that are really just tax-free vacations that ‘fail’ as start-ups. Tax law needs simplification, not further complexity.

If you invest as a start-up and it fails, you get a tax break already. If it succeeds, the gain is your upside. No further incentives are needed from a tax standpoint.

If you still want to do this, make sure it makes economic sense for the entire system, considering the cost of the change/management of the tax code and the cost of proper oversight/policing against the benefits to the boost in venture investing. A good proposal should address and quantify potential negatives as well – the lack of such an effort in your proposal above seems to indicate you haven’t thought through all the implications – or worse, you have considered these issues, and are presenting only the positives without the negatives, which results in a biased presentation lacking transparency.

I do like the creative thinking, so keep it up. But let’s get some destructive creation too – remove some of the tax clutter before building on top of the current mess.

-Norris

Norris Boothe Friday, February 27, 2009 at 12:41 PM PT

If we really want to help entrepreneurs, then focus taxes (which only de-stimulate) on the end product and leave the front-end effort of the entrepreneurs alone. This can be done easily by establishing a Federal sales tax that would eliminate the need for all income taxes (personal and business).

Marc Schniederjans Saturday, February 28, 2009 at 4:04 AM PT

Your proposal is very interesting on several levels. I do like the idea of being able to setup a personal investment fund for the following reasons — dramatically lowers my gross adjusted income hopefully below the soon to be infamous $250k level (a tax savings there), makes it so that people are more self-responsible and less dependant on the government and keeps money out of the government hands so they can not take from one of the various “lock boxes” aka Social security, Medicare, etc which all seem to have skeletons made available to politicians as soon as they get to Washington DC. If the venture invested in, made money the income should be taxed at the long-term/short-term capital gains rate not ordinary income based on the length of the investment.

The downside is that the Obama would never go for empowering the individual as it clearly goes against his wealth redistribution/socialist view point. You would have to paint this in such a way to make it seem like it is right to every person such as healthcare. Also, you have to make it look like Obama came up with the idea. He clearly does not tolerate any outside thinking or suggestions but if he “came up with the idea” he would mandate and no one would be able to stop it. Economics can be used with Obama as his actions have clearly shown that he is against capitalism and self-determination.

Nodens Sunday, March 1, 2009 at 4:06 AM PT

Other ideas:
1) SBA — have money put into these programs by the government and make more loans available to businesses. If the governemnt is going to take more money, then try to divert more of it to programs that would be useful to entrepreneurs vs. typical government programs/social engineering efforts

2) Get increased tax credits put into the code for home offices — rational is that telicommuting is more “green” / lower carbon footprint, make it less likely for an audit / hassle from the IRS for having a home office.

3) Push for tax credits to a business when they install solar panels, wind power (renewable energy) — this is very good in combination with a home office tax incentive.

4) Lower Social security withholding in favor of the money going into a 401k or simple plan instead. The goal is to keep more money and be able to control it vs. having it get stolen , never to be seen again like social security withdrawl.

5) Corporate tax credit for contributions to medical savings plan for employees — if Obama wants to go after manditory healthcare, then you need to set up some way to reduce the amount of money going to the government for it while providing the cash for your employees to get healthcare outside the soon to be nationalized healthcare disaster.

As you can see, I am a strong advocate of personal responsibility and avoiding giving the government any money when possible in the cases where they are going to hold on to money for my protection — just look at social security, medicare, medicad, etc. The government does very few thing well if half decently (such as a standing military), so the less money they can play with the better for everyone involved (assuming you are actually working for a living vs. being a sponge on society).

Nodens Sunday, March 1, 2009 at 4:24 AM PT

Srmana —

I very much applaud the spirit of your thinking. If we are hoping to create more permanent, long-term jobs (not the shorter-term “fix bridges and roads” jobs) and help to improve productivity, we need to invest in innovation.

One way to help motivate investment from angels and VCs might be to create a “long-term capital gains tax holiday” if you invest in a small business. Right now, there is alot of cash on the sidelines, looking for a place that can generate decent returns, and it would be helpful if there were incentives to put that money to work in funding the next great innovation. Instead, Washington is looking at increasing the taxes on VC carried interest, which creates a disincentive to invest.

Joyce Chung Monday, March 2, 2009 at 3:21 PM PT

I think, VCs have enough motivation as is, Joyce, with the hyper-inflated compensation programs. I don’t mind at all that Obama wants to tax VCs more.

I am actually more interested in helping entrepreneurs access cash through tax-free savings pools and other means that will jumpstart more ventures.

I don’t think Capital Gains is the right place to focus tax policy on at all, because for the majority of the entrepreneurs, this is not even an issue. A very small % of startups get any outside capital, and have an exit.

Sramana Mitra Monday, March 2, 2009 at 4:12 PM PT

Leaving VCs aside, I think it would help motivate that rich uncle or angel investors to put their money somewhere where the returns could be juiced a little. Many entrepreneurs, particularly in the technology area, need a little bit of capital to get started. Service-based startups can more easily be bootstrapped.

Joyce Chung Monday, March 2, 2009 at 4:40 PM PT

Yes, but the rich uncle needs the cash to invest before capital gains becomes an issue. If he has to give the cash over to the government in form of taxes, he doesn’t have any cash left to invest.

I think, the debate needs to move away from Capital Gains, to the realm of tax-free investment pool.

Capital Gains comes much, much later. We need policy to start things up. That’s a different challenge, and yes, some entrepreneurs need to put either their own cash, or rich uncle’s cash.

Cash.

Not Capital Gains.

Sramana Mitra Monday, March 2, 2009 at 5:40 PM PT

Sramana—Your point about stimulating angel investment in small business is spot on. Every entrepreneur needs a rich uncle… and most of us don’t have one. A couple years ago, our business was the beneficiary of a state program in Arizona that gives angel investors a state tax credit on their investment in a “qualifying small business.” For our company, this credit was just the nudge several angel investors needed to go forward on an investment in our company. We raised about $400k from those angels. Today, we have about 140 employees, our business is excelling and our investors got their state tax credit.

I believe Oklahoma, Indiana and a couple other states have state tax credit programs similar to Arizona’s program. And one more thing: the paperwork and compliance measures we had to follow were not overly burdensome. The definition of a “qualifying small business” was clear and the program was easy to follow.

What you’re proposing, essentially, is to put something similar in place at the federal tax level… and I couldn’t agree more! This would be a powerful incentive for folks making a couple hundred thousand dollars per year or more to invest in innovative start-up ventures that create value, provide jobs and chip away at our recession using the tools of hard work, innovation, creativity and tenacity. What a great way to capitalize on what makes the U.S. great and stimulate innovation and entrepreneurship across the country!

Now, the other thing needed is an infusion of debt financing via loose and lenient SBA loan programs. But that’s a discussion for another day. For now, let’s focus on the equity financing dollars that are sitting on the sidelines right now because angel investors can’t find a good place to invest those funds.

Clate Mask Monday, March 2, 2009 at 11:57 PM PT

Entepreneurship is the backbone of our country, and all countries. Virtually all businesses started as small entrepreneurial ventures. Having a favorable tax policy for entrepreneurs is valuable. Having customers with money to buy your products or services is CRUCIAL.

Anyone who has studied our free market economy knows that the middle class drives the economy by buying the vast majority of all goods and services. The top 2% of income earners spend most of their money on stock or commodity investments. Almost all of the stocks traded each day are existing stocks, which do not benefit businesses. Only initial public offerings provide funding for enterprises.

All businesses need a strong infrastructure, including transportation. Note how the high gasoline prices, brought on primarily by lack of competition due to oil company consolidation, have added tremendous costs to businesses. By necessarily passing on those higher costs to customers, the buying power of those middle income customers has greatly diminished.

Congress was designed by our forefathers to have pork. How else can one state’s congressperson get favorable legislation without trading pork to another state’s congressperson? That’s the way it has always worked. So to say that I don’t want to pay taxes because of too much pork is naive. To provide states’ rights, Congress must have some pork, though most of us wish it wasn’t so.

Then who is going to pay for the infrastructure necessary for businesses, and alas, for the pork? Since businesses, including new entrapreneurial ones, must have customers with money to buy their goods and services, and because middle income customers buy the vast majority of those goods and services, upper income earners must invest in the infrastructure (and alas the pork). There is no other way to have a healthy economy than to have middle income earners stimulating the economy with their purchases, while shifting the tax burdon onto very high income earners through progressive income taxes. Use taxes (like gasoline and sales taxes) are regressive, hitting the vast majority of needed customers harder because they cut deeper into the non-essential-goods buying power of middle income earners, than very high income earners.

If you think about it, everyone including very high income earners and enterpreneurs will be much better off IN THE LONG RUN, if infrastructure taxes are progressive income taxes, because that will allow for the greatest number of customers to have the buying power to make businesses thrive. If very high income earners would be patient with their investment in the infrastructure, and if entrepreneurs and middle income earners were given tax breaks, we could all enjoy a healthy economy.

Dr. Scott Greene Tuesday, March 3, 2009 at 1:23 AM PT

I am glad to see this kind of proposal. In my mind this is the type of program that we should have been developing all along. We don’t need to stimulate local government…that will just grow the government. We can see the stock market is not responding to big government increases. We are getting away from our entrepreneurial and capitalist roots. “The business of America is business.” If some regulation needs fixing, fix it; don’t turn us into another doomed socialist society. I think we also need to stimulate new product development in large corporations. Research and development spending has been declining, yet we know that the majority of corporate profits come from new products.

Dr. Debra Zahay Tuesday, March 3, 2009 at 8:24 AM PT

By the way, I was just speaking with someone about Angel investment. Pls look at the 2-tier capital gains structure I have proposed if you are looking for specific capital gains related policy.

I have proposed that there be lower capital gains taxes for early stage investors than for those who invest in lower risk, later stage deals.

Sramana Mitra Wednesday, March 4, 2009 at 3:30 PM PT

I think you have a wonderful idea to have high worth individuals to contribute to a tax free investment fund. Organized properly a small business corporation can also benefit from tax losses through carrybacks and carryforwards. If high worth investors can shelter some of their other income as a result of initial losses an added benefit would be provided to them. A good stimulus package might increase the carryback provisions to more than the current three years and tax carryforward to more than the current five years. The shelter of a high worth individuals income from tax might stimulate more of them to invest in small businesses.

Phil Harris Tuesday, March 10, 2009 at 2:57 PM PT

[…] issues as well. Infusionsoft’s CEO, Clate Mask, noted in a comment on her post titled, “Stimulus Package for Entrepreneurs,” that “…stimulating angel investment in small business is spot on. Every […]

Re: President Obama’s Small Business Plan | Infusionsoft Blog Wednesday, March 18, 2009 at 5:41 PM PT