Should California Tax Its Startups 5% Of Their Equity To Solve The State’s Budget Crisis?

Should California Tax Its Startups 5% Of Their Equity To Solve The State’s Budget Crisis?

Should California tax its startups 5% of their equity to solve the state’s budget crisis? A venture capitalist proposes giving the state ownership in new companies. Photo by NESA by Makers on Unsplash

A venture capitalist argues against taxing the wealthy and instead proposes taxing the equity of California startups, giving the state ownership in new companies as the best way to solve its massive budget crisis.

California is a talent and brain trust. “Most founders would be more than happy to give up 5 percent of their initial equity for access to the region,” wrote Sam Lessin, co-founder of Fin Analytics and a partner at Slow Ventures, in a column for The Information.

A former vice president of product management at Facebook, Lessin proposes that a startup equity tax would be a great way to align the state with the interests of its economic engine, and would be very lucrative for California.

A startup equity tax could work like this, Lessin said: “Any new company that has more than X employees in the Bay Area, or that has raised more than Y dollars of capital, would have to grant upfront to the state of California 5 percent of its equity, with certain traditional rights attached. The state would be able to invest as the company grows to maintain its ownership level.

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“The state would then immediately raise a large fund from outside investors, where presumably it could start to charge fees as a VC firm would do for access to investing in its pro-rata slices of companies down the line. With around $300 billion of global venture capital every year, it isn’t hard to imagine the California state fund deploying $10 billion a year, which, given investment time horizons, could easily build to $1 billion a year in fees charged to investors just for access to the fund.”

If this strategy had been applied for the last 20 years, the state would have stakes in companies such as Facebook, Apple and Google that would be worth hundreds of billions of dollars today, Lessin said. 

Faced with wildfires and the unemployment and business closures brought on by the covid-19 pandemic, California has a projected $54.3-billion budget deficit, the L.A. Times reported. It’s the worst financial crisis in state history. California has lost a greater share of revenue than most states due to covid-19, according to NPR.

“California’s progressive tax structure means state revenue does well in good economic times but suffers more than most other states when there’s a downturn,” NPR reported.

If California raises income taxes too high, people could just leave, Lessin said. Covid-19 has made people comfortable working from home, and that could be anywhere.

A wealth tax seems to be on the table for California. Lessin said that’s problematic because a wealth tax is almost impossible to calculate and enforce accurately or fairly, and a wealth tax will cause market distortions.

“It can take armies of accountants and lawyers (and frequently lengthy negotiations) to figure out how to value and pay taxes on an estate. Now, imagine trying to do that every year! It would be a bonanza for accounting and law firms, but an unmitigated disaster for everyone else involved,” Lessin said.

“Affluent people store the bulk of their wealth in complicated and hard-to-assess assets,” Lessin added. “Trying to continuously account for their value and calculate taxes seems nearly impossible to do in a way that wouldn’t lead to all sorts of wild gaming.”

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For venture capitalists, a wealth tax would make high-priced private rounds expensive to undertake, Lessin said. Beyond VC, a wealth tax would make it harder for companies to stay private for long and it would also be more difficult for people to found, own and operate businesses with no liquidity events on the horizon. 

Although Lessin cannot imagine a wealth tax working, he said he can imagine a startup equity tax working.

He said he can picture an alignment between the state and the innovation community that “would, despite the tax burden, draw more ambitious startups to California. Other proposals might have them running for the exits.”