The last decade hasn’t been a very good one for venture capitalists, showing poor returns for their investors. There are many reasons for this including over-expansion, poor management, and a dearth of companies going public. Now to make matters worse Congress is trying to take away the VC’s traditional greatest single source of income, called “carried interest” — their piece of the pie, so to speak. That is if there was any pie. I’m not here to defend carried interest, nor to condemn it. My purpose is to point out that the VC industry will just restructure itself to regain any lost income if carried interest is taken away.

Easy go, easy come.

Venture capitalists raise money from investors like pension funds, university endowments, wealthy individuals and insurance companies — institutions that don’t claim any special expertise in technology investments. The idea is that this money will be invested in a basket of tech startups and more mature private technology companies over a period of 7-10 years after which the fund will be liquidated or refinanced and the money returned to the original investors, hopefully along with a large profit — a capital gain. During that period the money doesn’t actually sit in some VC’s mattress — they have the right to call on their investors to pay as-needed. VC’s make their money by getting a management fee that is usually two percent of the fund total ($20 million per year for a $1 billion fund) and take a 20 percent share of any eventual profit. This share of the fund’s capital gain is called “carried interest.”

Since it is a share of a capital gain, carried interest has always been taxed as a capital gain, which means currently at a maximum 15 percent federal tax rate. But Congress has lately been looking for more revenue and carried interest sure looks like a commission — regular income — taxable at up to 35 percent. The difference between these two tax rates amounts to more than $1 billion per year, even in the current lousy venture economy. It’s that $1 billion they are fighting over.

Only the real amount is much larger, because there is huge pent-up profit to be shared among venture investments as the economy improves. Better times are clearly ahead or the VC firms wouldn’t still be successfully raising money.

Carried interest isn’t peculiar to VC’s, either. The proposed changes also affect hedge funds and private equity funds — both of which are far larger than the $20 billion venture capital industry.

I’m not, nor have I ever been, a VC but I know lots of them and understand the crux of their dilemma: they like their Porsches.

Carried interest clearly is a commission, not a capital gain, since VCs typically have almost none of their own capital at risk. They’ll argue this point, by the way, but 100-to-1 leverage based on borrowed money looks like pretty close to nothing to me.

So Congress will pass a law making carried interest taxable as regular income and the venture funds might, in response, move their incorporations to Bermuda or the Cayman Islands, evading taxation altogether. Or maybe they’ll restructure, creating some derivative security that cleverly sequesters exactly 20 percent of any gain in some unassailable place in the space-money continuum. These are exactly the kind of threats being made right now by lobbyists trying to preserve the status quo.

In this case — since Porsches are at stake — I think they mean it.

That’s no reason not to change the tax treatment of carried interest, but every reason to believe that it won’t lead to a measurable increase in tax revenue.

We need a better idea.  Do you have one?