A Clause Worth Fighting For

The start-up industry has grown into a viable ecosystem. Now, the German government wants to eliminate vital tax breaks – retroactively.

German politicians want to axe a tax break for capital gains arising from the sale of company shares by venture capitalists who own less than ten percent of a company. Simply put: if you own a small minority of shares in a company and decide to sell them, you will pay more taxes than a majority investor. The aim is to bring German law in line with international custom, and level the playing field within the European Union. In most other countries, capital gains tax breaks only apply above a certain minimum threshold level.

Let me reply to that argument.

The start-up industry functions like any other economic sector: entrepreneurs reinvest their profits into other companies. A start-up investor is usually involved with more than one company, and investments are often long-term.

But shares of start-ups aren’t only held by individuals, they are also held by other start-up businesses. Current tax breaks apply to both types of investors, private and institutional. This makes sense, since the logic of reinvesting company profits into company shares is common practice across the industry. In concrete terms, having a tax break of 25 percent means that start-ups can invest 25 percent more capital into new business models and new companies. It should be evident that the availability of more investment money benefits young companies or those who want to increase their capital base and expand.

Investments by companies in other companies are the basis of sustainable economic growth. The actors within this economic ecosystem aren’t interested in drawing money away from it for personal gain, but in using their investments to fuel the growth of start-up businesses. Indeed, this exact logic was invoked when current tax breaks were first instituted. The aim was never to reduce one’s tax bill or keep one’s money out of the hands of the government. If investments cease to be reinvested and lead to the accumulation of private wealth, they are taxed as normal capital gains.

At its core, this discussion thus isn’t about a tax reduction. The law in question is a tax break, i.e. a temporary change in taxation rules that applies as long as money is reinvested productively. The discussion focuses on nothing less than the rule of law: if the new bill passes, it could be applied retroactively.

Debates about the shift away from fossil and nuclear energy and towards renewables have already shown what happens when a whole industrial sector cannot plan for the future. The German government is being sued by the nuclear industry for billions of Euros in compensation because of political decisions that voided existing contracts. “Green” companies are facing an unclear future as well: as long as politicians remain uncommitted about the future of energy policy, about their preferred energy mix and about possible subsidies, investments are harder to justify. If the same climate of uncertainty comes to dominate the start-up industry, Germany’s economy will surely suffer.

But what about the ten percent clause? If course, investors will continue to provide money even without tax breaks. But it’s a blatant denial of reality to attempt to preserve the tax break for investors who hold more than ten percent of company shares. Increasingly, start-up enterprises are becoming interesting to private investors or companies from other economic sectors. They won’t throw all their money at a single company and purchase more than ten percent of shares outright. Instead, the will tiptoe into new investments, get a sense for emerging markets, and orient themselves carefully.

Additionally, start-ups support each other not only with money but with knowledge, experiences, and contacts. Such mutual help is often compensated through so-called “supporter shares” that might amount to nothing more than a few tenths of a percent. It’s a good model: networking and network effects are incentivized through a simple share-based compensation model.

To sum up: not every investor shows up with suitcases filled with millions of dollars. Politicians should keep small and medium-sized businesses and private investors in mind as well.

Start-ups – like traditional small businesses – base their investment decisions on economic interests and ideational convictions. Money is invested to make more money. A “business angel” is thus no angel in the altruistic sense of the word. He or she invests in companies whose business models promise to be successful, who generate profits and increase their revenue. Many actors who now invest in companies once started their own businesses, thanks to the seed funding of others. After they sold them, they naturally gravitated towards a new generation of young entrepreneurs and helped them with realizing their business ideas. They are motivated by the belief in a technology-driven new industry with innovative potential and economic power.

We thus see the combination of economic interests and ideational conviction. Until now, this combination was supported by law: those who used their capital gains to fund new ideas and new companies could claim a tax break. Axing that law indicates that our politicians haven’t grasped a basic notion of policy-making: it’s good to seek a conversation with those affected by a policy change before their economic and ideational situation is undermined.

Newconomy is the new weekly column for the start-up industry. It focuses on the intersection of classical and new economies and of politics and entrepreneurialism. Newconomy is sponsored by Factory, the new start-up hub in Berlin.

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