*********This post is a translation of the article: « Pigeons » : le cri d'alarme d'un fonds américain published on LaTribune (12/10/2012) and is a response to the proposed tax law proposed by the government of Francois Hollande, suggesting to tax all capital gain at the same level than salaries or 60%.
While France has been a fertile ground for innovative start-ups, the new fiscal law threatens to disrupt an ecosystem that has slowly emerged over the past 12 years. Instead of increasing the tax burden on these companies driving job creation, why not take full advantage of this evolution of the tax law to position France as the most attractive country for entrepreneurs in Europe?
France has proven its ability to develop innovative internet models
Over the past three years, we have invested over $60 million in French technology start-ups with Showroomprive (number 2 in Europe for online private sales), BlaBlaCar (Covoiturage.fr the European leader in ride-sharing) and Shopmium (offering coupons via a mobile app) and as a result have contributed to creating close to 600 jobs. While our investment focus covers all of Europe, we consider France to be a very important market for our business and we are actively seeking new investment opportunities.
France is indeed a country with a proven track record of developing innovative business models.
Here are a few examples: the “flash sales” model was launched by VentePrivee and Showroomprive, the two European leaders and has been copied in the US by several companies such as Gilt Groupe; “online retargeting” was invented by Criteo, who currently operates in 30 countries with over 3,000 customers and whose success relies, among other things, on its 10,000m2 R&D centre located downtown Paris. Since its launch, Criteo has created 800 jobs, 40% of those in R&D; France has also been a pioneer in the space of ride-sharing with the creation of covoiturage.fr, a company that has built a strong community of over 2 million members and transporting a number of passengers equivalent of 1,000 high speed trains every month. And the list of success stories continues with companies such as Free, Meetic, AuFeminin.com, PriceMinister, SeLoger…
The second strength of France resides in its talent pool of entrepreneurs. With the experience accumulated during the first internet boom, this talent pool has grown considerably and gained in strength over the past few years. Those who have enjoyed success have given back to the community as business angels, through the creation of seed funds such as ISAI, Kima Ventures or Jaina Capital, or by sharing their personal experience through forums, conferences or teaching. A good example is the creation of École Européenne des Métiers de l'Internet (EEMI) in September 2011, founded by Marc Simoncini (Meetic), Jacques Antoine Granjon (Vente-privee.com) and Xaviel Niel (FREE).
Finally, another notable strength of France resides in its Telecom infrastructure. Indeed, France enjoys the highest penetration rate for broadband in Europe (32.7% for France vs. 26.5% on average in Europe according to Eurostat, Jan. 2011).
Amendments proposed to the 2013 Tax law are insufficient and threaten to destabilize the ecosystem
I will not go over the initial regulation proposal, which recommended a 60% tax rate on profits made by entrepreneurs after an exit (basic idea is to apply same tax rate on salary and capital gains). Instead, I will focus the discussion on the recent amendments suggested by the minister of economy and explain why these amendments are insufficient and threaten the growth of a booming ecosystem that has already proven to be and should remain a source of job creation.
The first amendment relies on the definition of « founder » and imposes a minimal ownership of 10% of the company and a holding period of two to five years to benefit from a lower tax rate. Let’s examine first the ownership constraint proposed by the amendment: the ownership level of a founder in his / her company depends on two key factors: the number of founders in the start-up and the potential dilution that occurs with fund raising (needed to sustain the company’s growth). Imposing a minimum ownership threshold on founders penalizes teams with several co-founders, while the combination of talents and skill sets coming from having several co-founders is usually core to the success of a start-up. This proposal also penalizes companies that have struggled to grow and had to raise several round of funding before reaching a critical mass, and have therefore been diluted more than they would have liked. Finally, it puts a break on the fast growing start-ups that could benefit from an additional injection of capital to fuel their growth but won’t do it to avoid further dilution. In our portfolio, we have companies with founding CEOs who own less than 10% of their companies for some of the reasons I just listed. Why should they be penalised in such an arbitrary way? The duration criterion is also very punitive for start-ups playing in the dynamic technology market. Let’s take an example in our portfolio: Playfish, a “social gaming” company, was launched in London in 2007. It enjoyed explosive growth, created 200 jobs in two years, and was acquired in 2009 by the American giant Electronic Arts. If that company had had to comply with the proposed regulation, its founding partners would have faced the following dilemma: either forfeit 60% of their gains in tax, or … ask Electronic Arts to come back later. Why should rapid success stories be penalised more than companies whose success is slower to come?
The second amendment proposes to apply tax rebates on capital gains applicable over a six years period for those who cannot meet the founder status. While this measure also relies on an arbitrary duration, which does not account for the dynamic environment in which start-ups operate, it will also create inequalities among start-up teams by dividing them into three “classes”: the “founders” who will be protected in some instances, the employees who have received stock options (and will fortunately not be impacted by this regulation) and the employees who have received shares and will be subject to a complex tax waiver scheme. Is this the “social justice” announced by the government?
To conclude, the ecosystem of internet start-ups is based on three key stakeholders: the entrepreneurs, who create the start-ups, the employees, who contribute to their success and the investors (business angels and venture capitalists), who invest capital to fuel growth. Those three constituents share the risks and play a key role in the development of start-ups. The proposed law, instead of bringing more cohesion to the ecosystem and aligning stakeholders’ interests, will in fact introduce inequalities that will ultimately lead to disequilibrium and conflicts… in addition to adding unnecessary complexity to the model.
Why not take advantage of this law to make France the champion of Entrepreneurship in Europe?
Instead of introducing extra layers of complexity and penalising both start-ups and entrepreneurs, why not going back to simplicity and proposing positive changes that would position France as a beacon for innovation and entrepreneurship in Europe?
If we all agree that start-ups need to be protected given they are a unique vector of economic growth and job creation, why not take a step further and give them an attractive tax rate that could apply equally to all shareholders independently of any ownership level or duration? Why not apply a 15% tax rate on all capital gains coming from start-ups? Not only would such a measure boost the French technology ecosystem, but it would also attract entrepreneurs and investors to France.
One way to create boundaries for this proposal, would be to apply it only to shares acquired during the first twelve years of a start-up’s existence, after this date all transactions would be taxed at the current capital gain tax rate (regardless what the rate is – although I personally do not agree with the tax rate currently proposed by the government). So why twelve years? While that threshold should be thought through, it would apply well to our current portfolio: among the 250+ active companies we have funded, the proportion of those founded before 2000 is minimal.
Such a change would play to France’s advantage and give a boost to the start-up ecosystem. Why not take a chance?