Business

I am a capitalist . . . a risk-taker: someone who is willing to risk my capital for a long period of time with the goal of receiving a much larger reward. Sometimes it works. Often it does not. Our essential business is unleashing the power of ideas organized into innovation by emerging private companies; and therefore, facilitating capital formation . . . and corporate expansion. Because, it is capital that fuels the future. Through our efforts, companies create new products and services; jobs; wealth; and, tax revenues.

The Power of Creative Destruction

The Austrian-American economist Joseph Schumpeter articulated what he called “creative destruction.” “Creative Destruction,” he said, “is the essential fact about capitalism.”[1] As Peter Drucker noted:

[Capitalism is] organized for systematic abandonment of the established, the customary, the familiar, the comfortable — whether products, services, and processes . . . skills, or organizations themselves.[2]

Just as there are only two kinds of computers – experimental and obsolete — our capital (because we fund new and innovative companies) makes the present obsolete, and the future wide open to those entrepreneurs with ideas who knowledge, skills and abilities to experiment with the possible. But, as we see the world, “no success by the risk taker or entrepreneur goes unpunished.”

Let me give an example. I made my first trip to a particular Asian country looking for business opportunities in 2003. I stayed there for two weeks evaluating the potential and speaking with local business leaders. I came home and began an intensive study of the economic and financial conditions of the country. I spent months going over reports, white papers, business journals, personal correspondence and meetings with experts in the area.

It was too soon. So, I put it on the back burner and moved on. I returned a few years later. The place was vibrant with activity. I knew it was time to move. We organized a two-day seminar for 300 companies in the region. Ten of the most knowledgeable financial professionals in the world spoke at the event: attorneys, auditors, investment bankers, and our own company. We paid for it all.

I returned there many times where I spent an average of two to three weeks each time. I toured dozens of factories; met with top governmental officials, leading businessmen and women all across the country (some of the best business leaders there are women); drove for days on end on dirty back roads; motored out to an empty island in a six foot sampan in a driving rain storm to look at a prospective luxury golf and resort site (we didn’t invest in it, by the way); and, ate more local, roadside and riverside food than a person ought to digest in a lifetime.

All in an effort to find those creative companies ready to change the future in their industry. In just that country alone, we invested more than six years and a million dollars.

Undermines Capital Formation and Capital Movement

Unfortunately, because our reward comes primarily in the form of company stock from the companies with which we work, here is how our investment is treated:

• If I sell my stock within the first year – not the first year of my investment six years ago – but the first year from the date the company goes public – it is taxed as a “short-term capital gain.” That means that I have to pay 35 percent of that gain to Uncle Sam.
• But, if I hold that stock for another year – making a good part of my investment sit for seven years or more – then the rate is reduced to 15 percent.
  

If I could get my return back in the first three months after the company goes public . . . rather than having to hold it for a year . . . I could service three more companies in the same amount of time by re-investing my capital gains back into our future growth. This would quadruple the explosion of innovation; the number of jobs created; and, the amount of taxes paid by all sources: companies, suppliers, employees, distributors, service and support companies, and a host of others.

Sure, I’d make more money: but so will everyone else – and mine goes back into investment in other innovations again. They’re not just punishing me for succeeding – they’re punishing thousands.

By raising the taxes I pay on the income I earn from my own labor – government decreases my ability to expand capital opportunity for those who create America’s wealth through innovation. So, in effect, they are potentially depriving thousands of families of better paying, technologically competent jobs while discarding jobs that are obsolete.[3] That’s what creative destruction means.

Ironically, at the very moment when America and the world so desperately need new economic growth and stimulation, too many of our political leaders are advocating that the way to cut the federal deficit is raise taxes on businesses and investors (called “the wealthy”) – the very engines of economic growth itself. So, rather than rewarding those who create wealth for society, they want to further erode our ability to expand economic opportunity.

At the same time, the entrepreneurial company with which we work is also being penalized. With the addition of new regulations, the average cost to a company that is grossing $20 million in revenues (with between one and two million dollars in net profit) is about $1 million dollars. Compliance costs alone add about $400,000 every year to a company’s operating costs. For a small or emerging company, that can be as much as 80 percent or more of their net profit. And, this doesn’t even begin to measure the cost in time to the small public company working to get approval to trade on the public market. I have seen companies that have been required to answer questions month after month from regulators for more than a year before they either give up or finally get cleared for trading.

All of this regulation has been put in place because of the billion dollar cheaters who are the poster children for another round of regulation tightening for the more than 30,000 public companies that have done nothing wrong, all because the reformers believe that the only solution is to pass more legislation and regulation.

And, these regulations hit the most financially vulnerable companies hardest: the small and emerging companies just breaking into the system: companies that are idea rich and cash poor. These regulatory excesses drive the small companies and the small investment banks out of business leaving only the giants to monopolize the industry. This kills innovation and risk capital providers.

Symbolic Politics vs. Real World Outcomes

The result is that symbolically the regulatory bodies are seen as having taken bold action to prevent cheating. By passing more laws and instigating more regulation, those in power can claim that they have made the financial world safer.

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The very act of “doing something” – regardless of whether it works or not – is so engrained in the psyche of legislators, regulators, staffs, government attorneys and the sycophants that surround them that it is beyond their comprehension that many times the best thing they can do is absolutely nothing!

Let the market do its job: destroy and create. This is not an argument against independent audits and corporate transparency. I’m not saying the SEC is unfair or that the IRS is mean; or – heaven forbid – I wouldn’t dare suggest that President and Congress don’t know what they are doing. I’m just sharing the reality of what the real consequences are of their actions.

I am absolutely in favor of giving the investor all the information needed for him or her to make an informed decision as to whether to buy, hold or sell stock. In fact, I think it is imperative; and, absolutely the proper function of government. At the same time, the real world outcome of over-regulation to the small company – where 80 percent of all new jobs in America come from — is quite different from the symbolic one.

Here is what really happens.

First. Companies that want to be publicly listed go elsewhere: they list in London or Singapore, on the Hang Seng or Shanghai exchanges, or even Frankfurt. Because, capital will find its own level where it can move the quickest and with the least interference. Make no mistake: the U.S. government certainly has the authority to tell companies that want to list in the U.S. what they have to do; but, they cannot force them to list here. And, they cannot keep capital from moving freely offshore out of the U.S. forever when it is in the best interest of the owners of that capital to do so.

Second. The small companies . . . those who cannot yet afford to spend all of their dollars and time just on compliance . . . become even less transparent by throwing their hands up, saying “I quit!” and moving to the public markets that do not require the same level of government compliance. Ironically, the actual end result of this avalanche of new regulation is less transparency for the investor – rather than more – and opens up even more opportunity for the cheaters of the world to do so. In either case, the American investor, the American entrepreneur, the job seeker and the federal treasury all are the losers.

Beware of Governments Bearing Gifts

So, beware of governments bearing gifts. When politicians talk about saving obsolete companies, ask yourself: if these corporations are the innovative companies of the future, why must they be propped up by your tax dollars? Or ask: why should we not allow the market to creatively destroy them in the process of creating new ones that fit the future of the industry? After all, for example, General Motors was not in trouble because they ran out of money: they were in trouble because people didn’t want to buy their cars at the price they were charging! And, that’s the real reason they ran out of money along with crippling union contracts. Government did not make that decision: the market did. So, since money was not the problem – just an intervening variable – more money did not solve the problem.

Millions of people voted with their pocketbooks that General Motors was obsolete. Apparently, in spite of a resounding rejection by the American people through their buying patterns, government decided that the rule of innovate or evaporate shouldn’t apply to the American car manufacturers or their obsolete union boss system. Proof was in the “cash for clunkers program” that was supposed to stimulate U.S. car purchases. Instead, 80 percent of the cars purchased under to program were foreign cars!

And, as if that weren’t enough, I live in California where the government refuses to allow new off-shore drilling for oil (for the first time in 40 years) where there is sufficient proven reserves to pay off all of the debts of state and local government through 2022. Instead, that same government wants to again raise taxes — the primary beneficiaries of which are the unionized employees of the government itself.

Finally, remember: all you need to know about almost all legislation is “who gets” and “who pays” . . . and whether or not you want a particular group to get the financial benefit being legislated, and whether or not you want a different particular group of taxpayers to pay for those benefits. While I am committed to being a part of those who make possible that we provide a safety net for those who cannot do for themselves, as the father of the bride in the 1953 musical “Brigadoon” says to his younger daughter who is about to buy food for the guests, “the object is to be hospitable not philanthropic.”

Unfortunately, for those of us who are on the cutting edge of innovation and innovative financing, this feels an awful lot like “they” get and “we” pay. And, I can absolutely assure you that too many are committed to giving the “theys” a lot more, and the “we’s” are going to pay a lot more . . . for decades to come. So, as Bette Davis playing Margo Channing, the aging Broadway star in “All About Eve” in 1950, said, “Fasten your seatbelts, it’s going to be a bumpy ride.”