There are a lot of new tax ideas circulating in conversations. With aging infrastructure, growing inequality, and an expectation of less federal support in the future, conversations among state and local politicians about raising more regional revenue through things like a wealth tax or adding high-earner income taxes abound.
I have a counterproposal that I think would serve the Bay Area well and is consistent with the ethos of the region. All new tech startups should be required to give 5% of the founder’s equity in new ventures to a state or regional fund.
In a sense, there is already a very tried and true model to follow here. Y Combinator and other accelerators have been charging companies a similar “rate” for access to their community and network for years now. If you believe a region also adds value to what startups are doing, then the community should also be “dealt in” to the new business.
Sovereign wealth funds are also an example. In traditional instances, a region or nation has inherent wealth in the form of mineral resources, and the government makes sure that the whole region is dealt into the value through vehicles like sovereign wealth funds.
The Bay Area provides a globally unparalleled network and ecosystem for young companies. So why should the region not be included at the earliest stage in new ventures? That would give the municipalities in the region directly aligned incentives with the outcome of businesses started here.
A Great Model for Public Finance
Once a regional wealth fund has 5% stakes in all of the companies started in the region, all of a sudden the region has an asset which can be leveraged to improve public finance. In theory, on day one the municipality could sell a percentage of the fund for an instant cash infusion rather than just waiting for long-term profits. I know that I would invest in an offering like that.
You could also leverage off of the asset and improve the municipalities’ borrowing rates. The municipalities could also do what Y Combinator has done and raise a fund to follow on to maintain your pro rata stake in companies (which would probably be important to keep to prevent the municipality being diluted down over time).
The upshot is that a 5% equity tax would be an enormous and instantly valuable asset for the community even if liquidity events and returns were far in the future.
A Preferable Form of “Taxation” for Entrepreneurs
If you start with the assumption that there will be higher taxes and some wealth transfer in the future, a 5% equity tax on startups in my mind will be far more palatable to most than alternative proposals.
Few founders would vociferously object if they were told that part of the deal of setting up in the region was that you had to be civic-minded and add the region to your cap table. After all, most are in the Bay Area specifically because they think that the region provides a great ecosystem which they can leverage. And, of course, it is all the more digestible in that at the founding of a company, the value is all theoretical.
At the same time, it would be stellar for the community to have a direct stake in the success of startups. If, all of a sudden, a government knows that they will directly benefit from the success of new companies founded in the region, it’s likely to become more receptive to helping those companies where they can. I believe that entrepreneurs would, as a class, gladly give the government some stake in their businesses upfront to help foster an even better entrepreneurial culture and relationship with the government.
On the flip side, other proposals—like wealth taxes or higher-earner taxes that come down the road—feel far less palatable. Instead of being aligned with the region and the community, increasing taxes on success later feels far worse—not to mention the fact that taxing founder equity would simply apply to far fewer people.
Managing Catchment, Evasion and Flight
The strongest argument against a regional wealth fund is that entrepreneurs might leave. But while a marginal entrepreneur here or there might choose to instead start their company in New York or LA, I think the effect would be minimal.
First, just as is the case with Y Combinator, if people think the region truly is helpful in them getting the talent and ecosystem they need to succeed, then the initial equity is a rounding error most will happily pay.
Second, I would suspect that if the San Francisco region made this move, other big municipalities would come up with similar taxes. Most face the same challenges. Sure, perhaps just as some states don’t have income tax, some areas will declare themselves equity tax-free zones and try to attract talent that way. But, frankly, people that make big decisions—like where to found their companies—on marginal things like this are frequently not the most successful anyway.
There is also a challenge, of course, of exactly how to set up the tax to capture the high-growth tech companies for whom the local ecosystem matters most, and not just local businesses and restaurants. You would likely have to specify some terms. For example, that it only applies to companies that raise more than X dollars at a valuation greater than $Y million beyond their physical assets and have at least Z people working from the Bay Area at salaries in excess of $100,000 a year. That isn’t sufficient, but I have high confidence that a mechanism could be designed to achieve the purpose fairly and with minimal distortion.
There is also, of course, a more local regional challenge. This wouldn’t work very well if it only applied in San Francisco and the south bay, but not Oakland. That said, I think if you drew a circle of 150 miles or so around San Francisco you would set up a meaningful enough region that—while there would be a flight to the periphery by some—you would achieve your goals.
Let’s All Get Aligned
As someone who has founder’s equity in the Bay Area, I would never unilaterally walk down to city hall and give them 5% of my initial equity. But, if you told me this was the way things worked I would accept it—and in some ways perhaps even welcome the idea that I work in a bit more of a tangible way for the city and the community.
Companies that have already been founded would have to be grandfathered in not being required to give up equity. But I believe enough in this that if it rolled out, I would happily deal the municipality into the equity of my startup, Fin, if a new regulation like this ever came to pass.
It would feel good to be aligned more directly with the region—and I think it would very meaningfully help improve both the infrastructure and the community in the region. I am pretty sure many entrepreneurs in the region feel similarly.
Had this strategy been in place over the past decade, the region would have a wealth fund valued at least tens of billions of dollars by now. Facebook alone, in this world, would be something like a $10 billion win for the region.
The many small towns and competing municipal interests of the Bay Area have had a lot of trouble coordinating action historically. But this seems like the type of prize everyone could align around.