Venture Capital and Private Foundation Withdrawal
The actual money managed by a Venture Capital Fund comes from many sources including private foundations. Venture Capital and private foundation withdrawal creates some tax complications.
The tax codes of the Internal Revenue are not totally inimical to the Venture Capital industry. This is because the United States has encouraged the growth of the venture capital industry because it feels venture capital fills an important gap in the economic growth policies of the nation. Since many tradition lending institutions are not quick to assume the risks on emerging and innovative technology, there is a serious danger of falling behind in a global and competitive world market place. Venture capital that comes from a private foundation is subject to certain tax law regarding withdrawal from a venture.
One of the problems with private foundations providing venture capital in exchange for equity interest is the IRS regulations restricting private foundations from holding an excessive percentage of the voting stock of any individual organization. The intent of these regulations is obvious and actually quite fair. The IRS views private foundations and those that make contributions to them in a very favorable light.
The IRS is interested in encouraging contributions to private foundations that are created to encourage important emerging technology. They have given the foundations a favorable tax position and also extend this protection to investors who are “donating” to the foundation. This enables private foundations to raise large sums of money and gives them an unfair advantage over venture capital funds that draw their investment income in more conventional and higher taxed manners.
The regulations do not permit the foundation to own more than 20% of the voting stock of any organization. This keeps them in a position as a powerful and influential investor, but also prevents them from using their tax advantage as a means to virtually control any company that they select. When a foundation exceeds the ownership limitation, via the results of the capitalization phase expansion, the foundation must make a withdrawal from the fund that brings them in compliance. Specific IRS codes detail the limits and tax status of the withdrawals.
The private foundation remains a very success method of channeling money and resources into selected and necessary business ventures that serve significant social needs or encourage start up companies expanding the technological boundaries. The Government is very supportive of the foundation concept and extends tax advantages that make them players in the venture capital field, but they must play by some special rules.