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Start-ups, Venture Capitalists and the Capital Gains Tax

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  • Keuschnigg, Christian
  • Nielsen, Soren Bo

Abstract

A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas but lack their own resources as well as commercial experience. Venture capitalists provide start-up finance and managerial support. Both types of agents thus jointly contribute to the firm's success, but neither type's effort is verifiable. We find that the market equilibrium is biased towards inefficiently low venture capital support. In this situation, the capital gains tax is particularly harmful. The introduction of a small tax impairs managerial advice and leads to first order welfare losses. Once the tax is in place, limitations on loss offset may paradoxically contribute to higher quality of venture capital backed entrepreneurship and welfare.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3263.

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Date of creation: Mar 2002
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Handle: RePEc:cpr:ceprdp:3263

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Keywords: capital gains taxation; double moral hazard; venture capital;

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References

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  1. Vesa Kanniainen & Christian Keuschnigg, 2000. "The Optimal Portfolio of Start-Up Firms in Venture Capital Finance," CESifo Working Paper Series 381, CESifo Group Munich.
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