Taxes and Venture Capital Support

Christian Keuschnigg and Søren Nielsen

Review of Finance, 2003, vol. 7, issue 3, 515-539

Abstract: In this paper we set up a model of start-up finance under double moral hazard. Entrepreneurs lack own resources and business experience to develop their ideas. Venture capitalists can provide start-up finance and commercial support. The effort put forth by either agent contributes to the firm's success, but is not verifiable. As a result, the market equilibrium is biased towards inefficiently low venture capital support. The capital gains tax becomes especially harmful, as it further impairs advice and causes a first-order welfare loss. Once the capital gains tax is in place, limitations on loss off-set may paradoxically contribute to higher quality of venture capital finance and welfare. Subsidies to physical investment in VC-backed start-ups are detrimental in our framework.

Date: 2003
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