Start-Ups, Venture Capitalists, and the Capital Gains Tax
47 Pages Posted: 19 Mar 2002
There are 2 versions of this paper
Start-Ups, Venture Capitalists, and the Capital Gains Tax
Start-Ups, Venture Capitalists and the Capital Gains Tax
Date Written: June 2002
Abstract
A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas but lack 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 off-set may paradoxically contribute to higher quality of venture capital backed entrepreneurship and welfare.
Keywords: Venture Capital, Capital Gains Taxation, Double Moral Hazard
JEL Classification: D82, G24, H24, H25
Suggested Citation: Suggested Citation
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