Sweat Equity as a Gift: Venture Capital Investments and Tax Law in Japan
8 Pages Posted: 2 Apr 2009
Date Written: March 30, 2009
Abstract
We can observe a typical two-sided agency problem between human capital providers (entrepreneurs) and monetary capital providers (venture capitalists) in a venture company. If one party feels too much risk, she will hesitate to invest her capital. To maximize each party's payoff, both parties need to bargain with each other to motivate each other to invest their respective monetary and human capital. The incentive bargain will be made on control sharing and value sharing. In Silicon Valley, such a two-sided agency problem is resolved by making entrepreneurs abandon control to venture capitalists and complementarily giving entrepreneurs additional cash-flow right as "sweat equity." Japanese tax law is, however, hostile to the use of equity as an incentive. Particularly, the Japanese National Tax Agency might challenge the sweat equity practice as a gift and entrepreneurs would be required to pay gift tax. As a result, sharing cash-flow rights cannot be complementary to sharing of control, and the two-sided agency problem is not yet solved.
Suggested Citation: Suggested Citation