With bipartisan support, Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017. Opportunity Zones, identified by states and declared at the Federal level, are economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment. Roughly 8,700 areas in all 50 states have been designated – the largest such preferential place-based tax investment effort in history.
The problem is that the investors who are willing to be “first movers” and get involved in Opportunity Zone investing aren’t connected to, or embedded within, the communities that are qualifying. This discrepancy has the potential to take a new economic development tool and use it to exacerbate the inequity we see getting starker every year.
Since its launch, the Opportunity Zone Tax Incentive program has been difficult to understand. A somewhat fragmented network of investors, tax lawyers, municipalities and community development organizations have been seeking ways to work together to provide real funding opportunities for both real estate transactions as well as small businesses.
The challenge for small business opportunities is that it is difficult to align what investors are looking for with what investable opportunities exist. But this potential miss-match can be solved for by
- aligning investor expectations with the opportunity and
- preparing the small businesses to qualify for this program.
I was invited to two convenings at the Economic Equity Network’s Opportunity Zone Community Wealth-Building Roundtables this Fall. Both of these dynamic events have achieved what few events can: “real talk” on the gap between what “the money” wants and what the community needs.
“It’s critical that we bridge the gap between what “the money” wants and what the community needs.
The Money – i.e. aligning Investor Expectations
The investor opportunity is a tax reduction on capital gains by directing investments into designated areas called Opportunity Zones. In real talk, this is a way for investors that make money on an investment, to reinvest that new money (i.e. the gain on their investment), into an economically distressed community and thereby get a very nice tax break on that investment. The benefit is tiered with incentives directed towards keeping the investments for up to 10 years, thereby creating “patient capital”.
By participating in this program, investors are essentially getting a negative interest rate loan from the government on their capital gains as well as no tax on the profit their equity investment into a business if they hold that investment for at least 10 years.
This translates to a reduction of 10% of their tax burden if held at least 5 years, 15% reduction if held 7 years and if held for the full term of 10 years, a 15% reduction and no capital gains tax for any and all profit made on that investment. This means that whatever gain in value the business creates post investment, those investors don’t pay any tax on that value. This compares, in general to 15%-20% tax they might otherwise pay on gains for non-Opportunity Zone qualifying equity investments.
Many investors seeking investment opportunities in small business, however, are still miss-guided about their ideal business profile. One investor at a recent convening shared that he is looking for scalable tech businesses that need $2+ million in investment. This is where we get going in the wrong direction.
Identifying scalable tech businesses as a target for a government tax incentive program like the Opportunity Zones is going to perpetuate the inequity of investors saving money on the in the investment profits they make, that spurred the creation of Opportunity Zones in the first place. We need instead to practice full consequence investing and see the opportunity that is harder and takes longer to realize, but that creates the real lasting value in our communities: investing in growth-oriented small businesses that create good jobs in our communities.
“We need to underwrite to the positive social outcome of putting this money to work on our communities by our community.
The Community Need – i.e. preparing Small Business for “Ozone” Investments
ICA has worked with small businesses in the 9 county Bay Area for over 23 years. In 2013, we launched a CDFI that invests in growth-oriented small businesses using equity like products that are flexible. We know that small businesses, particularly those run by people of color and women, lack the assets required to get traditional (and even in many cases CDFI) debt.
Instead, what these growing businesses need is equity — money that doesn’t hurt their cashflows and can be used to leverage access to additional money from other sources (bank, CDFIs, etc.) Opportunity Zone capital offers a new source of equity capital for these businesses but only if investors can see the opportunity.
If small businesses can frame their opportunity to the needs of the investor, we get to a match. The business owner must show how they will use the money, the business model that demonstrates the anticipated growth in the next 5, 7 and 10 years and how investors will achieve liquidity within an agreed upon time frame.
Most market-driven private equity investors are concerned with 1) not losing money 2) making money 3) having access to the money they make [1] – in that order. If small businesses can demonstrate that the investor needs will be met, there is a true opportunity for small businesses within the Opportunity Zone tax benefit.
[1] Philanthropy can play a role here in providing liquidity to investors over the long term. Foundations and grant providers can and should define a target ROI to investors that growth-oriented small businesses can feasibly achieve in a 10-year time period and is sufficient to attract the capital. ICA’s experience suggest that this is 2x investment.
