Will the Opportunity Zone Program Help Small Business Thrive?
This post, contributed by Michael Hokenson of Community Investment Management and Garrett Jacobs of Workforce Equity, reports back on the October Novogradac Opportunity Zone (OZ) Conference and explores the risks and opportunities for small business in OZ census tracts.
The OZ Program is a new tax incentive within the Tax Cuts and Jobs Act of 2017, intended to spur long-term investments in low-income census tracts in the U.S. The new law allows investors to place unrealized capital gains from the sale of an asset into Opportunity Funds (O Funds) that invest capital into designated OZs. The greatest tax benefits would go to investors who invest for 10 or more years. To learn more about the program, please see MIE's evolving OZ Library.
The Opportunity Zone (OZ) program, with its light legislative wording, has created equal parts interest and uncertainty, as its implementation and execution remains unclear. This was a key theme during the Novogradac Conference on OZs in New Orleans on October 2nd, 2018, where legal, accounting, and tax experts gathered to explore the latest thinking and activities around the program.
MIE member Community Investment Management (CIM) has kept an eye on developments related to OZs and got an update on the conference from Garrett Jacobs of Workforce Equity. The founders of CIM, which provides responsible loans to small businesses, began their careers in international microfinance at a time (2005-2006) when the global industry experienced a significant increase in capital, technical assistance, and resources toward commercialization. This maturation was achieved in part by a number of European legislative rulings that provided tax incentives for investors placing assets in microfinance investment vehicles. The authors see a similar moment here with the OZ legislation, which has the potential to alleviate the chronic underinvestment quotient into America’s low and moderate income census tracts.
But there are still several hurdles to overcome. As many participants at the conference noted, a high degree of uncertainty remains around Opportunity Zone Funds (O Funds). Significant gaps exist in the federal level guidance on fund structuring, tax treatment of assets over the life of O Funds, and clarification on how an operating company becomes eligible for O Fund investment. And for organizations like CIM and others centered on making a difference for American communities, the vague legislative language associated with impact — as well as the possibility that many investors entering this space may not prioritize community needs — is a cause for great concern.
The OZ legislation also presents unique risks for small businesses, an area of particular focus for CIM. While many small businesses in America are starved for responsibly serviced debt, only equity investments qualify for the tax benefits under the current legislation. Given their scale and growth trajectories, it is not likely that the majority of small businesses in OZs will qualify for venture capital and private equity investment. We can certainly expect venture activity, and a number of funds are being formed. However, with less than 3% of traditional venture funding going to companies led by women founders and less than 1% backing African Americans, impact investors like Access Ventures, which is structuring their own O Fund, hope to see more equitable portfolios created in OZ contexts. For the remaining majority of ineligible small businesses, the rising tide may “lift all boats,” or gentrification may dampen the existing small business ecosystem by leading to higher rents and operating costs.
The OZ program is at a significant crossroads, at which early movers will ultimately shape the direction of the program. And the more foundations and mission-driven investors are among them, the more likely we will see innovative, high-impact projects emerge — supporting investees, while ensuring that the small business owners and community members indirectly affected by neighborhood change are not forgotten.
We applaud the early efforts of foundations that are seizing the moment to shape fund behavior, such as Meyer Memorial Trust, Oregon Community Foundation, and Ford Family Foundation, who are supporting the development of a platform to source qualifying projects in Oregon and neighboring states and reach less prominent and/or rural investees. Kresge Foundation is also providing a combination of technical assistance and unfunded guarantees to fund managers whose strategies overlap with their programmatic areas. (See MIE’s OZ resource library for additional examples emerging).
The OZ legislation is intended to spread prosperity beyond the top decile. We believe this is only possible with thoughtful, collaborative approaches between those that hold the capital and those motivated by purpose. As we come nearer to the release of final legislation in the Fall of 2018, we look forward to working with other impact investors to ensure that communities needs and priorities remain at the center of discussion.
The authors would like to acknowledge the committed backers of the Opportunity Zone Act: Economic Innovation Group, Shawn Parker, John Lettiere, Steve Glickman, Vice President Mike Pence, Senator Tim Scott and Gary Hobbs. Also, they applaud early efforts by The Kresge Foundation and The Rockefeller Foundation for their RFP process to identify and provide resources for new fund managers overlapping with their programmatic areas of interest.