The finance world is stoked about Qualified Opportunity Zones. Investors are hoping to capitalize on a newly clarified provision under the December 2017 tax bill that confers massive tax benefits for investing in designated low-income areas. Anyone with capital gains can put that money–within 180 days of reaping the profit–into a partnership or corporation which invests at least 90% of its assets in “property” in a QOZ. Property can mean stock, partnership interests, or business property, such as a building.
Real-estate investors are raring to go, even if some of the mechanics are still unclear. For venture investing, the process is a little murkier, nuanced. We caught up with Peter Brack and John Ryu, two of the three founding partners at Hypothesis Ventures, an early-stage fund founded a few months ago for this exact opportunity.
Barron’s: What’s changed?
Peter Brack: We’re entering a new chapter where there’s a lot of acceleration around the idea of decentralization. The belief that innovation only happens in one particular geography is becoming quite an antiquated notion. We’ve all seen meaningful start-ups of great scale in other geographies across country. Our firm is built around that notion, that non-Bay Area markets and founders who choose to locate themselves in under-represented markets should be supported, and offer a huge opportunity for the firms that do support them. Opportunity Zones present that same strategy but on steroids. That’s where things start to get really exciting.
There’s a common misconception that Opportunity Zones are geared for and pointed toward real-estate investors. The legislation itself was really formed around small businesses and entrepreneurship; we’ve been speaking for quite some time to our friends at EIG, and have a very tight relationship with them and Steve Glickman, who was leading the charge and now has branched off and started his own consultancy around Opportunity Zones. We started talking to them early on in the process, late last year, before the new tax code was enacted. Steve’s a personal friend and now a very close friend to the firm. But as they explained to us, this legislation was geared around fostering new businesses and small businesses in Opportunity Zones across the country, not just real estate.
Is it harder in venture?
Brack: It is certainly simpler for real-estate investors to take this ball and run with it right now. But there’s a huge opportunity once we get a little bit more clarification.
John Ryu: Real estate and diversified funds, and venture-fund investors alike would agree there still is a lot of grey area in the guidance. There’s going to be a second round of guidance coming out shortly; some people are saying that’s probably not going to be the last.
I was actually on a call a few days ago and they were talking about real estate. The topic of conversation was that this may sound good for real estate, but it’s still difficult. There’s a working-capital requirement that says that if you’ve identified a project, you can use working capital in a safe harbor for 31 months. To anybody with any real experience building anything from a patch of land to a building, 31 months is not that long. It’s just not enough time.
On the venture side, we have some grey area as well; a lot of the basic questions we had were answered in this initial round of guidance, like what sort of gain can be invested into Opportunity Zone Funds, is recycling of investments allowed. Even though the IRS didn’t give a firm answer on recycling, the implication was we’re going to allow it but we’re going to answer in another round of guidance. Some things, like around the growth income requirement, actually got a little foggier, because the guidance is written very differently than the law–it’s just more colloquial or conversational. That made people question the growth-income requirement that was a constraint for venture: If you have a business in an Opportunity Zone, does it mean that all the sales have to come from within that zone? We’re confident that’s going to get cleaned up, that it’s just a misinterpretation, but it’s a good example.
What does the U.S. landscape look like for venture investing?
Brack: We see that there are clusters around certain geographies, as almost domain experts. Pittsburgh and Carnegie Mellon Infrastructure have a lot of innovation around automation and robotics. We’re seeing the midwest becoming a center for enterprise tech, and to a large degree ad tech. So as we’ve been talking to founders in emerging ecosystems across the country, we’re seeing common threads and themes across different domains.
If you don’t know a local network, how do you find founders?
Brack: [Investor and former America Online CEO] Steve Case has it right; he’s been beating the drum of decentralization for quite some time. Over the past year, 66% of the tech company initial public offerings are companies headquartered outside of the Bay Area; 72% of the most recent technology company acquisitions were companies outside of the Bay Area. The opportunity already exists. It’s just fascinating that most venture firms are Bay Area-centric when there’s this huge opportunity outside of their home market. Yes, America is a large country and there are a lot of different geographies, but there are many ways to approach the local nature of venture capital.
We’re building a network of venture scouts across the country in our markets who can be our eyes and ears on the ground. Those venture scouts are entrepreneurs themselves; they’re not angel investors, they’re not other VCs. They are operators who are already building businesses in their geographies. Entrepreneurs attract other entrepreneurs, and there are usually at least four or five in a given market who have a very strong gravitational pull to other founders. As we’ve been building our network of scouts, those are the types of people we’re looking for. That will help us be more present in different geographies.
We’ve built a broader team and a bigger platform from day one, because we feel that founders, especially in these emerging ecosystems, don’t necessarily have access to all the tools they should have and would have were they in either a larger coastal city. So we brought on functional partners like Justin [LaBaw-Rivers], our design partner and an expert in user interface and user experience, and Nancy [Soni] our talent partner who built a business around moving people across the country and placing them into exciting new roles in tech. That’s really just the beginning for us. Diverse firms attract diverse founders, and we’re on a mission, too.
Write to Mary Childs at email@example.com
Originally Published on November 15, 2018 at 07:46AM
Article published originally via opportunity zones – Google News https://www.barrons.com/articles/q-a-venture-investing-in-qualified-opportunity-zones-1542283201