Most discussion of the new federal Opportunity Zone program has centered on how its potentially substantial tax benefits could boost investment in real estate in economically-distressed communities. Less recognized, but also significant, is the program’s potential to drive angel and venture capital investment in these struggling neighborhoods.
Created as part of the tax bill passed by Congress in 2017, the opportunity zones initiative offers long-term tax breaks for investment in businesses that have 90 percent of their assets in designated opportunity zones. This favorable tax treatment offers clear benefits to angel, venture capital and social impact investors and could go a long way to getting unrealized capital gains off the sidelines and rolled into qualified opportunity funds, investment vehicles established for investing in opportunity zone businesses.
The opportunity zone initiative effectively reduces some risks inherent in investing in any startup company and particularly in those operating in distressed communities. The program would provide an upfront tax benefit in the form of deferred payment of tax obligations until 2026, coupled with a tax basis step-up for opportunity fund investments maintained for at least five years.
The step-up increases for investments held for more than seven years. Additionally, investments held for at least 10 years will receive a 100 percent tax basis step up – the equivalent of the fair market value on the date that the opportunity fund investment stake is sold or exchanged, meaning no federal taxes will be paid on the sale.
Along with encouraging long-term investment in low-income, high-poverty areas, opportunity zones could prove transformative in opening up early stage funding for those from groups typically underrepresented among entrepreneurs, including business founders who are minorities and / or economically disadvantaged. These underrepresented founders frequently lack networks with ready access to disposable income, which leaves them unable to tap into the usual “friends and family” round of early stage financing.
With less than 1 percent of angel and venture capital going to black and brown founders, any increase in funding availability for this growing demographic of entrepreneurs amounts to an improvement. Certainly, not all of those starting or expanding businesses in opportunity zones will be minority entrepreneurs. Even so, there is solid potential for opportunity funds to spur investment in companies created by black and brown founders, who are already selling products or providing services in these underserved neighborhoods.
Here in Baltimore, and around the state, the pool of innovative, scalable ideas from nontraditional entrepreneurs extends well beyond the startup funding programs currently available. Some are working to build tech companies, while others have created small businesses selling specialty drinks and cocktails or products for textured hair. They share a drive to take their businesses to the next stage and the struggle to get the financing to make that happen.
In October, the U.S. Department of Treasury issued proposed regulations on opportunity zones and opportunity funds. Final rule-making remains before the program is formally introduced and opportunity funds can be structured. Although the Opportunity Zone regulatory framework is still taking shape, the tax incentives for private investors are likely to remain very attractive.
It will be interesting to see if opportunity funds bear out the promise they show as a game changer for funding access for minority entrepreneurs. For opportunity zones to support the development of more inclusive startup ecosystems and bring about lasting change, they must create opportunities not just for private investors and outside founders, but also for the homegrown entrepreneurial talent that springs from struggling neighborhoods more often than is commonly recognized.
Healing communities, in Baltimore and elsewhere, begins with nurturing the businesses that start there, grow there and stay there.
Venroy July is a principal at Miles & Stockbridge, where he counsels clients on private equity and venture capital financing as well as other transactional, corporate law and corporate governance matters. McKeever Conwell II is co-manager of the Minority Business Pre-seed Fund at the Maryland Technology Development Corporation (TEDCO), where his focus is business founders who are economically or socially disadvantaged.
Originally Published on December 24, 2018 at 10:17AM
Article published originally via “opportunity zones” – Google News https://www.bizjournals.com/baltimore/news/2018/12/24/viewpoint-opportunity-zones-may-spur-angel-vc.html