On September 24th, the Economic Innovation Group hosted a webinar to share emerging efforts to support new and growing operating businesses in Opportunity Zones.
Presenters covered a host of topics; from structuring and managing Qualified Opportunity Funds (QOFs), to becoming a Qualified Opportunity Zone Business (QOZBs), to real-time insights on raising capital from Opportunity Zone investors, and more. Highlights from the webinar and a full recording is available below for more information.
Creating a vibrant investment ecosystem for entrepreneurs and small businesses is key to realizing the promise of Opportunity Zones. There has been a significant uptick in activity across both the public and private sectors to support investment in operating businesses since Treasury released the second round of proposed regulations in April, which provided much needed clarity and guidance.
- Catherine Lyons, Economic Innovation Group, kicked off the webinar by discussing the key issues addressed in the second round of regulations, as well as what additional tweaks might be needed to optimize functionality.
- Rachel Reilly, Economic Innovation Group, followed by sharing examples of incentives and resources being offered at all levels of government to support employers and employees in Opportunity Zones, as well as a number of Opportunity Funds, intermediaries, and investments in operating businesses geared toward impactful outcomes.
- Korb Maxwell, Shareholder at Polsinelli, then discussed the portfolio of work he is leading for his firm to structure transactions, saying “we are starting to make real positive change in communities and I think that is only going to continue to grow.” He shared six iterations of structure models, as well as a seventh hypothetical model for a tax exempt organization.
- Brian Phillips, Managing Partner at The Pearl Fund, shared his experience as the first venture capital fund to have launched an QOF, including the challenges presented by the initial lack of regulatory guidance. With increased certainty, he spoke about the high potential of venture capital investing in operating businesses located in Opportunity Zones, calling the potential upside of the policy “unprecedented” and citing beneficial social outcomes through job growth and increased local spending.
- Anne Driscoll and Chris Schultz of Launch Pad then provided their insights and advice as an organization that recently became a QOZB, is in the process of raising capital, and is building the capacity of others looking to do the same. They underscored that traditional impact investors, including individuals and funds within Opportunity Zones, are needed to support early proof concepts, saying “investors invest where they live, where they work, where they grew up so that’s a great way to target.”
See below for answers to questions asked presenters by participants during the webinar presentation.
Question & Answer
Disclaimer: The views represented below do not necessarily reflect those held by the Economic Innovation Group. The content provided below is based on questions received during the September 24, 2019 webinar, and guest speakers’ responses are based on their personal experiences. Please do not attribute information provided below as the viewpoint of EIG. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Our thanks to Launch Pad, Polsinelli, and The Pearl Fund for participating in this webinar and spending time to share the insights below.
Does Launch Pad have any rural sites in Opportunity Zones (OZ)?
Launch Pad (LP): Launch Pad’s current operations are in New Orleans, Newark, Memphis, Nashville, and Stockton. As of September 30, 2019 we have entered into agreements in Philadelphia, San Antonio, and Mesa. We are also finalizing agreements in a number of additional cities that will support entrepreneurs in a diverse set of momentum markets across the country, and leverage the Opportunity Zones (OZ) benefit for business and entrepreneurial growth in rural, suburban, and urban communities. We would be very interested in opening Launch Pad locations in rural markets, in addition to connecting with investors or grant funders who are working to support economic development through the ability of people to work entrepreneurially in rural sites. We would welcome making a concerted effort together and encourage any organizations pursuing these efforts to get in touch with us.
How can Launch Pad benefit from the OZ incentive if it’s been around for longer than the last 2 years?
LP: Our mission is completely aligned with the OZ benefit. A number of our current spaces were opened in 2018, and our new spaces will all qualify for the OZ benefit. We are working closely with our accountants and lawyers to structure Launch Pad MGMT as a Qualified Opportunity Zone Business (QOZB) for our investors. Our original location in New Orleans does not qualify, even though it is in an OZ, and for this reason it is not wholly owned by Launch Pad MGMT. To us, what’s more important is the fact that by virtue of Launch Pad spaces being located within OZs, it will support businesses for those operating in our locations who believe taking on OZ capital will be beneficial. Additionally, we will raise a venture fund to support QOZBs operating at Launch Pads and in the markets where we are working.
Why not form multiple single-asset funds in parallel?
LP: Single-asset funds in parallel are attractive for real estate and for some QOZB investments. As we structure our venture fund, we have the benefit of looking at this from the perspective of an investor and founder/business-owner since we are currently going through our raise. We anticipate our QOF that will focus on business growth in OZs will have both tax-advantaged (OZ) gains and non-tax advantaged investment capital and we will work with our investors and our portfolio companies to find the best fit. We have developed a proprietary fund structure for the venture fund that does involve multiple QOF’s to hold stake in each underlying QOZB. This will achieve the portfolio effect necessary for a diversified venture fund while allowing the risk mitigation of a single QOZB becoming non-qualifying to not impact the whole portfolio of QOF investments.
Would public funds count as a Joint Venture (JV) partner?
Polsinelli (P): Yes. A public fund can be a JV partner in an OZ investment.
Does the business have to purchase a building in order to qualify or can they be renting space?
P: A business can rent space and qualify. The most recent round of proposed regulations specifically approve leasing property in an OZ, and the value of the lease counts as qualified property for purposes of the QOZB asset test, which requires that 70 percent of the tangible property owned or leased by a QOZB be qualified property. The lease value is generally determined by the present value of all payments under the lease, including renewals (where the lease amount is fixed).
What is the strategy for substantial improvement today, considering asset-by-asset method?
P: Unfortunately, the asset-by-asset requirement does present some significant administrative issues, and our first strategy with operating businesses is to try to avoid it. The strategy often depends on the type of business we are dealing with. First, to be a QOZB, 70 percent of the tangible property of the business must be qualified, by being acquired from an unrelated party after December 31, 2017, and meeting either the original use or substantial improvement test (not both). However, leased property can qualify without meeting either the original use or substantial improvement test.
For example, a start-up or tech business, which has very little tangible property, may be able to meet the 70 percent test without regard to the substantial improvement test simply through its office lease, leasing some furniture, and the purchase of a few computers (which do not have to be new). On the other hand, a business heavy in tangible assets may have to use a leasing strategy until it can either substantially improve enough property or purchase enough new property. Otherwise, it may be necessary to undertake a somewhat painstaking review of the tangible assets of an operating business and determine when each was acquired, whether it may be possible to substantially improve it, and what additional property may be purchased or leased in order to ensure that the test is met.
Given the difficulty of running a small fund at “Two and Twenty” (refers to a fee arrangement), is there an appetite from investors to accept higher fees?
The Pearl Fund (TPF): Larger well-known venture capital funds do charge higher fees and often are still oversubscribed. If they were to move into QOZB/venture, they probably could demand higher fees and easily get them. Given that this is an emerging space with new actors, fundraising can be difficult and many think raising fees at this time may further hamper investment. Perhaps this will change in time, with momentum in the space.
Will The Pearl Fund implement strategies to include current residents and/or mitigate gentrification impact?
TPF: Each company that The Pearl Fund(s) invests in must have more than half of all employees and subcontractors working inside one or more OZs. We expect each to grow rapidly and thus hire more and more people as time goes by. Each company is unique in the products and services they provide and thus in what their hiring requirements will be. Qualified local residents in the OZs where they operate will have an advantage over potential hires who need to be relocated or have long commutes.
Additionally, due to the focus on operating businesses, jobs created in the communities are likely to remain in the communities (vs. project-based construction jobs), to be higher-value and higher-skill jobs that build career trajectories, and to include additional wealth creation elements such as stock options. Many of the operating businesses and the managers of geographically based Pearl Funds are deeply networked into their local communities, including local and state governments and civic groups, chambers of commerce, and local universities, all of which increases the relevance of the businesses to their local communities and further opens the pipeline for local resident involvement and employment.
All Pearl Fund investments are also being measured on impact metrics including job and wealth creation in the local communities, along with management by as well as hiring and promotion of women, minorities, veterans, and other recognized groups. The Pearl Fund is committed to the dual ambition of OZ, namely tax-advantaged returns for investors and substantive positive economic and social impact in OZ communities. We actually believe these two goals go hand-in-hand, due to our direct experience both in the U.S. and in global economic development. Investment in entrepreneurship, in our experience, is an extraordinary catalyst for sustainable community development, while also holding the potential for exponential investor return on investment.
Will this fund provide socially priced shares for low income investors?
TPF: All of our OZ/venture funds are Schedule D 506(c) funds and are regulated by the SEC. This means each fund is limited to accredited investors only and allows only 99 investors per fund, all of which are of the same class. We are looking to ways we might be able to have other funds that could co-invest in the same opportunities that don’t have these requirements. This is a still evolving frontier for OZs.
EIG’s OZ Webinar Series: This webinar was the fifth in a series EIG will host throughout 2019. These webinars address a variety of topics related to Opportunity Zones implementation, showcase best practices from around the country, and serve as a resource for investors, project sponsors, and community developers looking to use the incentive. So far, EIG has covered an introduction to Opportunity Zones, an analysis of the most recent round of regulations, and community best practices in heartland, rural, and tribal communities.
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