Investing in overlooked entrepreneurs
A central animating theme of the American dream is that anyone with an idea can launch their own business. This entrepreneurial energy makes enormous contributions to society by addressing unmet needs, improving lives and solving pressing problems. These entrepreneurs also serve as an economic engine for communities by creating jobs that lift people out of poverty.
But that engine is breaking down. Capital pools are drying up, leaving many entrepreneurs without a means to finance their ventures. More than 75 percent of venture capital in the U.S. is invested in just three states: New York, California and Massachusetts. More than 10 years after the financial crisis, small business lending remains below the pre-crisis level.
The federal Opportunity Zone program could change that. The program encourages those who have benefited the most from the economic recovery – those with capital gains – to reinvest those gains in projects located in struggling communities. These 8,700 low-income neighborhoods designated as Opportunity Zones tend to have higher unemployment, lower incomes and larger minority populations. But they also have overlooked entrepreneurs and innovators who have been bypassed by investors.
The law offers three tax incentives for investors that grow the longer the investment stays in an Opportunity Zone: Deferred payment of the federal capital gains taxes on the reinvested accrue until 2026, a capital gains tax liability reduction of up to 15 percent if they hold the investment for up to seven years and no taxes on any generated gains from that investment if held for at least 10 years.
Venture and small business investments are a natural fit for the program given that qualifying investments must be equity. But many investors stayed on the sidelines while waiting for the Treasury Department to clarify how several provisions of the law apply to business. Treasury proposed several ways for businesses to meet a gross income test that protect the program from abuse while also supporting local businesses such as hardware stores as well as internet businesses.
What does all this mean for the nation’s innovation ecosystem?
For investors, Opportunity Zones offer a new pool of eligible capital and new financial vehicles through which to invest it in areas outside of Silicon Valley. Hypothesis Studio is focusing on investment in health care technology, education technology, agricultural tech, financial tech, mobile and the internet of things. Modeled after the Edison Labs, Hall Labs will soon launch a new Qualified Opportunity Fund called Hall Venture Partners to invest in early stage companies. Capital intensive projects such as renewable energy are also well positioned for the patient capital incentives built into Opportunity Zones. That has attracted the attention of investors such as the Obsidian Opportunity Fund investing in projects such as solar farms.
There is also an opportunity to leverage this program to help those most marginalized by the current venture ecosystem. Only 10 percent of venture funding goes to women, and less than 1 percent to African Americans. In Philadelphia 41 percent of the population is African American but only 2.5 percent of businesses are African American-owned.
Opportunity Funds can be structured to support these underserved groups. WIFAX is using a mix of an incubator, shared workspace and investment in companies where the C-suite is made up of at least 50 percent women. After nine seasons in the NFL, Derrick Morgan retired and launched the KNGDM Impact Fund, which will invest in minority-owned businesses. In Washington D.C., 20 Degrees has launched an Opportunity Zone Justice Accelerator (OZJA) program, which seeks to strengthen and grow businesses founded by people who were once incarcerated.
For entrepreneurs, locating their business in an Opportunity Zone opens expanded investment options. For example, Galen Robotics was able to take in additional Opportunity Fund investment to move its surgical robotics company from Silicon Valley to an Opportunity Zone in Baltimore. CoLabs, a company that specializes in Software-as-a-Service (SaaS) using artificial intelligence has been able to raise $6.2 million in Qualified Opportunity Funding.
A growing number of incubators are also strengthening local entrepreneurial ecosystems. In Ohio, the Youngstown Business Incubator and Bounce Innovation Hub offer the chance to learn about advancing manufacturing and industrial 3D printing. Located in the middle of a Tampa Bay Opportunity Zone, the Embarc Collective is helping start-ups with coaching, talent acquisition, product testing and securing investment.
The capital available through Opportunity Zones offers a needed boost to help revive main streets in struggling communities and jump start new businesses. But it also can help unlock a new generation of entrepreneurs helping not only their communities in local Opportunity Zones but unleashing new innovations that can serve the rest of the country as well.
John Bailey is a visiting fellow at the American Enterprise Institute and an advisor to the Walton Family Foundation. He is a former White House advisor, deputy policy director at the U.S. Department of Commerce, and cofounder of Whiteboard Advisors.
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