The next big venture-capital gold rush may be in Opportunity Zones, dubbed the 'emerging markets of the United States'
- Venture capital firms are starting to launch and raise funds to invest in companies located in designated Opportunity Zones, where investors can get protection from certain taxes.
- So far, most of the money pouring into Opportunity Zones has been from funds looking to purchase real estate, but recent regulatory guidance from the Internal Revenue Service states that it’s also possible to invest in businesses.
- The Opportunity Zone tax break, pushed through Congress by Senators Corey Booker and Tim Scott, defers taxes on the sale of a stock, bond, property, or business if an investor places the money into a fund that invests in a low-income area.
- Venture capital funds that have been set-up are targeting companies in Scranton, Brooklyn, Newark, and Provo, Utah.
Venture capitalist Dan Borok didn’t set out to create a fund that would benefit from Internal Revenue Services’ Opportunity Zone tax break. He was trying to invest in new businesses in Newark.
But when the IRS placed Newark among the neighborhoods eligible for tax-deferred funds, it was a no-brainer for Borok: He was going to a run an Opportunity Zone fund now.
Newark Venture Partners’ $40 million fund is one of several VC funds that aims to benefit from the new tax law, which allows investors to sell an asset and within 180 days reinvest those profits into opportunity-zone-focused investments. The profits are later taxed at various levels depending on how long the capital is invested.
Ever since Senators Tim Scott and Corey Booker, who is from Newark, pushed the Opportunity Zone legislation through, real-estate investors have been preparing funds to invest in building projects across the country.
See more:Big-money investors are piling into ‘opportunity zone’ funds in lower-income neighborhoods, but there are a bunch of reasons to be cautious
But only with a recent regulatory update from the IRS has venture capital started looking at the space. Millions of dollars in VC money is now being pulled together to invest in companies in Scranton, Brooklyn, Newark, and Provo, Utah.
“People call me all the time and say ‘Hey, I was just talking to my accountant, is this real?'” said Brian Phillips, who runs the $25 million Pearl Fund that will invest in businesses in Scranton, Pennsylvania and Brooklyn.
Potential of big returns
Troy Gayeski, co-CIO of fund-of-hedge-funds SkyBridge Capital, called opportunity zones the “emerging markets of the United States,” in terms of the potential investment return. Gayeski was speaking on a panel at the SALT Conference last week in Las Vegas. For an investing community starved of yield, the chance to get exposure to venture capital-level returns is enticing.
Estimates vary widely on how much money could be pumped into Opportunity Zones funds; the main lobbying arm that pushed to include them in 2017 tax reform, the Economic Innovation Group, has it projected as high as $2 trillion. Sen. Scott has floated a $100 billion figure.
The newest update from the IRS gives venture capital funds more wiggle room to find attractive start-ups to invest in while also getting the tax benefits from the regulation. The original legislation stated that half of the taxable gross income must be made in an Opportunity Zone to qualify, but the most recent regulatory update stated that companies can also qualify if half of the total hours worked by employees or total dollars paid to employees were in an Opportunity Zone tract.
See more:In its return to the Bellagio, Scaramucci’s SALT conference shuns hedge funds for political pros
The new guidelines from the government were “more generous than many practioners expected,” and it has spurred “immediate interest” in venture capital funds aimed at the more than 8,000 qualified neighborhoods, John Lore, managing director at Capital Fund Group, said in an interview.
One last hurdle venture capital funds getting into the space need to be aware of is the timeline required by the tax break, Lore says. To get the tax break, all funds must invest their capital within 30 months after fundraising ends — “a shorter timeframe than usual,” he says.
“The structuring needs to reflect that,” he says. There is a chance that regulation is lessened after a comment period. A statement from Scott’s office said “it is critical that we make certain the regulations will work for operating businesses and job creators, and I look forward to hearing from these folks during that process.”
Venture capital might be more attractive for investors than real estate. While real estate can be the safer call, venture capital returns have more potential. Thompson Reuters Venture Capital Index has returned 31% over the last five years, compared to 7.9% by Vanguard’s Real Estate index fund.
‘Not mom-and-pop businesses’
Phillips, who has been the CEO of several tech start-ups that were then purchased by larger companies, said his fund is targeting young companies with big growth potential, “not mom-and-pop businesses.”
While the Opportunity Zone tax break has been met with enthusiasm in the investing world, community advocates have been vocal about protecting against gentrification and displacing long-time residents.
Despite a focus on companies that could change the fabric of many towns, Phillips and Borok both believe that venture capital is more community friendly compared to real estate funds, which require rents and real estate prices to increase to make money. Both funds have been geared to focus on communities they know — Borok grew up near Newark, while Phillips said he splits his time living in the communities in Brooklyn and outside of Scranton.
Borok also said some big-name employers in Newark — like Prudential — have supported the work his firm has done bringing start-ups to the city.
“I don’t want to be invested in companies all over the country, we want to roll our sleeves up and get to work with our investments,” Phillips said.
“Our dream is that other people across the country, in Oklahoma and Iowa and everywhere else, see what we are doing and decide to set up something similar in a community they know.”
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