I never thought I’d be sending 🙌emojiss in Slack about IRS regulations, but Drew Carlson shared the regs that treasury dropped today, and boy is it favorable for the Opportunity Zone legislation in particular for startups.
If you haven’t been following this as closely as we have been at Launch Pad, the Opportunity Zone legislation is a tax incentive designed to increase the flow of capital into underserved communities across the country. Traditional tax incentives have been complex and virtually impossible for small businesses to take advantage of — incentives like New Market Tax Credits (NMTC) have benefited real estate developers on big projects but have been beyond the reach of most companies because they just aren’t worth the brain damage.
TL;DR — we didn’t know if OZs would really work for startups
There have been a number of open issues with the Opportunity Zone legislation that amount to panelists at conferences, accountants and attorneys all qualifying their enthusiasm with “we’ll have to wait for the regs to come out.”
Well, as of today, they’re real and they’re spectacular.
As John Lettieri, president of the Economic Innovation Group said in the New York Times.
“This round of regulations removes some of the most significant impediments keeping capital on the sidelines, especially as it relates to operating businesses,”
The open issues had the potential to be deal breakers for startups to be Qualified Opportunity Zone Businesses (QOZBs), most significantly a test whereby 50% of the revenue needed to come from within the OZ. Most startups target global markets or at least sell to customers outside of their immediate census tract, so this rule would have virtually killed the benefit for startups. Fortunately, this was resolved with today’s guidance, according to the WSJ.
“Under Wednesday’s rules, Treasury says a business can qualify if 50% of its employees’ hours or wages are in the zone. A business can also qualify if property and managers needed to produce 50% of the revenue are in the zone or if it can otherwise show that 50% of the revenue is generated in the zone. The location of customers would be largely irrelevant, the official said.”
Just as significant as the regulations for startups are the rules that came out for Opportunity Funds (which we are watching closely at Launch Pad… stay tuned for what we are working on). If rules made it too difficult to create Opportunity Funds that would invest in operating businesses, this would also have killed the flow of capital to startups in these underserved markets. Once again there were several rules that came out favorably to funds, as our friend Steve Glickman highlighted.
Opportunity is knocking…
OK, OK, clearly we’re geeking out over an IRS tax incentive program. You might be asking yourself:
“So, what does this mean for me?”
We believe there really is a first-mover advantage here. For one thing, the program is already live. In fact, Launch Pad raised capital using an Opportunity Fund in our seed round that closed in January. Let me lay out some thinking on why it makes sense to dive in, understand what’s going on, and, if you are trying to raise capital, consider Opportunity Fund investors.
- The clock has started —Because this legislation requires a 10 year hold, the maximum capital gains tax benefits will flow to investments made early in the program. That means this year is better than next year since the program is only authorized through 2026 (for now).
- People raising funds are required to deploy capital — Unlike traditional VC, there is a requirement to deploy the tax advantaged dollars within a limited period of time; therefore, you will find some investors looking to make investments because they are up against a clock. (As I always say, tax incentives are lagniappe, so you still have to be a great company to invest in.)
- There is a dearth of dealflow — we are talking to a lot of investors right now and they are not seeing q̶u̶a̶l̶i̶t̶y̶ any operating company deals. I hear this a lot. This program has the potential to unlock billions of dollars of capital into underserved markets, and no one can find good deals. Be the unicorn!
As we shared above, your business must be located in an Opportunity Zone to qualify for this program. If you work at Launch Pad, you’re in an Opportunity Zone. And if not? You should come check us out.
True to the Intention of OZs
A crucial point here is that not only does this benefit startups, but in doing so, it really opens up the door for the community impact and type of job and wealth creation that’s the whole idea of the legislation in the first place.
Startups are the engines of resilient job growth in a way that real estate alone can’t be, so these new regs nailed it in their intention of impact in OZs that officially sets it apart from NMTCs.
We’ve seen this happen first hand in the 10 years that we’ve been running Launch Pad in New Orleans, and it’s starting to happen in the markets that we are expanding to. We want to celebrate the regulations coming out in a way that aligns with our intention and our mission — to create economic development through entrepreneurship in underserved communities across this country.
Let’s go get ‘em!
If you’re interested in learning more, Launch Pad and OZ.Guide are hosting a forum on Opportunity Zones at the inaugural InnoConf in New Orleans on May 1st. Email us at firstname.lastname@example.org if you’re interested in attending, or buy tickets on the website.
In addition, Chris will be speaking on investing into operating businesses at the Novogradac Opportunity Zones Conference in Denver next week, and Anne is speaking at the Forbes Opportunity Zones Summit in Newark May 21st.
Big shout out to Drew for all his help summarizing the regs and inspiring this post.