(Photo by Flickr user tehshadowbat, used via a Creative Commons license)
This essay was originally published via ImpactPHL Perspectives, a multi-part series which explores the many facets of the impact economy in Greater Philadelphia from the perspectives of its doers, movers, shakers and agents of change. This version has been edited for style only.
It’s just days before Christmas 2019, and we await the gift of regulatory clarity. Word is out that final OZ regulations have made their way to the White House. Can these offer what we need to craft a path forward for using this tax-benefited capital tool to grow local businesses?
Private markets can provide far more capital that can make a difference in our regions than either Washington, DC or our state capitals ever can. As a public-private partnership supported by the state to spur innovation and job growth through our investments in early-stage, technology-based firms, Ben Franklin Technology Partners of Southeastern PA has made this the basis of our capital strategies for years. We combine the best practices of early stage investing with social impact, creating jobs and transforming lives. Ben Franklin is the leading seed stage capital provider for the region’s technology sectors, with over $200 million in investments in more than 2,000 regional technology companies, many of which have gone on to become industry leaders.
The Opportunity Zone (OZ) framework created in the 2017 tax code update promised to amplify this mission by attracting new capital to low-wealth communities. Our resources and the scale of a regional OZ fund were sure to be smaller than the big players could create, so we hoped to learn, and then ride the coattails of other OZ funds raising business capital. With support from the U.S. Economic Development Administration, we dug in, studying the tax code, engaging expert advisors and conferring with others seeking similar goals. To our dismay, however, we have not yet found such coattails.
Our advisors, seeing the same challenge with others with whom they worked, captured these issues and the conditions that kept investors on the sidelines despite the OZ tax benefits. In Realizing the Transformative Potential of Opportunity Zone Business Investing: A Guide for Practitioners, Bruce Katz, director of Drexel’s Nowak Metro Finance Lab, and Evan Weiss, senior advisor for public finance to New Jersey Governor Phil Murphy, detail how the Administration and Congress can unlock investment in Qualified Opportunity Zone businesses (QOB) and fulfill the OZ promise of creating quality local jobs, greater community wealth and growing economies.
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The most important correction would require statutory change. As business investors buy and hold investments for variable lengths of time based on the success and growth trajectory of a business, taxes on interim gains incurred by an Opportunity Fund that buys, sells and reinvests in different businesses during the 10-year holding period should also be exempt.
But other regulatory adjustments could accelerate the creation of OZ funds that would attract capital to high-impact ventures in distressed places. These include:
- Clarifying the 40% intangible property test. This test requires that at least 40% of a QOB’s intangible property be used in active conduct of its business. Clarifying the test would ensure investors feel confident investing in high potential IP-intensive companies like tech and biosciences. The April 2019 regulations presented multiple ways to meet the requirement that more than 50% of gross income comes from active conduct of business in an OZ. Something similar would offer offer a strong solution.
- Dropping the “asset by asset” substantial improvement requirement and allowing business-level investments to count towards the substantial improvement test. The goal should be to ensure investment in businesses, not just in their tangible assets: an investment that allows a business to hire should count as an investment in new equipment does.
- Greater clarity for the “facts and circumstances” methodology for the 50% gross income test. Such clarity could help businesses, like in life sciences, that depend on highly specialized contract research and manufacturing. It is still unclear what it means for a fund that may not meet other safe harbors to be subject to a test that based on all facts and circumstances, 50% of the gross income is derived from active conduct in the QOZ.
- Greater flexibility for the 31-month working capital safe harbor and new rounds of investment. For sectors like life sciences and advanced manufacturing, adding additional time to the 31-month period would encourage investment in those businesses. Allowing for infusions of additional growth capital without restarting the ten-year clock could also better suit the lifecycles of IP-intensive businesses.
As an investor committed to regional growth, Ben Franklin is motivated to make Opportunity Funds work and would be fully prepared to report on the social and economic impact of our investments. Such reporting is a reasonable element of incentive requirements.
However, if not for the generous pro bono assistance of counsel and advisors, the work to figure investment structures and assure compliance would be cost-prohibitive, This means that better-resourced real estate projects in the queue would have an even greater advantage over smaller, high-impact business deals.
Routinized and democratized assistance for development and compliance would open the playing field to smaller fund managers and smaller deals. Opportunity Fund rules seem easier than many tax incentive programs. But because funds must make equity investments, nascent but viable businesses managing equity investment for the first time may struggle to meet difficult compliance needs that require accountants and attorneys. Developing and distributing simple documents to guide businesses could facilitate Opportunity Funds’ use.
We recognize that we currently have more questions than answers. We continue to probe what can be possible. We believe we have reached a threshold moment when leading practitioners and investors must apply the same fervor traditionally reserved for attracting and retaining big corporations to instead developing and adapting solutions that facilitate high-growth small and young businesses, particularly in Opportunity Zones. We cannot squander this opportunity for success.-30-
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