Since it was announced, OZ legislation has catalyzed the formation of an estimated 92 new OZ real estate funds and already more than $26.6 billion in new capital has begun to flood these funds. We believe the same will happen to OZ businesses.
While real estate is typically a reliable way to generate capital gains over time, we believe that real estate prices in OZs are already overinflated and many investors are meeting all the new OZ fund offerings with the same skepticism. Therefore, we believe that the legislation’s impact on operating businesses will quite literally open the floodgates for investors looking to speculate on riskier but potentially more rewarding company-level investments on businesses based in opportunity zones since the risk/reward may actually be more compelling.
In our estimation, this is going to incentivize a new wave of capital for businesses that figure out how to tap this capital source.
We believe that an entire ecosystem of businesses will form to service this new wave of businesses in underserved communities. From co-working spaces to commissary kitchens, the possibilities are endless.
Not only does this ruling stand to improve the funding options for minority-owned businesses already based in these neighborhoods, but we also believe that many young companies will consciously choose to relocate to take advantage of these benefits, creating new high-paying jobs with considerable equity compensation in neighborhoods that have missed out on much of this growth.
How do the tax benefits work?
As an example, if Uber had been a designated Oz business and an early investor had invested $50,000 in the company’s seed round, that investment was worth approximately $248 million in the recent IPO. That would mean the investor would owe more than $50 million in capital gains taxes. If Uber had been an OZ business designation, 100% of those taxes would be avoidable. Instead of ending up with $200 million, the investor would keep all $248 million.
An online database of OZ businesses is beginning to catalog all of the eligible businesses. Interested investors can search by zip code or category.
Not only does this legislation have bipartisan support, but the potential social impact and increase of capital to a fragile startup ecosystem outside the major tech hubs is a seriously positive development for economic development in underserved communities.
We think this could be as transformative to the startup ecosystem as the ICO craze was in 2017.
Legislative policy has the potential to dramatically impact capital flows. Consider the mortgage interest tax deduction which created our nation’s enormous single-family home real estate economy. Also consider 401ks, which have created the retirement investment market. Government incentives reshape industries in a massive way. Opportunity zones are likely to have a similarly massive impact on the small business and startup ecosystem.
You heard it here first.
Here at Compound we are taking advantage of this and are qualifying as an opportunity zone business to provide tax benefits to our investors.
*The new guidance clears this large hurdle by creating four distinct tests that can be used to qualify a business under the new 50% test:
- Total hours worked by employees and independent contractors within an Opportunity Zone must be at least 50% of the company’s total hours worked.
- Total dollars paid to employees and independent contractors for services performed within an Opportunity Zone must be at least 50% of the company’s total dollars paid for services performed.
- Both the management/operational staff and the tangible property of the business that is in the Opportunity Zone must be necessary to generate 50% of the company’s gross income.