Starting a business is hard, and it requires patience, hard work and perseverance. It also requires capital. Unless you have a trust fund, a huge savings account or a wealthy partner, you will need to not only build your business, but also raise money to get it started.
Whether you’re starting a time-tested business like a restaurant or a hair salon, or building a startup with a business model that has never been done before, your access to capital is likely to determine much of your success (or failure.) Loans make sense for certain types of businesses and they tend to be readily available. But, businesses that need patient equity capital have fewer options.
All of that is about to change. The opportunity zone incentive has created an enormous opportunity for startups and small businesses and it stands to dramatically increase equity capital for young companies.
Opportunity zone legislation was established by Congress in the Tax Cuts and Jobs Act of 2017 and was designed to incentivize investment in underserved neighborhoods around the United States and its territories by providing generous capital gains tax reductions for real estate developments in those areas. In 2018, the U.S. Department of the Treasury released a map detailing the location of every opportunity zone in the country. Real estate investment firms pounced on this news in 2018, and more than 1,700 opportunity zone funds were announced, all designed to funnel investment into real estate projects in these zones. Over $26 billion in capital has already been committed to these funds.
Then in April 2019, the IRS released additional clarification about tax benefits for investors who invest in businesses that are based in opportunity zones. This changed the game.
Investors in businesses based in designated opportunity zones are eligible for the same exact capital gain tax benefits as real estate investments in opportunity zones. Qualified opportunity zone businesses must pass certain tests of revenue and income to self-certify, but in general, as long as businesses are headquartered in an OZ and are not engaged in vice (for example, they cannot be massage parlors, hot tub facilities, tanning salons, racetracks, gambling facilities or liquor stores), they are eligible.
So far, the capital flow to OZ businesses is still just a trickle, but I predict that now that the word is out, a wave of change is coming.
Government incentives often reshape industries in a massive way. There are many examples of legislative policies that have dramatically impacted capital flows. For example, the mortgage interest tax deduction created our nation’s enormous single-family home real estate economy. The 401(k) legislation created the retirement investment market. Opportunity zone legislation will have a similarly massive impact on not only residential real estate, but also the small business and startup ecosystem.
If even a tiny percentage of the real estate capital allocations finds its way to company-level investing in OZ businesses, then this legislation will have created an entirely new category of funding for American small businesses and startups — and what’s more, it will have done so in underserved markets where such funding has historically been harder to come by.
Therefore, if you are considering starting a business — a business that requires equity capital — you should consider qualifying as an opportunity zone business. That means basing your business in one of the designated zones and hiring most of your employees to work in that location. (There are a host of other requirements to ensure that the intent of the law is not abused, but they are not hard to satisfy if the business owner is committed to locating in an opportunity zone.) This legislation could be a windfall for young companies in these locations, and what’s better, they’ll actually create jobs in neighborhoods that need them.