Our small business community faces an existential threat. [1] While government assistance and philanthropy have provided critical support for many businesses, the prolonged economic impact of the pandemic requires us to do more. It requires us to do things differently. Opportunity Zones have the structural framework to be a transformative tool, but only with targeted implementation and key policy reforms.
Since OZs are a tool designed to spur economic development and job creation in distressed communities, let’s use them right. [2] The legislation’s purported intent in other words, is shared prosperity. To make this a reality, qualifying investments should be required to prioritize the creation of high-quality, attainable jobs while offering existing residents an avenue to participate in the broader economic development occurring around them. This can be done through direct investments in purpose-driven companies, investments that build community wealth through collective ownership, and by expanding legislation to allow for direct investment in Community Development Financial Institutions (CDFIs).
QOF DIRECT INVESTMENTS IN OPERATING BUSINESSES
Only 3% of the 811 tracked Qualified Opportunity Funds (QOFs) invest in operating businesses, and only 1% invest exclusively in operating businesses. [3] The proportional flow of capital to real estate via this economic development tool is staggering. Imagine how distressed communities across the country would be transformed if a meaningful portion of this capital was invested in the creation of permanent, high-quality jobs that were attainable for existing residents.
QOFs can currently make direct investments in operating businesses. Though it can be enormously productive, this type of direct investment takes substantial investor and entrepreneur commitment to utilizing the incentive. Deployment rules and the strict investment time frames introduce complexities not typically encountered in venture capital. The types of small businesses most in need of capital don’t typically generate the kind of growth that private investors require.
However, mission-oriented investors have a powerful tool at their disposal. Community Development Financial Institutions (CDFIs) have been investing in capital and resource starved communities for decades. These organizations have strong track records deploying capital while mitigating risk and returning measurable impact. Through extending capital to businesses when mainstream financial institutions wouldn’t, they’ve built profound community trust which translates into unique deal flow inaccessible to outside investors.
Interested investors can finance the growth of small businesses through diversified QOFs administered by CDFIs. Impact investors can access these investments while building on the expertise of local economic development organizations.
BUILDING COMMUNITY WEALTH THROUGH COLLECTIVE OWNERSHIP
There’s nothing inherently equitable or positive about OZs. But when thoughtfully implemented, this legislation can make it easy to invest in more inclusive and equitable economic development. Two underutilized applications of the legislation could transform distressed communities by offering workers and current residents avenues for participation in the wealth creation.
Small businesses nationwide are poised to undergo a significant shift in the coming decade. Baby boomers own more than half of all privately held businesses in our country, and the vast majority (85%) don’t have a succession plan in place. [4]
An early exploration by the Aspen Institute found that funding employee share ownership models like employee stock ownership plans (ESOPS) and workers cooperatives through OZ investments could “contribute to the goals of the opportunity zone initiative by broadening opportunities for residents to both earn and own.” [5] We have yet to see OZ investments utilized for such transactions, but the infrastructure is in place.
A second high-impact vehicle for OZ investors looking to contribute to their small business economy is the Community Investment Trust (CIT). This is an innovative but proven financial product that allows residents of a particular neighborhood the opportunity to invest in commercial real estate in their own backyard. [6]
OZ investments in CIT structured real estate projects can enhance the viability of small businesses operating in distressed communities. The Kansas City, Missouri City Council recently approved a project that combines the CIT with OZ capital to fund the redevelopment of a historic theater into a business incubator and economic development project. Merging the CIT with OZ capital offers current residents an avenue to participate in the broader economic development happening around them. This wholistic approach to economic development and OZ investing incorporates opportunities for financial inclusion, equitable development and inclusive growth.
DIRECT INVESTMENTS IN COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS
Businesses with fewer than 500 employees account for 48% of American jobs and 43.5% of GDP. [7] Although they're an essential part of our economy, these small businesses often lack cash reserves to survive even a minor economic shock. As we continue to face an unprecedented public health crisis, consider what a future without your small business community would look like.
Direct equity investments in operating businesses aren’t an ideal fit for a lot of small or microbusinesses. Many are unable to generate the kind of growth that would provide attractive returns to investors, and investors would struggle to get comfortable with a lack of exit strategies. [8] With policy adjustments, OZ capital can still play a critical role capitalizing these businesses.
Revenue-based financing and other equity-like capital options that structure repayment as a percentage of future revenue, as opposed to an ownership stake can provide small businesses the flexible financing they need. This type of capital will be an essential piece of rebuilding a more resilient economy. Though such debt-equity hybrids aren’t a direct fit for OZs investments, there’s a strong nationwide network of community-based lenders that are ready to fill this void, but they need capital.
CDFIs across the country are in the business of innovating financial products designed to build a more equitable and inclusive financial system, but often lack capital necessary to pilot new products. These economic development financing intermediaries have an established history of creatively using complex tax credits that attract private investment to distressed communities. [9]
OZ investments have the potential to provide a meaningful source of capital to these small business lenders. Representative Gregory Meeks (D-N.Y.) has already proposed a bill allowing CDFIs to directly accept opportunity fund investments. [10] This legislation is a required step in catalyzing the flow if high-impact capital to our nation’s small and microbusinesses at a time of unprecedented need.
INVESTING IN SHARED PROSPERITY
Through a combination of market mechanics and good public policy, OZs can indeed create positive social and economic impacts while providing attractive financial returns. They present a truly unique situation where investors can achieve both the personal financial benefits of a traditional investment, as well as the broader community benefits typically associated with philanthropy.
OZ investors can realize financial returns while contributing to a more equitable and inclusive financial system. The tools and partners are already in place for facilitating direct investments in small businesses and in innovative community wealth building tools. Additional legislation is needed to broaden the reach of OZs so that CDFIs can further enhance the impact of this capital.
Philanthropy and government assistance alone aren’t going to save our small businesses. Thriving regional economies rely on the kind of patient, friendly investment capital OZs are designed to stimulate. The time has come to leverage all the tools in our toolbox. It’s time for OZs to live up to all the hype.
Notes:
[1] McKinsey & Company Which small businesses are most vulnerable to COVID-19—and when, June 18, 2020
[2] https://www.irs.gov/newsroom/opportunity-zones
[3] Novogradac, “Novogradac Opportunity Funds List Surpasses $12 Billion in Investment” September 1, 2020
[4] Project Equity, Small business closure crisis.
[5] Aspen Institute, Exploring Employee Share Ownership as a Potential Investment Strategy in Opportunity Zones, December 18, 2018.
[6] Mercy Corps CIT, A Missing Piece in Community Wealth Building: The Community Investment Trust - Financial Ownership and Real Equity
[7] A Way Forward for Small Businesses (hbr.org)
[8] Next Street, “The Equity Capital Gap for Entrepreneurs of Color in Chicago”
[9] US Department of the Treasury, Community Development Financial Institutions Fund New Markets Tax Credit Program
[10] H.R. 7262 To amend the Internal Revenue Code of 1986 to allow qualified opportunity funds to invest in community development financial institutions.
Powered by Froala Editor