opportunity zones investments in operating …...opportunity zones investments in operating...
TRANSCRIPT
Opportunity Zones Investments in Operating BusinessesPANELISTS
Michael KressigNovogradac & Company LLP
Chris SchultzLaunch Pad
Rick HollidayFactory OS
Jonathan GoldsteinAdvantage Capital
Operating Businesses
For purposes of this discussion, how are we defining “Operating Businesses”?
Businesses whose principal source of revenue is other than rental income.
Operating Businesses
• Why important to a low-income community?• Permanent job creators• Tax base• Catalytic• Creates psychological sense of vitality
• Observation: It is likely what Congress intended was not a tax benefit targeted principally at real estate.
Qualified Opportunity Zone Businesses (QOZB)
A trade or business in which substantially all of the tangible property owned or leased by the taxpayer is qualified opportunity zone business property(QOZBP) and:
At least 50% of income derived from
Active Conduct
Substantial portion of intangible property used in active conduct of business
< 5 percent unadjusted basis of property is nonqualified
financial property
QOZB: Excluded Businesses
Can’t be a “Sin Business”
A private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling,
or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.
Qualified Opportunity Zone Stock and Partnership Interests
• The investment must be acquired after December 31, 2017 solely in exchange for cash;
• Must be a qualified opportunity zone business, or is being organized for the purpose of being a qualified opportunity zone business;
• Must remain a qualified opportunity zone business for substantially all of the qualified opportunity fund’s holding period
Qualified Opportunity Zone Business Property (QOZBP)
Tangible property used in a trade or business
Acquired by purchase from an unrelated party (20% standard) after December 31, 2017
During substantially all of holding period, substantially all the use is in a QOZ
Original use in the QOZ commences with the taxpayer
ORTaxpayer substantially improves the property
during any 30-month period after acquisition, additions to basis exceed an amount equal to the adjusted basis of such property at the beginning of such period
Operating Businesses - Non-qualifiers
• What types of operating businesses are NOT likely to qualify as either a Qualified Opportunity Fund (QOF) or a Qualified Opportunity Zone Business (QOZB)?
Businesses such as financial institutions - hold large amounts
of NQFP
Businesses holding intangible property not actively used in the TOB
Sin businesses cannot be QOZBs
Operating Businesses - Non-qualifiers
Businesses that may qualify with clearer guidance and/or structuring finesse:• Businesses which use a substantial amount of their tangible property outside of OZs:
• Multi-location businesses• Businesses with substantial in-house distribution (trucks and other vehicles used
outside the OZ)• Existing Businesses
• existing in an OZ as of December 31, 2017 (unless a large expansion is planned)• existing outside an OZ if it owns substantial tangible assets
• Companies that lease a substantial amount of the property used in their business pursuant to operating leases? (Need guidance)
Guidance Priorities for Operating Businesses
• Ability to defer interim gains reinvested in QOZP• If permitted, timing requirements for reinvestment
• Ability for investors to invest in QOFs through feeder partnerships• Treatment of Operating leases for “Substantially all” QOZBP requirement.• Can we “substantially improve” an existing operating business?• Treatment of construction cash reserves (e.g. financing a business expansion)
VC Fund OZ Investing ModelChris Schultz
Applying the Venture Model to Opportunity Funds
Thesis: Traditional tax credit incentive programs bias towards investments in real estate and hard assets which present a different risk/return profile than traditional VC. Successful early stage VC investing requires a portfolio approach that presents additional constraints to the OZ program.
Assumption 1: The goal of the OZ program is to drive investment dollars towards underserved markets and communities.
Assumption 2: The most impactful businesses on a community in terms of job creation and wealth creation are high-growth technology businesses which are asset and real estate light businesses.
Feeder Partnership
Example Investments
• Lucid - a market research technology firm• Started at Launch Pad w 1 employee, today has more than 250
employees, raised 60mm
• LidCore - a music licensing watermarking firm• DigDates - a dating app for dog lovers
Example Investments
• Types of businesses:• Software / technology companies w. knowledge workers and high growth
potential• Asset light businesses that meet QOZB
• Keys to success:• Nationally diversified deal flow across OZ’s
A Case Study – Factory OSRick Holliday
• Occupancy: July 1, 2017
• 256,700 SF• More than 100k SF larger than the other facilities we
considered• Extra SF allows for increased productivity and a greater
focus on R&D / Innovation
• Located near a good pool of labor and in close proximity to the Northern California Carpenter’s Union training facility
Mare Island – Building 680 Factory_OS Facility
Mare Island –Building 680 (today)
Factory_OS Facility
Factory OZ Substantially All AnalysisPhase I QOZBP NQ TotalIncurred through 12/31/2017 - 3,800,000 3,800,000 Est. cost to complete 7,400,000 - 7,400,000
Est. Ph I total 7,400,000 3,800,000 11,200,000 66%
Phase 2 QOZBP NQ TotalBudget with assumption of leased existing building 15,000,000 - 15,000,000
Est. Ph I + II total 22,400,000 3,800,000 26,200,000 85%
TANGIBLE PROPERTY
Est. purchase price of Ph II existing building* 10,000,000 - 10,000,000
Est. Ph I + II with bldg. purchase 32,400,000 3,800,000 36,200,000 90%
*Building would be substantially improved with $15 million of Phase II improvements.
Options
If Substantially All = 70%1. The targeted amount of QOZBP is approximately $8.9 million so
one option would be to spend an additional $1.5 million in Phase I on QOZBP.
2. Spend an at least $1.5 million of Ph. II QOZBP during the grace period.
Options
If Substantially All = 85%1. The targeted amount of QOZBP is approximately $21.6 million
so it would be necessary to complete Phases I and II within the grace period in order to qualify all.
2. If, for other business reasons, it isn't feasible to complete both phases within the prescribed timeframe, the timing of the QOF investment into the QOZB could be delayed such that Phase II qualifies on its own. In this scenario, Ph II would be owned by a separate entity (QOZB).
Options
If Substantially All = 90%1. Purchase the Phase II land + building and substantially improve
it.2. Qualify Ph II separately. Ph II would be owned by a separate
legal entity (QOZB).
Uncertainties
• What is "Substantially All" %?• Treatment of operating lease of Phase I (and possibly Phase II)
real estate for substantially All purposes.• Grace period to qualify as QOZB
Real estate and Equipment financing models for OZ Based Operating BusinessesJonathan Goldstein
Providing Real Estate Finance to Support Operating Businesses
• Focus on scalable, repeatable structures for small business investment capital• Challenges to direct operating business finance:
• Absence of debt alternatives• Requirements that favor new and/or asset-lite businesses• No clear application (yet) of “substantial improvement” clause
• Wider latitude in real estate development finance:• Direct ownership option• Substantial improvement alternative• 10 year horizon more easily accommodated
Providing Real Estate Finance to Support Operating Businesses (cont’d)
• What might a real estate purchase/lease look like?• OZ Funds could offer highly flexible capital solutions:
• OZ Fund might purchase desired real estate • Ownership of real estate would qualify, assuming sufficient improvements made
within 30 month statutory window• OZ Fund can operate real estate under lease to operating business• No prohibition on giving business purchase option, e.g. after 10 year hold
Providing Real Estate Finance to Support Operating Businesses (cont’d)
• Potential benefits:• QOZBP should be easy to qualify• Direct investing eliminates “active conduct” requirement• In “pass-through” funds, qualifying leverage should provide basis to OZ fund to
permit some losses to be recognized during hold period• Cash flow during initial years can offset investors’ phantom income event on
12/31/26• After 10 years and sale, all capital gains (including interim depreciation) should
be forgiven
OZ Funds for Equipment Finance
• What might equipment finance look like?• Long-lived assets (e.g. heavy equipment), like real estate, might be suitable for direct
OZ Fund ownership• New equipment purchases, used first in OZ, should qualify• No active conduct requirement in direct ownership• Similar ability to use qualifying leverage to generate basis• Depreciating asset might limit or eliminate benefit of 10 year step up in fund
basis
Opportunity Zones Investments in Operating BusinessesPANELISTS
Michael KressigNovogradac & Company LLP
Chris SchultzLaunch Pad
Rick HollidayFactory OS
Jonathan GoldsteinAdvantage Capital