There is an innovative new program created by recent changes to federal tax law that could incentivize investment in startups across the middle of America. That program is called Opportunity Zones, and it’s piqued the interest of economic developers and startup ecosystems in several cities.
The new law allows governors to create Opportunity Zones by designating up to a quarter of their state’s census tracts as economically distressed. Once that occurs, a Qualified Opportunity Fund (QOF) can be created. That fund can be used to invest in startups within the Opportunity Zone.
The federal government also incentivizes investors to put their money into QOFs.
How?
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Let’s say my investment in Apple pays off, and I have capital gains of $10,000. I can defer and (after staying in the fund for five years) reduce my taxes on those original gains if I invest my $10,000 in a QOF. If I stay in the QOF long enough, I can further reduce and even ultimately eliminate both the entire original capital gains tax as well as taxes on further gains resulting from the success of QOF investments.
For midwestern startup ecosystems, one of the most important provisions of the new law is that investors do not have to live in Opportunity Zones to invest in a QOF.
We can use a real-life example to illustrate why that provision is a potential game-changer.
Ellie Kemper is the star of the Netflix series The Unbreakable Kimmy Schmidt. She also played receptionist Erin Hannon during the last four years of The Office. She grew up in St. Louis, and her family founded Commerce Bank.
Ms. Kemper obviously has strong ties to the city. She could reinvest the capital gains she receives from her other investments into a QOF. The creation of this program would incentivize her—and other, less-famous former residents of the Silicon Prairie—to invest in the economic growth of a community she has strong emotional and family ties to, even though she no longer calls St. Louis home.
You don’t have to be a television star to invest in Opportunity Zones. All along the coasts there are potential investors who still wear their Cardinals, Royals, and Cornhusker hats on game day. They still come back for Thanksgiving to see their friends and family. In their heart—no matter where they lay their head—a cornfield at the edge of town will always feel like home.
You don’t need to leave a city to invest in Opportunity Zones, but the ability to attract funding from outside the region represents one of the few tangible ways to bring money into the Midwest that would otherwise remain on the coasts. At some point, simply telling the world there are investment-worthy startups outside of Silicon Valley isn’t good enough. The Midwestern entrepreneurship community has tried that. Opportunity Zones create real and necessary incentives for coastal capital to flow into the Silicon Prairie.
While Opportunity Zones are new, a handful of cities across the country have already started creating investment vehicles using them. Erie, Pennsylvania—located in the largely industrial northwestern corner of the state—has set up the Flagship Opportunity Zone Development Company and will soon begin pitching investors. Cities like Erie that recognize the potential of the program early on will have the best chance at building robust funds.
Investors will not put their money into Midwestern startups simply because it is the right thing to do.
There have to be real financial incentives.
One of those incentives can be a 10x return on a game-changing startup. With Opportunity Zones, another incentive can be deferred and reduced capital gains taxes.
That’s great news for capital-starved founders.
And it’s great news for the small and mid-sized cities across America that have made entrepreneurship a focus of their economic development strategy.
