Will Opportunity Zone Investments Work as Intended? Foundation Experiments with Guarantees

An extraordinary amount of ink has been spilled regarding whether opportunity zones, the hot new incentive for investment in low income communities under the Tax Cut and Jobs Act, will in fact generate community benefits.  (A recent New York Times cover story is particularly stinging.)

There clearly is a role for philanthropy to play in ensuring that opportunity zone investments indeed benefit the communities as intended.  These roles range from cheerleader to investor to focused community support activities.  The Knight Foundation sponsored a really thoughtful piece that establishes a taxonomy of funder roles with examples.  Along with a panel of colleagues, I presented some thoughts on this topic at the recent New York Funders Alliance conference.  (Interested readers are welcome to email me for a copy of the presentation.)

In this post, I wanted to explore some interesting work that the Kresge and Rockefeller Foundations have been doing trying to put theory into practice by investing in opportunity funds.  This effort, which has been undertaken in a deliberately public manner, is intricately structured, and serves as a model for efforts of this type, both within and outside of the opportunity zone areas.

The process began in 2018, when the two foundations issued a joint request for letters of inquiry for partnerships with mission-aligned fund managers. Consistent with the extraordinary transparency surrounding this initiative, there is a recorded webinar in which the funders respond candidly to questions from hopeful managers.  While 141 funders responded, as explained in an interview with SoCap, Kresge determined that they wished to focus on experienced fund managers, of which there were only six respondents.  (Rockefeller appears to have decided not to make impact investments, but rather to fund municipal efforts to showcase their cities to potential investors.)   

Of those six respondents, two have been publicly announced as finalists.  Interestingly, in the SoCap webinar, Kresge stated that two were not interested in adhering to Kresge’s terms, and one was too big for Kresge’s proposed guarantees to make a difference.  This left the two awardees, Arcadis Capital (private equity) and Community Capital Management (real estate) as well as a venture capital fund that may receive an award in the future. (Another webinar explains the process and the investments.)

The theory is simple.  In exchange for guarantee commitments to opportunity zone funds, Kresge extracted promises from both as to transparency, accountability, reporting, and impact.  In other words, Kresge is using its ability to derisk the investment for third-party investors as a way to bully the fund manager into making the fund more socially responsible.  Remarkably, even though the funds are expected to raise $800 million in capital, a $22 million guarantee (plus the publicity and further guarantees from other partners) was enough to do the trick.

To me as an attorney, the most interesting public document is the sample term sheet published by Kresge.  It is cast as a sample, and the actual agreements with the awardees haven’t been released.  Here are a few points of note about the term sheet:

  • The guarantee in the sample is available on an investment-by-investment basis for investments meeting the guarantor’s social impact covenants. If this is how the Kresge investment is structured, it would explain how the Foundation was able to use such a small guarantee to influence such a large fund.  The reporting criteria in the sample appear to apply to the fund as a whole.
  • The specific covenants are worth reviewing. Some are objective (50% of investments not to exceed 120% of AMI) and some are subjective (adopt an anti-displacement strategy). It would be instructive to understand how compliance with the subjective criteria is determined.
  • It’s interesting to compare the terms that were actually negotiated with the aspirational terms in the Opportunity Zones Reporting Framework. The real world is more complicated than theory.
  • The nature of the loss protection provided by the guarantee is not explained. Of course, there are many ways to skin the cat.
  • There is a guarantee fee. The second webinar indicates that this is intended to cover administrative expenses.
  • It’s unclear what the general public will see of the data collected. It appears to be limited to the Foundation’s use.  Based on the term sheet, it appears this will be for the investor’s internal use only.

It will be fascinating to watch these experiments as they unfold over time.  The lessons learned will apply not just to the opportunity fund universe, but beyond.

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