CC003: Opportunity Funds // a coffee chat with Peter Brack (Hypothesis Ventures)

Peter Brack: 00:00:00

Diverse founders are attracted to diverse partnerships when it comes to venture and I think that from my own experience having worked literally all over the world and across multiple cultures, there’s no substitute for vastly different points of view.

Jay Clouse: 00:00:22

The startup investment landscape is changing and world class companies are being built outside of Silicon Valley. We find them talk with them and discuss the upside of investing in them. Welcome to upside. Hello. hello, hello and welcome to the upside podcast, the first podcast finding upside outside of Silicon Valley. I’m Jay Clouse. I’m accompanied by my cohost, Mr. Opportunity himself, Eric Hornung. Eric, how are you doing?

Eric Hornung: 00:01:05

Are you saying that because I always sees the opportunity or because of what we’re going to be talking about today on the podcast.

Jay Clouse: 00:01:11

I say that because we’ve been talking about our subject matter of today’s show for a while and it was something that you sniffed out months ago right after the new tax law went into effect, so I’m trying to give you credit here.

Eric Hornung: 00:01:27

Well, that was nice of you. You giving me credit, but at the same time you’re kind of calling me a nerd because I found something in the tax bill like that is.

Jay Clouse: 00:01:36

That’s right.

Eric Hornung: 00:01:37

That’s not something to really brag about Jay.

Jay Clouse: 00:01:39

I think it is. I think it is. I think you should be proud as I look over your shoulder and see the wealth of nations on your bookshelf.

Eric Hornung: 00:01:45

It’s actually not the wealth of nations. It’s called the public wealth of nations. It’s for everybody. It’s how management of public assets can boost or bust economic growth. It’s about utilizing the public assets of an economy, so whether that’s your national parks or the minerals that you have underneath your soil or your air, and it is a. well, I’ve only read about a chapter of it, but to date it’s a good read.

Jay Clouse: 00:02:14

Nerd status granted. So Eric talk to me about our show today, what we’re going to be talking about and how you came across it by waiting through tax law.

Eric Hornung: 00:02:24

So I didn’t wait through the tax bill to start. I was tipped off on Twitter as I usually am to some sort of niche thing that existed in the universe and I dove down a rabbit hole and found it. So when the tax bill was passed and I believe it was either late 2017, early 2018, Jay you remember the date?

Jay Clouse: 00:02:46

I don’t.

Eric Hornung: 00:02:47

Okay. Something like that. I think it was early 2018.

Jay Clouse: 00:02:50

I’m gonna say early 2018

Eric Hornung: 00:02:50

Okay. There was a section that was kind of carved out about these things called opportunity zones, which in theory would be under represented zones in the economic development of the nation. So in Ohio we’re used to like Appalachia being like the socioeconomically most depressed area of Ohio. That could be a great opportunity zone. It’s done by consensus tracks and the idea is that if you make equity investments into companies or qualified entities, then you can convert your unrealized gains into a new investment, not tax free but effectively tax free depending on your holding period. We’ll probably get more into the details of exactly how this works in the interview, but the idea here is that we’ve been on a 10 year bull run in the stock market, so the majority of people’s gains in their portfolios are unrealized, for the listeners and unrealized gain is just something that’s on paper. It doesn’t exist in real life. You haven’t cashed out effectively. So if I bought apple at 100, it goes to 300 my unrealized gain, $200. If I cash out, my realized gain becomes $200. When you cash out, that’s when something becomes taxable. So being able to convert that $200 of profit to a new investment is something that’s incredible and only really happens in real estate and what’s called a 10, 31 exchange and you usually have like a 90 day window. So there’s a lot going on here. There’s a lot of nuance, a lot of tax, a lot of financial, what I’ll call engineering, but I think that the idea behind it is solid. The practice is really what we’re going to see kind of flush out in the next two to three years.

Jay Clouse: 00:04:36

So I think you were talking to me about this in early January, 2018. I just my quickest search and here take of when this was passed, came from a search of one. The New York Times article run about opportunity zones, which was several weeks after you had tipped me off to something going on and that was January 29th, 2018. The New York Times article tucked into the tax bill, a planned help, distressed America run, and you’re told me is every week before that because you would. You’d say, Hey, I think there’s something interesting going on here and I think it has implications for early stage startup investing. And I said that’s interesting. And we had a dinner with some friends and folks here in town and we had told us to them and they said that’s interesting. And then a few weeks ago we saw an article in fortune about a venture capitalist firm based in San Francisco. That is an opportunity fund investing only in opportunity zones outside of Silicon Valley and that firm is called Hypothesis VC and today we are talking to the founding partner of Hypothesis Ventures, Peter Brack, so I’m excited we’re going to get deep into the weeds here of what opportunity is at hand here with opportunity zones and what Peter has already found about it. He gave some great quotes to that fortune article that are pretty compelling and very interesting, so I’m excited to get into it.

Eric Hornung: 00:05:51

Likewise, it’s been something that I’ve been thinking about mauling over for I guess almost a year and I actually read about the idea and a different form in Ross Baird’s book, the Innovation Blind spot and it’s just been such a. I love creative policy, policy that takes maybe a more holistic, unique view and I think that this is a policy that is going to really kind of sparked a lot of these types of funds. So it’s going to be great to hear from Peter. It’s so far been hard to find people who’ve come out and said, we are going to be this fun because of a lot of regulatory uncertainty right now.

Jay Clouse: 00:06:26

It strikes me, and this is something that’ll ask Peter. It strikes me as something that is more of a no brainer from a real estate perspective than a angel investing perspective. Would you agree with that?

Eric Hornung: 00:06:37

I would definitely agree because if you take your unrealized gains and you invest in real estate and just hold for 10 years, you’re going to get rents that entire time. So you’re getting liquidity and then after that 10 years, your tax basis on that building is effectively free. The interesting part for a VC is if you invest in a company and it goes 100x while you’re paying 35x of that in taxes effectively because your cost basis in a VC is $50,000 in to an early stage company and if it goes 100x, they’re going to make $5,000,000, but the idea is that you’re going to get taxed on those gains. So that’s 5 million minus your 50,000. You’re gonna get taxed on that and with this, if all of your gains are tax free, that’s an incremental alpha effectively to any fun because you don’t need to perform as well as a fund that’s being taxed to do as well or your investors.

Jay Clouse: 00:07:30

That’s right. So I want to give a little bit more background on our guest today. Peter. Peter Brack is the founding partner of Hypothesis Ventures. Prior to Hypothesis, Peter was a venture partner at [inaudible] capital and an initial investor and advisor at Co-founders. Previous to that he was in media. It seems that Red Gate Media Group and One Media group, both of which went public on the Hong Kong stock exchange and prior to that he was a senior vice president for Time Inc. So he’s been around the block really playing at a high level for a while. Being a first mover Here in this opportunity fund space and excited to hear more about Hypothesis VC, what he thinks about opportunity zones and all the things that we don’t know because even though we have some basic introductory knowledge of this, there’s a lot that we don’t know and I’m excited to learn more.

Eric Hornung: 00:08:18

Same. Let’s jump in. You’re welcome to the show. Hey guys, great to be here. It’s great to have you here. We like to start our interviews off by kind of diving into the history of the founder in this case, that’s you. We want to kind of go back to the beginning though. I think you have a little bit different of a background, so could you tell us about the history of Peter?

Peter Brack: 00:08:42

Sure. And I hope I don’t bore you to tears. So I grew up on the east coast in Connecticut and I guess I started my journey as an entrepreneur a little bit early and that probably happened when I was around 10 or 11 years old when I, when I got my first paper route. So I was delivering newspapers to the neighborhood and a couple of adjacent neighborhoods early in the mornings before school and I realized not long into that job that I was building relationships with customers that could be used for other lead gen and so, you know, you’re, I was like 10 or 11 years old delivering newspapers and I had to collect all of the fees and subscription payments every couple of weeks and I ended up selling other goods and services, so I ended up doing odd jobs, mowing lawns, cleaning out garages, selling seeds that I bought out of catalogs to women who were growing herb gardens. And that gave me a lot of, a lot of pocket money when I was 10 or 11 years old. So I was pretty rich in those days.

Jay Clouse: 00:09:53

Was that you Being opportunistic or were you trying to buy something or did your parents push you in that direction?

Peter Brack: 00:09:59

No, that was just me being opportunistic. I liked getting out and doing something and having a job to do. So the paper paper route sort of ticked that box. But then I just realized that, you know, I could scale it into, into other things, so there was never a weekend that I wasn’t back to back busy, just doing like either manual labor or you know, helping someone clean out their, their garage or their attic and earning all of this, this pocket money. So it was, it was pretty great. But I learned, I think I learned at that very young age the value of having a close relationship with customer.

Eric Hornung: 00:10:37

That’s incredible. There’s got to be a study out there somewhere that shows how many people credit being a paperboy or having a paper route impacted their career and their mindset going forward. Just like off the top of my head, I’m pretty sure like Walt Disney, Warren Buffett, the founder of Fox, so many people who have done extremely well and who have done very well credit being a paperboy. So I feel like that would be a fascinating study.

Peter Brack: 00:11:00

I think it would be. Yeah, I like that. I think it would be really interesting and I, and I bet there would be a lot of interesting kernels there.

Eric Hornung: 00:11:08

Yeah. And it also, especially the future casting of papers going away and what that means for what’s the new paper boy job in 30 years when we’re looking back and saying when people were attending or 11, what was the job that they were picking up that was instilling these values in them?

Peter Brack: 00:11:23

Yeah, yeah, exactly.

Eric Hornung: 00:11:25

So you were a paper boy and that was a huge kind of moment for you. You learned the value of a customer. What happened next? How did you continue down this path of entrepreneurial thought and action?

Peter Brack: 00:11:37

Well, I kind of at the same time I sort of fell in love with media and the idea of media and, and not just that, but that coupled with the fact that my father had been in the, in the media industry for, for all of his career, so certainly tons of rub off there, but I, I sort of fell in love with, with that industry and was fascinated by it. So when I got to high school, I started pitching local cable TV companies for summer internship experience and I ended up getting a couple of really great internships mainly in, in New York city at Manhattan cable tv, which ended up becoming time Warner cable tv. But that was really great training and insight into what was going on in still a relatively new industry and that sort of gave way to my series of internships at Turner broadcasting, which ultimately kicked off my career because it was with Turner that I got my first job and actually moved overseas at the same time.

Jay Clouse: 00:12:43

Can you talk about that move overseas?

Peter Brack: 00:12:45

Sure. So I, I really, you know, through those internship roles that I had a Turner broadcasting over pretty much every summer during college I was sort of helicoptered into different teams and departments not doing anything overly important frankly, just doing the kind of stuff that interns do. But I, I was able to get a really interesting window on the business around Turner broadcasting. I gravitated towards CNN, which was kind of experiencing explosive growth at the time. This was very early 90’s. This was like 90, 91 that I was doing these internships and so I really knew that I wanted to be there after I graduated and get a real job there, but I also knew that I wanted to specifically focus in ad sales because that’s the revenue driver for the business and I really wanted to learn how that worked and I also wanted to at the same time get exposure into international because that was the geography that was really taking off for the business. So I was pitching two things at once to get hired into ad sales and to get hired overseas and I, I did get hired for a role in London, but at the last minute before I made the move and got on the plane, I got a call saying, hey, the job that you got in London still exists and you can still go, but we’ve just set up a budget to open up a small office in Hong Kong and you could do that if you wanted it to. And so I said yes, and two weeks later I was. I was living in Hong Kong.

Jay Clouse: 00:14:25

Where did you live in Hong Kong?

Peter Brack: 00:14:27

Well, over the years, all over Hong Kong. The first place I lived was a tiny little apartment right next to the race track in Happy Valley so I could. I could hear the horses getting their exercise in the mornings. That’s how I’d wake up in the morning. It was pretty cool, but it was the smallest department I’ve ever lived in in my life, including my tiny college dorm room, but I wouldn’t trade it. It was an incredible way to get started in Hong Kong and over the years I moved. I moved all over Hong Kong and also all over the region too, but it was a great start.

Eric Hornung: 00:15:02

I lived in Hong Kong for a summer in Jordan and I also lived in a very small apartment. The smallest apartment I’ve lived ever lived in in my life and I’ve lived in Manhattan, so it was a very small apartment. That’s interesting.

Peter Brack: 00:15:15

I didn’t realize that you had had lived in Hong Kong too. I will give you credit. Apartments in Jordan are a lot smaller than apartments in happy valley and that says a lot.

Eric Hornung: 00:15:25

Yeah, I could touch all four walls at once if I wanted to.

Peter Brack: 00:15:29

Yeah, that’s hilarious. And you can, you can sort of cook, shower, get ready to go out and answer the phone all at the same time.

Eric Hornung: 00:15:37

Yeah. And your predominant or just says two steps.

Peter Brack: 00:15:39

That’s right.

Jay Clouse: 00:15:42

So Peter, you are living in Hong Kong still in media. We have a long ways to go here to get to where you are today. Help us close that gap a little bit.

Peter Brack: 00:15:52

In a nutshell. I, I was at turner for about six or seven years. I’m running the Ad sales team as we were growing across the region. I then moved across Time Warner to Time Inc where I, I ran that PNL for a handful of years and learned a very different part of the business. At Turner I had been learning how is work and how sales and marketing and distribution works in a high growth company. At Time Inc. it was a very different experience in that you know, we were beginning to pare down the business and divest from pieces of the company in some cases, acquisitions that we had made over the years in the region, in other cases, unwinding partnerships that we had and really paring down to the core business. I learned a lot there. I always had an eye towards investing and towards emerging markets as I was building my corporate career and I was in a great place to do that because Asia was changing so rapidly and economies were exploding everywhere, so actually not long after I moved to Hong Kong when I was 21, I began traveling around the region and and learning a ton, not just in a sort of a corporate environment, but also just personally in terms of meeting a lot of people and getting to know all of these other markets. I fell in love with Vietnam. I spent a lot of time there. I’m just before and then a lot after the US embargo ended in the early nineties and was collecting Vietnamese art later on opened up an art gallery in Hong Kong as a side hustle and learned a bit about the art business that way and then in, in later years was in a really fortunate position given my role in Time Warner to meet a lot internet one point, oh, founders and China and other entrepreneurs all over the region. So that really gave rise to me leaving Time Warner in the early two thousands to co-found what became Redgate Media Group with two business partners and in the eye that we had then was to help consolidate parts of a really fragmented and vast Chinese media industry, which was, uh, you know, certainly a big problem that we were trying to solve and, and a tall order. Our first push was to build a content publishing vertical. And so as regulations on ownership, we’re, we’re changing in our favor. We started a business called One Media group, which was a content publisher and consolidator. we acquired a bunch of homegrown Chinese publications and online publications and then launched western magazines into China and took that business public and in 2005. Later on, as our business began to to really grow, we started moving into other verticals like TV advertising, digital radio, outdoor media, and consumer marketing. This is where we really learned how to be entrepreneurs and that we had built a business relatively quickly through acquisitions and we’re really feeling pleased with ourselves to have filed for a NASDAQ IPO in 2008 just before Lehman happened and the global financial crisis kicked in. So I think we sort of earned our stripes as, as entrepreneurs from really that 2008 period till 2012 when we were able to finally take that business public.

Jay Clouse: 00:19:38

That’s a wild, wild ride. An awesome accomplishment to go public with that that company. At the risk of going down a rabbit hole. Something I’ve been thinking about lately and I think you might be the perfect person to gives them insight into. We’re starting to see some of these large media organizations, the Atlantic, Time, Washington post become purchased by entrepreneurs and I don’t know what to make of that. Curious if you have any thoughts or insight into that trend.

Peter Brack: 00:20:07

I certainly have opinions and I think that on the one hand it’s very exciting. It was exciting to see Jeff Bezos swoop in for the Washington post. It was really interesting to see Emerson Collective come to the aid of the Atlantic, which is a great publication and it’s been really interesting to see what’s happened very recently with with Time magazine. I think all of these are encouraging and. Oh, and another notable is is LA Times also purchased by a very successful entrepreneur. I think you know, there is a public service aspect to certainly to high quality print journalism. It’s all double edge though. I think that it may very well last and endure and these publications may continue to have all of the editorial freedom that they’ve been afforded today, but we’ve seen how this trend can move. We’ve seen it in other parts of the world. We’ve seen it in Hong Kong with the South China Morning Post, for instance, which has traded hands many times from entrepreneur to entrepreneur in a very rapidly changing market and I do worry about all of this journalistic power and influence in the hands of very few people.

Eric Hornung: 00:21:32

Naval Ravikant oh, am I pronouncing his last name wrong, had a tweet a couple months ago that really resonated with me on this idea of journalistic power and it said that something along the lines of the news media like goddess power from its ability to distribute facts and now that facts have become so cheap like through things like Google and the internet, they have to figure out a new source of differentiation and that’s causing the news to become entertainment. I’m curious on Your thoughts on that and on journalism as entertainment versus journalism as truth.

Peter Brack: 00:22:08

Yes. I absolutely. I agree with that train of thought and you know, I think the biggest mistakes were made during the formation period of the consumer internet where I think choices were made very early on by publications and by media companies to make their content for free. And I had a front row seat to that because at that point I was still at CNN and I was actually running the online ad sales piece for CNN and for Turner. And then later on for Time Inc, you know, it was an add on, it was an add on to core print ad sales deals and it was free for consumers. And so while we had, you know, very high subscription prices for our premium content online, everything was open and free. And we know how that turned out. We know that it created a, a chase to the bottom. We know it created what’s now called click bait. We didn’t know what that was called back then, but we just started doing it and we know where it’s landed from a political standpoint too not only here in the US but around the world. So I, I wholeheartedly agree with that. And I think that, you know, the mistakes that were made early on by large media companies are still haunting us today. And I think that we need to do everything we can to preserve high quality journalism and premium content because premium is premium.

Eric Hornung: 00:23:42

So we left you in your story. You Had just went public. Lehman brothers had just crashed and we’re sitting at 10 years ago. Now you’re launching a fund called Hypothesis. It’s centered around an opportunity zones. I’m curious what happened in those 10 years to kind of steer you from running a company, running a public company to becoming an investor and specifically becoming an investor had centered around a almost esoteric tax bill incentive?

Peter Brack: 00:24:16

Right well, at this point I’d been, you know, as we were getting closer to liquidity and finding an exit for our business, I’d also been getting really interested in investing in emerging markets more on a professional basis and in working directly with founders and leadership teams. So, you know, around the time of our exit in Hong Kong, which was around the 2011, 2012 period, I found myself also spending a lot of time in Myanmar just as US and European sanctions for loosening. And good friend of mine had just been tapped to be CEO of one of the largest Burmese conglomerates. So at that point I invested in there what was then highly illiquid, thinly traded public stock in Singapore. And that turned out to be great timing as investors. We’re beginning to pile into the Burmese economy after sanctions were lifted and we saw more than a 10 acts on that investment in 18, 20 months and you know, it was that experience and a handful of others in emerging ecosystems where I realized I wanted to learn venture capital from the, from the pro’s. And so I started spending a lot of time traveling to the Bay area and to New York because I had connections in both places and I wanted to learn and I wanted to see if I could find a way to learn from riddle professional investors who, who do that for a living. And LA was kind of an add on trip for me. And when I did start to spend a little bit of time here, I quickly sensed an emerging market in la. I met everyone I could. My visits from from Hong Kong to to Los Angeles became longer and longer and I started spending a lot of my time with my friends Will and Eric who were building capital and I really loved the portfolio that they were building, but I really loved working with the founders across the portfolio and digging in and helping solve problems at that earliest formation stage, so it was, I guess because of my operating background that I found myself digging in and getting involved in a lot of problem solving and that’s when I started to also engage with the rest of the community here in la and get really involved in the growth of this ecosystem.

Jay Clouse: 00:26:45

What were some of the signals that you felt or saw in LA that signal to you? It was an emerging market?

Peter Brack: 00:26:53

Well, when I first started visiting in in 2011, 2012 thereabouts. There was no shortage of interesting companies, interesting startups to look at. I saw very quickly learned about the higher learning landscape around Los Angeles of Caltech and USC and UCIA and got to know people at all three institutions and and quickly saw a lot of engineering talent being churned out. A lot of interesting founders building, you know, interesting companies who decided to stay in LA because it’s a short flight to the bay area. You know, there’s not a lot not to like in la and aside from the traffic and the cost of living is a lot cheaper still. And so it started to form for me a hypothesis that I, I guess I sort of carried through my career to that day, which is emerging markets are interesting. Emerging markets are full of opportunity and a recurring theme which is that you know, to be a founder of an interesting or important company today, you really don’t need to be. You certainly don’t need to be in the Bay area, but you also don’t need to be really anywhere in particular. With I think the advent of cloud computing and and what has built and so many other software driven tools that we now all have at our disposal. It’s just so much easier to start a company anywhere and so the hypothesis that I had at first, you know, learning from the pros moving to the US to do it, not moving to the bay area, but moving to LA instead. The hypothesis just carries through to now we’re in 2018 and you really can build a meaningful business anywhere. ZIP code shouldn’t really be a gating factor,

Eric Hornung: 00:28:52

So this might be a good time to kind of transition into what is Hypothesis VC in your own words,

Peter Brack: 00:28:59

Very simply put, we’re a new farm which will support and invest in technology startups outside of Silicon Valley. You’ve heard me talk about opportunity zones, not in this conversation yet, but in previous conversations and I’ve been having that conversation with with a lot of people over the past several months because they represent everything that we’re about.

Eric Hornung: 00:29:25

So they being opportunity zones. What is an opportunity zone?

Peter Brack: 00:29:30

Okay, so opportunities zones are essentially a tax incentive for investors, but they’re all part of what’s called the investing and opportunity act, which is part of the new tax code which was passed in late 2017 and basically they’re designed as a stimulus for markets and cities, towns and ecosystems around the country that could benefit from an inflow of capital. There are 8,700 opportunity zones across the country. If you add up all of that geography, that’s 12 percent of the landmass of the country and these opportunities zones were identified by all 50 governors, so they exist in all 50 states and there’s at least one in every city. And the way it works is that now that those 8,700 opportunity zones have been identified, there’s an incentive for investors into those opportunity zones. And it’s relatively simple from a headline basis on how it works and I’m happy to sort of walk you through that.

Eric Hornung: 00:30:41

You know, let’s, let’s dive into that a little bit more.

Peter Brack: 00:30:43

Sure. So what treasury has laid out is that some or all of a capital gain from an investment or a property sale can be deferred for tax purposes within 180 days into a qualified opportunity zone fund. Now these gains won’t be taxed until December 30, first 20, 26 and less. The interests of the fund is sold or exchanged, but I’ll put it to you in a in a different way. If a taxpayer invests in the fund for five years, the capital gains tax will be cut by 10 percent. If the investment is retained for seven years, it’s cut by another five percent. But the real headline from this whole program is that if an investment is held in the fund for 10 years, which in the case of a early stage technology startup, it’s 10 years or more usually to get to maturity. If that investment is held in the fund for 10 years, there’s no tax owed on new gains made from that initial investment, so capital gains free and I think that is the crux of what opportunities zones and the legislation is all about and basically all current realized capital gains are eligible for this program. So if you look at the eligible money that’s able to move into opportunity zones, that’s estimated to be slightly over $6,000,000,000,000 in realized capital gains just from the last year that would qualify for opportunities and investing.

Eric Hornung: 00:32:22

You said realize there. Did you mean unrealized or is it realized gains.

Peter Brack: 00:32:26

Realized. So basically the regulation states that you must roll capital gains in from an investment or a property sale in order to qualify for this tax incentive.

Jay Clouse: 00:32:40

I see. So can you give me a tangible, fictional example of somebody that may have the opportunity to roll their realized gains into this? Just walk me through the process that it would look like in a fictional example.

Peter Brack: 00:32:54

Sure. So I’d say opportunity zones and qualified opportunities zone funds act very similar to a 10:31 exchange in real estate terms. So basically what that means is you sell an asset or you sell a property and that can be pretty much anything. Although there are in, in the case of, of this legislation, there are limitations on it can’t be a casino, it can’t be, you know, there’s, there’s sort of like a vice rule for this, so there’s certain businesses that it can’t be but very limited. You roll those capital gains into an optimized vehicle and by doing so you’re deferring taxes until a certain date. That’s sort of the headline number one. Headline number two is the longer you hold in that fund, the more discount you get on the capital gains tax that you’ll need to pay after the deferral period. But again, the headline is that any new gains made by investments from the fund itself that you’ve rolled into our capital gains free. So you’re on the hook for your previous capital gains, but not for capital gains derived in opportunity zones.

Eric Hornung: 00:34:15

Can you talk to me a little bit about, you said a qualified opportunity fund. What is a qualified opportunity fund and how’s that different from just any other fund?

Peter Brack: 00:34:24

Well, basically that’s designed just to create some hurdles to entry. I guess the easiest way to describe it is that if you’re just a regular person like you or me, you can’t walk into an opportunity zone and invest in say a restaurant directly like I want to be a partner in this new restaurant in the west loop in Chicago for instance, which happens to be in an opportunity zone. You can’t just walk in, partner with the entrepreneur or the restaurateur and then qualify for this program. You do need to have either a fund or some sort of vehicle, any kind of SPV like an LLC company would suffice, but there just needs to be one barrier removed from the actual investment and you need to have a fund to layer in order to take advantage of of the tax benefits and that’s also so that you can be certified as an opportunity zone fund. The certification processes is fairly straightforward from what we understand and it’s basically just registering the fund or the SPV in a, in a certain way. We’re still waiting for guidance from treasury on some very crucial mechanics around how the funds can and will operate. And until then there’s a lot of money sitting on the sidelines waiting to get into these programs.

Eric Hornung: 00:35:59

What is that crucial guidance that’s missing right now?

Peter Brack: 00:36:02

To put it, most simply, the concern is around how a fund can transfer from asset to asset without necessarily selling off the asset. So in the case of, uh, let’s, let’s say in the case of a, either a real estate portfolio or even a venture capital portfolio, if there’s an exit, where does that go? Right? Do you have to distribute all of that across an investor base and back to LP’s? Can you recycle that capital into the fund and make more investments? Do you have to distribute it? Do you have to keep it in the fund? We’re actually waiting for that guidance from treasury and it’s very crucial guidance because without it we can’t really get up and running with qualified opportunities on funds and I think there are more people waiting to hear about this than we even expect because this is becoming such a hot topic and I think a lot of investors are waking up to the opportunity around opportunity zones and getting very excited, but now it’s, it’s a bit of hurry up and wait.

Jay Clouse: 00:37:13

So If I can just kind of summarize where we’ve come to thus far, and you can correct me if I’m wrong on anything. We have an investor, we’ll call her Susan. Susan has $200,000 in Apple stock that she bought for $100,000 so she can roll. If she sells that stock, that investment, she can roll that into a vehicle that can invest in opportunities zones, we call the vehicle theory VC, so she puts her investment into theory VC, theory VC out and makes an investment in three different startups. One of them exits in year three, and the question then is what happens with the proceeds from that exit? Do they get funneled back to Susan because that’s before the 5, 7 and 10 year time horizon, or can it be reinvested in the fund or that’s the guidance we’re missing right now? Yeah.

Peter Brack: 00:38:03

That’s one piece of crucial guidance that we’re missing right now. There are certainly others. I think that’s the most important piece right now.

Jay Clouse: 00:38:11

So Peter, I’m curious, when these opportunities zones were determined to these 8,700 zones. I recall following this news in early 2018, the New York times put out an article and I put out a Google alert and just started following all this. It seemed like those zones were identified in a pretty short period of time. Do you have any insight into how they were determined?

Peter Brack: 00:38:34

I do have a bit. We’ve gotten to know a lot of people in and around the creation formation of the legislation. I think you’re touching on an interesting point because the the short time period that was given to governors across the board was on purpose and I think it served a very smart purpose in that it didn’t give enough time to make the process overly political and I think that short window that they had to determine what those initial opportunity zones would be really pushed the process a lot faster because there wasn’t the political wrangling around who would get opportunities own status and who wouldn’t.

Eric Hornung: 00:39:19

Though there was still some kind of contention because as I recall, there’s a certain qualification barrier for a consensus track to be an opportunity zone, but then there was something added in which said, or it’s adjacent to one of those qualified consensus trucks. Am I remembering that correctly?

Peter Brack: 00:39:39

Yeah, so this this is still a pilot project technically, and it’s a it’s a very long pilot project because it’ll last for at the very least 10 years, but probably a lot longer. This is also batch one of opportunities islands. So this, the, this first 8,700 opportunities zones are designed really to be the first with, with more to follow if the program works the way it’s intended to, so I think there’s a lot more to come depending on whether investors treat this the way treasury and specifically the IRS hopes that they will.

Eric Hornung: 00:40:19

So that’s something I also wanted to have. I had a question about to be a qualified opportunity fund. You said that there is a credentialing process, but then there’s also this idea that you have to have 90 percent of your assets in an opportunity zone. Is that correct?

Peter Brack: 00:40:34

Yes, that is correct. And that. And I think that gives a buffer for funds and fund managers and and investors to for the inevitable movement of, of certain assets. So for instance, if a company in, in the case of a venture fund, right, if a company moves outside of an opportunity zone, you’re not instantly penalized for that.

Eric Hornung: 00:41:01

So in a VC portfolio, there’s kind of the three, three, three mentality. I guess three three to three one, whatever. Where it’s three, you’re going to just go to zero. Three, you’re going to break even in three are going to do x amount. Well, um, that’s how you get to your like average return on a VC portfolio. Then you have that one outlier that might be a zero or might hit a home run. What happens in the case in a VC portfolio where that one home run, that Facebook that’s in your portfolio decides to move out of an opportunity zone because hypothetically it might be making up 60% of your assets on evaluation basis.

Peter Brack: 00:41:38

Yeah, I mean I, I think that is a very good example of why treasury guidance is so necessary right now because I think outliers like that, which are obviously the goal, right? And, and well, the goal of a venture fund obviously is to have a large game like that. The goal of the investing in opportunities zone act is to have companies actually stay put and stay where they are and build communities. But I think this is why we need, we need guidance from treasury because, well, everybody wants to see meaningful companies get created and built and have them grow. We do want to see communities benefit from this and so you know that treasury guidance becomes very, very crucial.

Eric Hornung: 00:42:28

I want to transition back to hypothesis and the way that you think about that opportunity zones in that context. I read somewhere, I believe it was in an article that you had targeted a few cities as your initial kind of launch phase. I think it was

Jay Clouse: 00:42:45

Pittsburgh, Philadelphia, Washington DC, Baltimore, Detroit, Chicago, New York, and Los Angeles is what I saw.

Eric Hornung: 00:42:51

Yeah, so one. Is that correct? In two if that’s correct. Why are like New York and LA in there as emerging frontiers?

Peter Brack: 00:43:02

Well, good question and you’re right on those initial markets. Those are markets where we’re all spending a lot of time now and well these are initial markets that we’re really excited about. There’s a plethora of other markets out there that we’re very excited about and intend to to to work in. I’d say the first part of your question I would answer by saying Philadelphia, Pittsburgh, Detroit, Chicago, DC, and Baltimore all have an enormous amount going for them. They’re all very important cities in their own right. They all have already thriving entrepreneurial ecosystems, they have a great university infrastructure, turning out smart engineers and there’s a lot of capital in those markets too, so we’re excited about working in those markets and in opportunities zones adjacent to or within those markets as well with New York and la, you know, there are opportunities zones and both of those cities too. So New York lower east side is an opportunity zone. Dumbo and parts of Williamsburg have opportunities, islands and in Los Angeles, just down the road from where I live in Hollywood is an opportunities zone. So there’s a lot to be done in these markets as we’re just getting. And then, you know, we certainly expect to expand from there.

Jay Clouse: 00:44:35

Peter, something you guys had on your website that I loved as a statistic statistic, 66% of the most recent US technology IPO’s. Over 150 were companies headquartered outside of the Bay Area. Obviously that’s aligned with your investment thesis. Curious, that’s the decision to be based in Los Angeles versus somewhere more central of the country.

Eric Hornung: 00:44:57

Jay, why don’t you to say Columbus?

Jay Clouse: 00:44:59

Yeah. We want you to come to Columbus Peter.

Peter Brack: 00:45:01

Well, first of all, I would happily come and visit you guys. How’s tomorrow for you?

Jay Clouse: 00:45:06

I’m here. You come to Columbus tomorrow?

Peter Brack: 00:45:09

No, but I can come. First of all. Yes, I’d love to come visit Columbus, but second of all, I’m based in LA now, but that doesn’t mean that I always will be, you know, as we’re getting off the ground were making a lot of decisions in terms of which markets where we’re paying closest attention to and we just talked about that but also In terms of you know, where, where the firm itself resides and that decision we haven’t made yet, but I would make a very strong educated guests that the headquarters won’t be Los Angeles.

Eric Hornung: 00:45:45

What are some of the factors in deciding where you’re from resides? Because that’s. That’s an interesting question when you have people from. I think I’ve scanned, you have people from New York and LA and a couple other places, but how does that decision making process go down? Are you looking for incentives? Are you looking for structure? Are you looking for, I don’t know, a trend? What’s the theory behind that?

Peter Brack: 00:46:07

I’d say it’s more logistics than anything else. It’s travel time to markets where we want to spend a lot of time and where we expect we’ll be spending a lot of time for the foreseeable future. It’s also walking the walk, right? We, we wanna, we wanna be in the markets that we’re working in most of the time and in addition to that I’d say across the country we’re also working towards building a scout network. So that’s been very helpful for us in having boots on the ground in markets where we can’t be all the time and with that initiative we’re really engaging with not with other investors but with, with founders in markets who have a greater gravitational pull with other founders and are in the flow and can be a really good source of information and deal flow on the ground and then bringing them into our farm and incentivizing them to, you know, to work hard alongside us with the investments that will make.

Eric Hornung: 00:47:14

It’s interesting. It’s something we haven’t talked about much on the podcast yet, but I think maybe one question on it and then we can turn back, but how do you build a great scout network?

Peter Brack: 00:47:25

I think that’s, that’s really it comes a lot from having a yourself. I think it’s really tough if you’re going out cold to just pound the pavement and get to meet people for the very first time and asked them to be scouts. I think there’s a huge benefit that comes from having existing networks and and, and all of us do. So we’ve been tapping into, you know, very warm connection. Some people who we know very, very well already have stepped up and said, I really love what you’re building. I really like the ethos behind hypothesis and I, I’d like to find ways to contribute however I can. Great. That’s a really easy conversation to have. And then there’s triangulating into people who we may know of and want to get to know better and just getting very warm introductions and spending time, educating them on our own hypothesis and how we want to build the farm. So it’s, it’s just like anything else, it’s just like getting to know VC’s as a founder. It’s, it’s a lot of leg work and a lot of warm introductions and then hopefully a lot of fruitful conversations.

Jay Clouse: 00:48:36

Will you guys have a specific vertical or industry focus with hypothesis, ecommerce or marketplaces or anything of that nature?

Peter Brack: 00:48:44

Well, given that we’re really focused on pre-seed, I’d say the common thread is we’re all really pulled towards mission driven founders who want to tackle big market opportunities and also given the fact that we’re very early stage, I’d say we’re pretty broad from a sector standpoint. So we look at FinTech, we’re looking at healthcare tech, AI, Ag tech, certainly autonomy and SAS and enterprise. So we see ourselves mostly as domain agnostic and opportunistic.

Eric Hornung: 00:49:21

On your website, you mentioned that diversity plays a key role in hypothesis as hypothesis. What does diversity mean to you?

Peter Brack: 00:49:33

I think that diverse founders are attracted to diverse partnerships when it comes to venture and I think that from my own experience, having worked literally all over the world and across multiple cultures, there’s no substitute for vastly different points of view that comes in the form of when you’re running a business. It’s great to have a diverse management team and I think that also shows itself very clearly if you look across portfolios from some of the most successful venture firms, you see a really diverse quilt of founders, different types of founders from different backgrounds, from different points of view. So we set up our firm right off the bat with a very diverse set of backgrounds, skill sets and origin stories. I think that’s going to be the trend moving forward for, for most venture firms and we’re seeing that a lot certainly over the past couple of years of a real push towards diversity and I, I mean better late than never

Jay Clouse: 00:50:45

Peter I know we’re running long on time, so I’ve got two real quick questions to wrap up here. The first being, given that you’re close to the Bay area geographically right now, have you gotten feedback from Bay area companies, investors about your hypothesis?

Peter Brack: 00:51:00

Yeah, I think we’re certainly beginning to ride a wave. I’m sure we all listened to a lot of the same podcasts, read a lot of the same publications and talked to a lot of the same people. Without question there has been an increased awareness and I think an increase in enthusiasm about investing outside of the bay area. Of course, that’s what your whole podcast is about. You guys are making a real business out of this and so too will venture firms and and I think investment firms across every single asset class, you know, I really do believe that the future is decentralized and that decentralization in entrepreneurship is really the big opportunity of the next several decades. So I think we’re all starting to wake up to that hypothesis and we’re certainly excited about it.

Eric Hornung: 00:52:00

So I want to follow up an app before Jay’s last question. You mentioned riding a wave and you mentioned this increased interest. The skeptic in me, obviously I run this podcast, so I believe in the future of starting grade companies outside of Silicon Valley, but the skeptic in me says the increased interest is maybe artificially inflated due to macro economic factors such as like cheap capital and just this low return environment that we’re currently sitting in. As someone who lived in Asia during the Asian financial crisis in ’97 and went public right before Lehman went bust in 2008. I’m curious on your perception of market cycles and how they affect venture investing specifically this round of venture investing.

Peter Brack: 00:52:51

I think that’s an interesting point of view, but I would. I would overlay one important factor and that is that certainly while there are macro economic forces pointing towards, I would suppose value investing. One very key overlay is information flow, so whereas let’s say 10 years ago you kind of had to be in maybe not the bay area, but certainly in an important financial market or a key city somewhere in the world. In order to build a meaningful business of scale and have all of the tools at your disposal to do that, I think what’s changed is that, you know, with the advent of so many tools that we’ve had AWS, Microsoft Azure, cloud computing in general, and then even small tools like Skype and Slack and Trello and Upwork, we can start building companies anywhere and I think this is a trend that is outside of the macro economic factors that you listed off. This is something that is just a systemic change that we’re all living with right now and I think that smart investors already see that trend and are already getting interested in pounding the pavement, exploring the world, exploring other markets and finding great opportunities no matter where they are and that’s not from evaluation perspective, that’s just great opportunities. I don’t think it’s about just finding cheap value because there’s a discount for non Bay area markets. I think that it’s about finding great teams, great founders, and great value because you’ve you’ve found these brilliant people who are building something very important.

Eric Hornung: 00:54:53

I love that. Thanks for that answer. I believe in the Charlie Munger quote that you need to understand the other side’s argument better than they do, so that’s why the skeptic of my head fights both sides and when I get answers like that, it’s definitely helpful.

Jay Clouse: 00:55:05

Peter, thanks so much for taking the time. This has been awesome. After the show, if people want to follow Hypothesis Ventures or follow you, where would you point them towards?

Peter Brack: 00:55:13

So Hypothesis is at HypothesisVC and I am at Peter Brack and that’s p e t e r b r a c k on Twitter and that’ll lead you everywhere else.

Jay Clouse: 00:55:26

Great. Thanks so much.

Peter Brack: 00:55:27

Thank you guys.

Eric Hornung: 00:55:32

All right, Mr. Opportunity. Eric Hornung. We just spoke with Peter Brack of Hypothesis Ventures. I feel like I learned a lot both in terms of solid answers and learned a lot in terms of what is still unknown in this space in some of the guidance he was talking to that is being looked to the US treasury for some answers and things that are just unknown. Couple things that stood out to me. 8700 opportunity zones this year alone, $6,000,000,000,000 that can be put into an opportunity fund. A lot of big numbers here. So to you, what is the opportunity here for the midwest or just areas across the country in general?

Jay Clouse: 00:56:16

First off, since when do we do the nickname and the debrief that that was new. You really threw me off there, man. Me nicknames in general is new and I’m going to play by my own rules,

Eric Hornung: 00:56:27

Jay, but play by his own rules Clouse. Okay, great. So the entire purpose of the opportunity fund section, the tax bill is to make capital move from higher areas of concentrated wealth to lower areas of concentrated wealth and not just capital but actively invested capital. So capital that’s going to return more capital in the future, not just a welfare distribution plan where that capital is going to get expensed effectively. So the thing that’s really interesting in the midwest to me is that because we’ve been on this huge kind of bull run in the public markets, a lot of individuals and accredited investors, their net worth is made up by a lot of these gains that Peter said are subject to opportunity zone and opportunity fund investment. And that makes up that $6,000,000,000,000. And that’s really exciting because that’s a lot of capital to invest in places that haven’t historically seen numbers of dollars that start with a T. And I think that one thing that kind of pops off the page to me is this idea that everyone outside of Silicon Valley, New York, Boston points to one stat, 75% of venture capital funding goes to those three cities. So this could be that kind of turning point where opportunity funds get capital that is effectively cheap. It’s cheap for the investor, it’s cheap for the fun and it can be deployed in risky assets that are riskier than Silicon Valley, New York, Boston because of the cheapness of capital. So it’s a risk return ratio that I think people can live with. So I think this is a really interesting law and that’s why I wanted to bring someone on, it’s why we wanted to bring someone onto kind of talk about it,

Jay Clouse: 00:58:18

Something that we didn’t ask Peter directly that you and I have talked about, but not on the show yet. The opportunity fund structure in opportunity seems like a no brainer in real estate. So if I am somebody who represents some amount of that $6,000,000,000,000, why would I roll it into a startup based opportunity fund as opposed to real estate?

Eric Hornung: 00:58:42

Well, I think that’s something that that the regulatory clarity is going to answer. If it comes back and says, well, all of those events are taxable at their current rates in the three to five year timeframe or in the one to five year timeframe, then it might not make as much sense for a venture capital firm. Although most returns are. They do come out outside of five years, seven years, 10 years, or even longer than that. but real estate is more certain and it’s more sure. And the payoffs are great. You can still get cash on cash return in real estate of eight to 20 percent. I mean, depending on who you’re investing with or whatever. I mean there’s probably a huge range that it was just a complete guess, but in Venture Capital it kind of gives you a allocation to the upside that a lot of investors who are sitting there with that money just on their balance sheet, they might not have an allocation to Venture Capital. It’s hard to get one. If you live in Cleveland, it’s hard to get an allocation to venture capital unless you’re one of the most well off people in the entire city and you have connections to silicon valley and you have connections in New York and you have connections to Boston, so unless you’ve invested as an angel investor in the city or a local or a mid-western venture capital firm, it’s unlikely that you have an allocation to this, this high risk high return asset class.

Jay Clouse: 00:59:59

Yeah. Not to mention that there will be VC’s like Peter who see the opportunity to raise an opportunity fund. They they’re already in the line of venture investing and they’re not going to suddenly pivot towards real estate, so it’s probably going to exist one way or another and it follows down to somebody’s interest in the risk tolerance and what they’re looking for. Something that I think is non trivial in a way that wasn’t discussed specifically. He talked about the treasury guidance being needed in case a company really starts hitting it. They grow and they need to move out of an area because they have talent shortages, let’s say. Totally agree. That’s a huge risk. Something we need to address because in the situation where that’s happening, that’s the potential real win of investing your money in and opportunity fund, so we need to know what happens if that happens. An earlier level, I think it’s a risk too because you see this with accelerators in grant programs all over the country already with similar goals of trying to build ecosystems or stimulate innovation in their areas. They offer grants for companies who come and set up headquarters in that area and companies will go and they’ll set up a headquarter or they’ll set up what seems to be a headquarter and they’ll take the grant money and then after a couple of years when there’s next to no recourse, they leave. Same thing happens with accelerators that are based In a certain city. You want those companies to come and stay and build their. That’s part of the reason that you’d do it, but it doesn’t always work, so I hope that the opportunity fund and the opportunity zones create a larger institutional incentive to develop ecosystems as opposed to just spread money around to these startups.

Eric Hornung: 01:01:40

It’s interesting that you say that because I’ve thought about in Ohio, and we’ll talk about Ohio for a second here because you and I are familiar with the way it’s structured. The third frontier program seemed to have launched a major public private partnership or effectively that in each of the cities.

Jay Clouse: 01:01:58

You’re going to have to explain what the third frontier program is.

Eric Hornung: 01:02:00

How about you do it because you’re better at that

Jay Clouse: 01:02:03

Third frontier program was a billion dollar fund carved out of Ohio tax payer money aimed towards innovation and a lot of that got earmarked for different institutions within Ohio who were non profit organizations that could disperse that grant money or had some nonprofit vehicle aspect to them. It’s actually very mystical to me and I don’t know or understand all the processes or how it all works and in fact that’s a large point of contention in Ohio is that it’s a non accessible vehicle, have a lot of funding that a lot of people could make use for and frankly all of Ohio taxpayers paid for and it’s never been quite transparent or clear everything that goes on with it.

Eric Hornung: 01:02:49

So outside of the problems of the third frontier, it did create ecosystems in specifically Cleveland, Columbus, and Cincinnati. I know that a lot of the other cities have them as well and each of those has a public private partnership that kind of spearheads the movement in each of those. The problem that you brought up earlier is that a lot of this money was invested in companies that are at accelerator stage, at preceded stage, at seed stage. The early companies who are finding their footing and developing and some of them have gone on, gone on to do well, but there hasn’t been a massive source of series a type funding and follow on funds. It’s been a complaint we’ve heard from entrepreneurs in the midwest is that, well, if I need to get follow on funds, I need to go to the valley. I need to go to Chicago. I need to go to New York or Boston and that’s where I can find money that will invest in evaluation. That makes sense for my company in a series. A level with the opportunity fund might allow them to do and I’m projecting here is they might be able to raise follow on funds to kind of solve that problem of keeping people for around for a little longer because if there’s enough money in the system and jumpstart or Rev One or Cincy tech went out and raised 100 million dollar series a fund from each of their respective cities and there was a tax incentive to that for the LP’s. Whether it’s done in a different structure, same structure that could keep around those people who come in with grants and make their way through an accelerator and made their way through some seed funding and then leave for a series a. they could stay for that series a because now they have the lead investor who was already there investor,

Jay Clouse: 01:04:26

I hope so, and I mean that’s at the core of this legislation, right? They, it’s, it has the goal, the stated goal of helping to increase innovation and investment in these areas that need it and so I hope it’s written and plays out in such a way that that actually transpires and it doesn’t become just another vehicle for those with funds to simply return more funds to themselves.

Eric Hornung: 01:04:50

Yeah. I’m really hoping that the smaller accredited investors take advantage of this. I think that the larger ones will and they have made allocate a portion of their portfolio to an opportunity fund. I think that there’s a lot of questions that are unanswered and to be honest, you and I have been talking about this for almost a year, but I don’t think most people in America know what this is.

Jay Clouse: 01:05:15

That’s crazy, you’re right, it has been almost a year since you first brought this up with me and yeah, anyone I talked to about this I say opportunity zone and they don’t know what I’m talking about. So opportunity funds follow and understanding of what an opportunity zone is and that legislation and it was. There was a several month lag time before that large article in New York times after the tax bill passed, so it is little known. It’s cryptic according to Peter. It sounds like some of the way they’re going about it is intentionally so. And I think that is with good intention. I think there’s a lot of legs here. I think there’s a lot of upside potential for communities and so I hope. I hope that plays out that way.

Eric Hornung: 01:05:55

Same. I’m really excited to keep on learning more about these. As new guidance comes out as new regulations are made and as we get a little bit of clarity, I’m also really excited to see more funds like Hypothesis pop up because when something comes around and is effectively legislated in. At first there’s a little cottage industry, but this seems like it’s going to be larger than a cottage industry. There is a lot of money at play here and barring a 60 percent crash in the market, there is plenty of funds to fund this new kind of space, so I’m really excited to stay on track with it. I’m sure we will have another guest on to discuss it because it is something that could potentially be incredibly impactful in the Venture Capital scene outside of Silicon Valley.

Jay Clouse: 01:06:44

Alright guys, would love to hear your thoughts, especially if you have some knowledge in this space we’d love to hear from you. Before we recorded this, Eric and I were reading through the actual legislation and it is just complicated to read, so if you’ve had experience reading through this. If you have a background in law, would love to pass this by you and try to discern some of these lines. In any case, you can tweet at us at upsidefm or email us at hello@upside.fm. And if you’re listening to this on Breaker, you can comment on this episode. We’d love to talk with you there. All right. Talk to you next week. That’s all for this week. Thanks for listening. We’d love to hear your thoughts on today’s guest, so shoot us an email@helloatupside.fm, or find us on Twitter at upsidefm will be back here next week at the same time talking to another founder and our quest to find upside outside of silicon valley. If you or someone you know would make a good guest for our show, please email us or find us on twitter and let us know and if you love our show, please leave us a review on iTunes. That goes a long way in helping us spread the word and continue to help bring high quality guests to the show. Eric and I decided there were a couple things we wanted to share with you at the end of the podcast, and so here we go. Eric Hornung and Jay Clouse are the founding parties of the Upside Podcast. At the time of this recording, we do not own equity or other financial interest in the companies which appear on this show. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinions of Duff & Phelps LLC and its affiliates Unreal Collective LLC and its affiliates or any entity which employ us. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. We have not considered your specific financial situation nor provided any investment advice on this show. Thanks for listening and we’ll talk to you next week.