For Entrepreneurs, This Bond May Beat a LoanJeremy Quittner
Few entrepreneurs consider bonds when they need major long-term financing. But by using a little-known set-aside in the public finance world called an industrial development bond, or IDB, small companies with strong track records can gain access to as much as $10 million with rates as low as 3%—similar to what large corporations get in the commercial paper market. (Up-front fees range from $70,000 to $200,000, but total costs are still about 20% to 30% less than conventional bank loans.) And while IDBs were designed to be used specifically by small manufacturers, the definition of "manufacturer" may surprise you, as the American Recovery & Reinvestment Act expanded it to include technology companies that manufacture software or other intellectual assets.
The proceeds from such bond issues can be used to buy land or manufacturing equipment, and to build new facilities. To ensure that IDBs contribute to economic development and therefore deserve their tax-exempt status, companies that issue them must promise local finance authorities that they will hire a predetermined number of employees over the life of the bond. About $3 billion in IDBs were issued in 2007, up 158% from 2006, according to the Council of Development Finance Agencies, which represents issuers of IDBs. Although issuance tumbled in 2008 to $1.27 billion, that's still the second-highest level in a decade. In the past year, Steve Eikenberry, senior vice-president of tax-exempt finance at First American Bank in Elk Grove Village, Ill., says he has seen demand for the bonds from new issuers grow about 30%. "I think this should be a very good year" for IDBs, he says.
"There are some headaches, but this is a good deal," says Louis Glunz IV, CEO of Regis Technologies, a $20 million, 80-person biotech company in Morton Grove, Ill. Regis has issued bonds three times since 1996, the most recent being a $7 million offering in 2008. Those bonds have so far funded two additions, for a total of 13,000 square feet, to the original 14,000-square-foot factory Glunz's grandfather built in 1956, and have enabled Glunz to hire 50 workers.
Among the headaches Glunz refers to are the mounds of paperwork and the cat-herding required to get the financing. Issuing an IDB is complex and time-consuming, requires a huge amount of documentation and coordination, and can easily take more than six months. Moreover, companies that use an IDB to acquire property and equipment must take a standard depreciation on those assets, rather than an accelerated one.
Banks are a critical partner, and in the past year the federal government has offered them incentives to issue IDBs. Banks that have up to 2% of their assets in tax-exempt bonds can now write off the cost of funds for issuing those bonds. It also has become easier for smaller banks to issue IDBs, as the Federal Home Loan Bank now stands behind them.
Your first step in issuing bonds is to find a "conduit issuer," typically a state or city industrial development agency. "Any county or city can also do this, and there are a few joint ventures [between them] that do it as well," says Stanton Hazelroth, executive director of the California Infrastructure & Economic Development Bank, or I-Bank, one of the largest issuing agencies in that state. If the agency is convinced that your project will create jobs and further economic development in your area, it can bestow the all-important tax-exempt status on the issue, which is how business owners get lower interest rates. The tax-exempt status may also be attractive to the bank providing the financing, or to bondholders if the issue is sold in the secondary market.
The initial paperwork will ask you to describe your business and how many jobs it provides to the area, but the issuer will also want to know about any union activity, pending lawsuits, details of your proposed project, and your plans to add jobs. One way large companies are prevented from taking advantage of IDBs is a requirement that issuers not spend more than a total of $20 million in the region in the three years prior and three years after the issue. "[Lawmakers] did not want $10 million of tax exemptions for a company with $500 million in cash to build a petrochemical plant," says Daniel Bronfman, president of Growth Capital Associates, a Los Angeles financial adviser for IDB borrowers. Assuming your plan passes muster, the conduit issuer will pass an Inducement Resolution approving your proposal.
'A PAPER CHASE'Next, you need a bank. In any market, there are typically a few institutions that specialize in this type of work; the conduit issuer or your financial adviser should be able to help you find one. Banks generally specialize in one of two types of IDB. The first is a direct purchase, where a bank essentially makes the loan to the company. The second is a letter-of-credit issue, where the bank certifies the company's creditworthiness then sells the issue, usually through an investment bank, directly to the secondary market.
Letter-of-credit issues, while more complicated to orchestrate, usually have lower interest rates. In that case, two banks are required: one to issue the letter of credit, and another to sell the issue in the secondary market. "It was a three-month procedure, and it was quite a paper chase," says Eric Dortch, who used the letter-of-credit structure to issue a $3.5 million IDB in 2008. His 89-person, $21 million Los Angeles company, iWorks, makes lighting for casinos and hotels. Dortch needed the money to buy land to expand his factory. "I would absolutely go through this again knowing what I know now," Dortch says.
Once you have the conduit issuer's stamp of approval, you'll be hearing from its bond counsel. The conduit issuer hires this attorney, but you pay his or her fees. The bond counsel builds the case for tax-exempt status, which ultimately will be granted—or not—at a public hearing. The bond counsel also helps determine the structure of the deal and may tailor it to take advantage of state and local tax exemptions as well.
All this back-and-forth is as time-consuming as you might expect. When Neil Foster, president of Santa Rosa, Calif.'s Foster Corks, a company with 30 employees and $20 million in annual revenue, wanted to raise $5.3 million through a bond offering, his operations manager had to dedicate half her time to coordinating and meeting with the conduit issuer, the bank, and other attorneys. The alternative, Foster says, would have been a Small Business Administration-backed 504 loan. But that would have required 25% down and carried a higher interest rate and prepayment penalties.
What exactly counts as manufacturing, and which companies are eligible, can be more than a little surprising. "It may seem straightforward," says Perry Israel, a tax attorney in Sacramento, "but there is a lot of judgment that goes into this." A company that cleaned and froze fish qualified, he says, but one that ground up stones for paving did not. That's because case law ruled the former was manufacturing a product, while the latter was not.
Your relationships with other business owners will be part of the determination, too. If you have a partner who also owns another business, expenditures of that other business would count toward the $20 million limit for your company.
In the meantime, the bank will conduct its own due diligence, including a profit-and-loss analysis, revenue projections, and an examination of your overall debt. The bank will draw up covenants for the bonds and the terms of repayments.
Once all these ducks are in a row, the conduit issuer will announce a public hearing on the bond. The hearings must be advertised, and they're open to the public. Generally they're a formality, and few people show up, but the entrepreneur should attend. Other business owners or local residents may come with questions about how the deal will affect them. But if the bond counsel has done her due diligence, experts say, there should be no surprises.
Following the hearing, the board of the conduit issuer votes on the bond and, assuming it's a "yes," formally adopts a resolution allowing the bond to be issued.
Finally, you'll get a check. In some cases, the bank will provide the funds on an as-needed basis. In most deals, a trustee will be appointed, usually a bank with public finance and trust expertise. The trustee acts as clearinghouse for information pertaining to the bond and is responsible for collecting the payments from the issuing company and, in turn, paying the bondholders. An IDB certainly isn't the simplest way to raise money. But in these tough times, it's no picnic getting a conventional loan, either.
Return to the BWSmallBiz August/September 2009 Table of Contents