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Low-cost bonds help small businesses --
if they can cope with the paperwork

Industrial development bondsIf your business is manufacturing and you're looking for more than $1 million for expansion, then the cheapest money around is likely to be a small-issue industrial development bond. Beware, though -- these cheap loans exact a price in paperwork, time and upfront costs.

Cities, counties and other municipal authorities in every state have the right to issue IDBs, often through local or state economic development commissions. In a typical deal, the local municipal authority approves a company's project and issues the bonds. They look and act like corporate bonds, but they're tax-free municipal bonds that are sold to private investors.

In 1998, businesses nationwide raised $3.23 billion in capital using small-issue IDBs, according to Aaron Mindel, executive director of the Council of Development Finance Agencies, a trade group based in Washington, D.C.

A good deal -- almost
Federal law allows companies to raise up to $10 million using tax-free IDBs, which carry an interest rate as low as half of prime. An array of terms is available, from a seven-day variable rate to a long-term fixed rate of up to 30 years. Currently, a company can expect to pay about 3.5 percent, plus a 1 percent fee to a participating bank for delivering a letter of credit.

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Does all of this sound too good to be true? Well, in some ways it is.

There are restrictions on the use of the money. IDBs are intended to finance new equipment and for building or retooling manufacturing facilities. In general, no more than 25 percent of the bond proceeds can be used to acquire and prepare land. And each $50,000 borrowed must result in at least one new job.

IDBs also can be used to refinance older industrial revenue bonds that may carry a higher interest rate.

Brace yourself for paperwork
But the biggest drawback to this kind of financing is the voluminous paperwork required to comply with the complex regulations.

When Crabar Business Systems decided in 1998 to use an IDB to refinance an industrial revenue bond of nearly 12 percent, which they acquired when they purchased a manufacturing plant in Belleville, Texas, Controller Charles J. Berg III had no idea what he was letting himself in for.

The company, which manufactures and prints custom business forms, has about $25 million in annual revenues and employs about 130 workers between the home office in Dayton, Ohio, and the plant in Belleville.

Berg, who has more than 30 years of experience as a CPA involved in financing businesses, worked on the project himself for nearly six months and also hired a consultant to handle part of the paper trail.

In the end, the company refinanced $2 million in debt at the current, attractive and variable rate. They also ended up with a four-inch-thick bound volume, complete with gold lettering, that contains all the required reports, forms and filings. "It was mind-boggling," Berg says.

One of the first things that any company interested in exploring this kind of financing needs is a bond counsel -- a lawyer with expertise in municipal finance in the region in which the company does business.

Bond counsels can help
Bond counsel John W. Peck, a partner in Peck, Shaffer & Williams LLP, with offices in Cincinnati and Atlanta, is accustomed to quarterbacking this kind of financing. Most of his business comes via referrals from economic development directors whose job it is to assist manufacturers in obtaining industrial development bonds.

Peck is the first to say that the process is complex, but he believes that if a company hires the right bond counsel and the economic development director is fairly savvy, the deal will come together.

But he does recommend that companies seeking less than $5 million do some calculations before embarking on the process. Filing fees, legal and other transaction costs can easily add another 5 percent to the cost of the financing when the amount borrowed is low. The transaction costs alone make loans of less than $1 million uneconomical.

In some states, there are additional regulations that can make the deal even less attractive. In most industrialized states, including Ohio, Peck, Shaffer & Williams partner Abbot A. Thayer points out, any building project financed with an IDB must pay employees the prevailing wage, which corresponds closely to union scale. "You have to deal with state law and federal law. Both have to come together, and sometimes that's a marriage made in hell," Thayer says.

How to get started
If, despite all this, the interest rate seems too good to pass up, Peck suggests embarking on this quest by contacting the state or local economic development commission. Someone there should be able to help a company find a law firm that has bond counsel services.

The bond counsel will determine whether the project your company has in mind can be made to comply with state and federal law. It also can help determine if there is any money available and who has it.

The federal government caps the amount available each year for small-issue IDBs in each state. The states decide how much is allotted for private businesses and how much will go for projects such as affordable housing.

Some breaks may be available
In some cases, Peck says, there will be several authorities willing to issue an IDB. Not all deals will be the same and sometimes it pays to shop around. If your company's willing to locate in an area badly in need of jobs, the issuing authority may waive some fees or provide a low-cost letter of credit or guarantee that will cut the interest rate still further.

Depending on how the deal is structured, your banker may be involved.

Peck says that increasingly, deals involve a letter of credit from the bank.

"Basically, the way these bonds get sold is on the strength of the letter of credit -- not on the strength of the project." So the next step will be providing the same kind of information that the bank would demand for any other commercial loan, including a business plan and some kind of collateral.

Finally, the company offering the bonds will need an underwriter, usually a local stock brokerage willing to sell the bonds. Peck says the bond counsel will help negotiate that deal, as well, making it as easy as possible for the business owner.

Once the bonds go on sale, they usually sell quickly to institutional as well as private investors. The income on IDBs flows to the bondholder free of both federal and, in most cases, state income taxes. This means there's lots of demand. Peck estimates the company selling the bonds will have its money in less than 60 days from the time the bank issues the letter of credit.

Jennie L. Phipps is a contributing editor based in Michigan

 

-- Posted: Nov. 4, 1999

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