Low-cost bonds help small businesses
if they can cope with the paperwork
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
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.
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.
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.
yourself for paperwork
But the biggest drawback to this kind of financing is the voluminous
paperwork required to comply with the complex regulations.
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
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.
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.
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.
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