Industrial revenue bonds (IRBs) are tax-exempt vehicles, typically issued by a state or local government for the benefit of private companies. Historically, the use of these proceeds was limited to a strict interpretation of the manufacturing elements of qualified businesses. For those companies that qualified, it proved to be an inexpensive form of debt to help fund growth.
One of the provisions of the recent American Recovery and Reinvestment Act (ARRA) was to make the definition of manufacturing less restrictive, allowing certain capital costs that historically would not qualify under the traditional manufacturing label.
“Certain research and development costs or certain elements of warehousing and distribution weren’t allowed under the historic rules governing industrial revenue bonds,” says John Sassaris, senior vice president, commercial division head, with MB Financial Bank.
Smart Business spoke with Sassaris about the changes in how industrial revenue bonds are administered and the key things you should know about the bond application process.
How did ARRA impact IRBs, and how long will those changes be in place?
First and foremost, the definition of manufacturing has been greatly expanded, allowing for more flexibility in bond sizing. Also, there is a designation entitled recovery zone bonds, which covers areas in major cities geared toward stimulus or recovery plans.
For example, the entire city of Chicago qualifies, as the city council recently designated the whole city as a recovery zone. Any company that’s looking to expand or build space in the city proper can likely qualify for a recovery zone allocation. There have also been several changes in how nonprofit entities can issue 501(c)(3) bonds or their version of tax-exempt indebtedness.
While we have seen a tremendous amount of activity this year on the nonprofit side, we have yet to see the same level of uptick on the private activity or IRB side. This is likely due to the economic uncertainty that remains in the overall marketplace, but as the economy settles, some deployment of capital is anticipated. While companies will have the ability to issue tax-exempt indebtedness for years to come, the changes that were implemented as part of the stimulus plan are set to expire at the end of 2010.
What are the eligibility requirements for IRBs?
In a normal setting, 75 percent of the proceeds need to be used for core manufacturing. You cannot exceed more than $20 million of capital expenditures going three years back and three years forward.
A company cannot issue more than $10 million of IRBs per project and cannot exceed an aggregate bond total of $40 million across the country.
In addition, only 2 percent of the bond can be used to fund the cost of issuance.
What do business leaders need to know about the bond application process and dealing with government entities?
First, it’s not as difficult as people believe. Depending on the structure, you can actually have a deal close within a 60-day window, which is much quicker than people anticipate.
Another key is making sure you surround yourself with a good team of professionals. A supportive bank and an experienced bond attorney are critical to the success of the offering.
Establishing contact with a municipal body that will issue the bonds on your behalf is another important early step. These are municipal bonds for the benefit of private activity, so you need a municipality to issue them city, county or authorities such as the Illinois Finance Authority. This entity has the ability to issue a certain amount of bonds every year throughout the state.
Every state has a similar authority. An inducement resolution needs to be passed by the authority in which your project is recognized by a municipal body.
Once that’s complete, any money spent 60 days prior to the inducement and going forward three years from that point will qualify for the tax-exempt project that you want to finance.
What is the cost of IRBs?
It varies on a deal-by-deal basis. For example, in a normal setting, a standard bond will be somewhere in the low to moderate five figures. While this seems like a large figure, the bulk of this cost is wrapped into the bond, so the actual cash outlay is very small. That being said, this type of financing only makes sense if you’re talking about bigger projects that exceed $2.5 million to $3 million.
If you’re going to move forward with the project and it fits the tax rules, you can make up the cost of the bond, in most cases, within two years based on the interest savings over conventional financing. That really helps you determine whether it makes sense to apply for an industrial revenue bond.
What are the benefits and drawbacks of IRBs?
IRBs have lower rates relative to conventional financing. It used to be quite costly to go through this process and issue debt, but the process has become easier over the years.
It’s always cheaper to pay a tax-exempt rate, but the greatest obstacle remains qualifying your project.
John Sassaris is senior vice president, commercial division head with MB Financial Bank. Reach him at (847) 653-1848 or firstname.lastname@example.org.