Due diligence needed Featured

8:00pm EDT March 26, 2007
For select businesses looking to expand their facilities, a novel financing mechanism allows owners to gain a 15 percent to 40 percent savings over conventional loans.

Known as industrial development bonds (IDBs), these instruments can provide up to $10 million in low-cost, tax-exempt financing. Issued by governmental agencies or authorities or a development corporation, these bonds are used to finance qualifying construction and equipment purchase. The interest paid to investors who purchase IDBs is generally tax exempt, while the borrower benefits from the lower cost of funds. The bonds can be a boon for companies, as long as requirements are met.

“We know that a business owner is focused on building a lasting and profitable enterprise, not navigating the IDB process,” says Don Starkey, senior vice president at Comerica Bank. “That’s where an experienced banker is needed: to help chart the course of a successful financing project.”

Smart Business spoke with Starkey about the banker’s role in initiating an issue of an IDB.

Are industrial development bonds more attractive to a certain class of business?

In order to be eligible, a business needs to operate as a manufacturer or processor.

IDBs can range between $2 million and $10 million, and can be used to finance the construction or purchase of industrial plants, warehouses and distribution facilities. Beyond that, the funds can also be used to purchase equipment and machinery, expand an existing facility, or even relocate. The ultimate goal of the IDB program is to benefit local economies through job creation, keeping a business in business and generating locally based revenues.

What are the benefits of industrial development bonds over other types of financing?

First and foremost, a company may see cash flow savings from 15 percent to 40 percent over conventional financing through the use of industrial development bonds. The cash flow savings is a result of the low-interest environment for IDBs in which rates are running 2.6 percent lower than the average prime rate during like periods (based on average interest rates from 1982 through 2003). Lower rates typically mean lower payments.

What role does the lender play in helping companies obtain IDBs?

Before proceeding with an industrial development bond project, it’s important to get your lender involved early to evaluate the feasibility of the project from a bank’s perspective. Bondholders don’t want to worry about whether or not a company can repay the bonds, so they typically look to a bank to provide credit enhancement for the bond issuance. This enhancement comes in the form of a letter of credit and ensures that the bondholders get their money in the event the company defaults on bond payments.

As you might suspect, most banks are going to evaluate a company’s creditworthiness before issuing a credit enhancement letter of credit. They do so by reviewing, at a minimum, three fiscal-year-end financial statements and personal financial statements of the owners.

Also, a ‘sources and uses’ summary is required to demonstrate that the funds will be used for eligible purposes. This summary includes the cost of the building, detailing land value separate from construction costs, new equipment purchases and other expenses related to the project.

Beyond that, most lenders will look for projections that demonstrate that the company has sufficient future cash flow to support the required bond payments. This might sound like a lot of information, but most of it is no different than what any prudent business owner should review prior to making a large capital investment.

In addition to the lender, who else is involved with the process?

Most companies use specialists whose sole mission is to maneuver through the differing requirements of issuing an industrial development bond. The tasks handled by this third party include processing the application with state and federal agencies, managing the bond issuance process with the public and coordinating with bond counsel.

With all of the moving parts, we find that very few banks support industrial development bonds because they can be so time-consuming, taking up to six months from the application submission to the closing of the bond issue. There is a fair amount of work that goes into these transactions but, in almost all cases, the long-term cost savings compensate a business for the short-term diligence.

How should a company proceed if it is interested in applying for an IDB?

A business owner should talk with a banker experienced in supporting IDBs who can speak in detailed terms about the application process, the underwriting requirements and an interim plan, should a business not have six months to wait for the bond issuance.

Because this is a unique process, an experienced banker should also be able to put you in contact with specialists.

DON STARKEY is senior vice president at Comerica Bank. Reach him at (619) 338-1541 or at dwstarkey@comerica.com.