Small-issue bonds can provide big opportunity Featured

10:09am EDT July 22, 2002
Business is good. Your company is ready to expand. Plans call for a new facility to increase production capacity, or perhaps the acquisition of additional equipment. Customers stand ready to buy up your increased output. Your friendly banker assures that money is available to pay for your expansion. Does it get any better than this? Quite possibly, yes.

If your company and your project meet certain criteria, the money you borrow to pay for your new manufacturing facilities could come with a reduced rate of interest. As part of federal and state policies to promote the expansion of manufacturing facilities and related employment, tax-exempt rates are made available to qualifying projects. Formerly known as industrial development bonds, "qualified small-issue bonds" can provide your company with a significant reduction in the cost of money to pay for certain improvements or new facilities.

Who is eligible to borrow?

Just about anyone in need of funding for a qualified manufacturing facility. Corporations, partnerships, individuals and other business entities can apply for tax-exempt financing under the qualified small-issue program.

However, two significant limitations exist:

1. A company seeking this type of tax-exempt financing cannot have more than $40 million of tax-exempt debt outstanding at any time, including the financing under consideration. In determining whether this $40 million threshold has been met, tax-exempt debt of all affiliates of the borrower anywhere in the United States or its territories is counted toward the total.

2. The applicant, together with all affiliates of the applicant, cannot incur more than $10 million of capital costs in the municipality where the project is located during the six-year period that starts three years prior to the date of the borrowing and ends three years after the closing.

Current project costs, as well as those previously financed with tax-exempt debt, are included in the determination of whether the borrower has met this threshold. Only costs incurred for facilities located within the geographic boundaries of the same municipality are counted.

What can be financed?

A borrower who meets the total debt and capital expenditure limitations discussed above can use proceeds of tax-exempt debt to pay for:

Land, including costs of acquisition, site preparation, environmental testing, etc. In most situations, not more than 25 percent of the total borrowing may be used to acquire land.

Buildings, including costs of acquisition, construction, rehabilitation, engineering and architectural services. If acquiring a building, at least 15 percent of the acquisition costs must be used to pay for qualified rehabilitation expenditures.

New equipment, including costs of acquisition, delivery and installation. Used equipment may be eligible if it is contained within a facility being acquired with proceeds of the qualified small issue.

Financing costs. Up to 2 percent of the total tax-exempt financing can be used to pay for costs of the transaction.

What's the catch?

In its efforts to ensure that the benefits of tax-exempt financings are not made too widely available, the federal government has placed a "cap" on the total amount of tax-exempt qualified small-issue bonds that can be issued in any calendar year. This cap is imposed on a state-by-state basis, and in Pennsylvania, as in many other states, the total amount available to be allocated to projects across the state is frequently inadequate to meet total demand.

A company with an eligible project must apply, through a local or state industrial development authority, for receipt of "volume cap allocation," i.e., a portion of the state's limited bonding authority. Generally, projects that apply earlier in the calendar year have a better chance of obtaining allocation.

Volume cap allocation is administered by the Pennsylvania Department of Economic and Community Development, which also provides general assistance in determining eligibility and must ultimately approve each project.

The maximum amount that can be borrowed is $10 million. The Commonwealth also requires that a borrower certify that, within three years of the borrowing, the new project must have created or retained one full-time permanent job for each $50,000 borrowed. The term of the debt cannot be more than 120 percent of the depreciable life of the assets being financed. Simply put, your can't borrow money long term to pay for an asset with a short useful life.

How it works

Tax-exempt financings can be structured in a wide variety of ways. One constant, however, is the need to borrow through an industrial development authority. These authorities exist throughout the state and serve as "conduits" for the debt. In other words, although the authority serves as issuer, all of the obligations related to the debt are between the company/borrower and the bank or buyer that funds the debt.

Indeed, qualified small-issue bonds for manufacturing facilities can provide up to $10 million at interest rates below those found in the conventional, taxable market. Companies in search of capital that don't explore this option may be missing an opportunity for significant savings.

Sara Davis Buss is a director at Houston Harbaugh P.C., Attorneys at Law, a Pittsburgh-based law firm. Buss can be reached by e-mail at