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 [email protected].