Jim Middlebrook, the founder and president of Vortech Engineering, was feeling the squeeze of success. After founding his Oxnard, California, company in 1990 to develop performance parts and accessories for the automotive aftermarket, by 1997, he'd revved up sales to more than $7 million.
But finding growth capital was still a problem. With the government taking a large portion of a company's earnings right off the top and tooling costing a pretty penny as well, Middlebrook says, "In the end, there's not a lot left to make the company grow."
Middlebrook knew he needed growth capital to expand in his existing market and enter the marine and industrial markets, but he avoided the usual sources, such as venture capitalists and angel investors. "They want too much involvement or too much equity--or both," says Middlebrook.
In early 1997, a commercial banker suggested Middlebrook consider an Industrial Development Bond (IDB), which provides long-term financing at low rates to manufacturing companies investing in fixed assets, such as land, buildings and equipment. The banker put Middlebrook in touch with Dan Bronfman, an IDB consultant and founder of Santa Monica, California, Growth Capital Associates.
Bronfman says IDBs are largely misunderstood and underutilized because prior to tax legislation in 1986, they were the province of large corporations, which used them to finance manufacturing facilities, distribution centers and retail outlets. Today, Bronfman says, IDBs--worth approximately $1.5 billion annually nationwide--finance companies involved in manufacturing or value-added processing that have sales between $5 million and $30 million and are looking for net financing proceeds of $1.5 million to $8 million.
David R. Evanson's newest book about raising capital is called Where to Go When the Bank Says No: Alternatives for Financing Your Business(Bloomberg Press). Call (800) 233-4830 for ordering information. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public.
Profile of a Lender
At the broad-brush level, there are certain key criteria that would-be IDB borrowers must consider--and ultimately meet.
First, the "B" in IDB stands for bond, which means it's a loan. Like other lenders, IDB issuers look for stable and predictable cash flows. Therefore, start-ups, prerevenue-stage companies and small independent businesses need not apply.
Next, the proceeds from an IDB must go toward paying for fixed assets and manufacturing operations with no more than 25 percent earmarked for the purchase of land. Finally, the maximum amount that can be raised is $10 million, a figure further constrained by the borrower's capital expenditures in his or her region. For example, if someone had a company in Ohio that only made $100,000 in its immediate area while conducting most of its manufacturing in other states, the $100,000 would still impact how much the entrepreneur could raise in IDB financing.
For those whose needs and profile fit the criteria, the process of acquiring IDB financing can be broken into three distinct phases. But before delving into these steps, it's worth mentioning that, unlike many other sources of financing, IDBs aren't something entrepreneurs should pursue on their own; it's analogous to trying your own case in court. A qualified consultant can lead you through the process. The good news is, many IDB consultants work on a success fee, which means they take their fees out of the proceeds.
The first phase in obtaining IDB financing, Bronfman says, is prequalification. This is largely a matter of determining whether your company and the deal you have in mind will fly according to state and federal requirements, and whether the business has the financial strength to support bond issuance.
During this first phase, the potential borrower and his or her consultant choose one of two basic credit structures for the deal. The first option is a letter of credit (LOC) structure. Under this arrangement, a bank guarantees repayment of the bond through the issuance of a letter of credit. Generally, the fee the bank charges for this guarantee is 2 percent of the bond issue proceeds. The second option, known as a private placement structure, is to have an institutional investor buy the bonds directly.
Of the two structures, Bronfman prefers the LOC. "It's a much more competitive interest rate market, with lower rates and more opportunity for a flexible structure on the deal, such as interest-only payment periods or optional balloon payments," he says.
If attended to diligently, Bronfman believes the prequalification phase can be accomplished in five to 15 days.
The next phase of the process, according to Bronfman, is to get state and issuer approvals. The language of IDBs can be confusing--the term "issuer" is a case in point. In most bond financings, the issuer is the company that receives the proceeds from the deal. In IDBs, the issuer is a city, county or state agency. In California, for instance, the California Trade and Commerce Agency has statewide issuance authority. Across the fruited plains, there are myriad of agencies entrepreneurs might tap, but, according to Bronfman, it's the consultant's job to find the one in your state that makes the most sense and will make the deal work.
The importance of the issuing agency cannot be underestimated. When a government body issues the bond instead of a private company, the bond qualifies for tax exempt status, which means much lower interest rates for the business owner. This is the heart of the IDB's advantage.
Once the right agency is selected, approval must be sought, which in most cases requires a hearing. Each state and issuing authority has its own conventions, but Bronfman says applications and approvals can typically be attained in 30 to 60 days. Approval criteria include: the overall viability of the product; potential for public benefits, such as job creation; and the financial strength of the borrower.
After obtaining approval, companies enter what Bronfman calls phase three of the process. Here, the team assembled by the consultant--consisting of the bond counsel, the corporate counsel, a rating agency, a trustee and a placement agency--goes to work drafting the bond documentation and completing the sale of the bonds. Once the funds are raised, they're placed with the trustee, who disburses proceeds to the company and makes payments to the bondholders. According to Bronfman, phase three can take from 15 to 45 days.
Let's Be Realistic
While IDB financing can sometimes be accomplished in one hundred days, it can take considerably longer. In Vortech's case, a process that began in early 1997 wasn't completed until September of 1998, when the company was finally funded.
Vortech was actually approved for IDB financing during the latter half of 1997. But as Middlebrook learned, tax exempt financing is a precious thing, and states only have so much funding to allot. By the time Middlebrook was approved, the state's allotment had run out. As a result, he deferred his IDB until the next funding cycle. Meanwhile, problems had begun to surface with the manufacturing site he'd initially selected. Further delays ensued as he looked for, and eventually found, a new site.
But for Middlebrook, it was worth the wait. The interest rate on his $3 million IDB averages 5.25 percent, and he has 25 years to pay it back. If you could get bank financing for 25 years--which you can't--the rate you'd pay would be at least 2 percentage points higher. Bronfman says that, doing an apples-to-apples comparison, $4 million in IDB financing, amortizing over 20 years at 5.25 percent, would cost $26,950 per month. On the other hand, a bank loan amortizing over 20 years at 8 percent would cost $33,450 per month--a huge difference over the life of the loan.
While the first thing everyone will tell you about the IDB process is how tricky it is, get past the pessimism. Middlebrook did. "I wouldn't recommend doing this alone," he says. "But I can tell you this much: It's a lot easier than trying to run a business."
To find an IDB issuing agency in your state, call the Council of Development Finance Agencies at (202) 857-1162 or call Dan Bronfman at (310) 581-8888.
Growth Capital Associates, (310) 581-8888, fax: (310) 581-8890
Vortech Engineering, (805) 529-9330, http://www.vortecheng.com