Cheap Capital That’s Worth the Hefty Paperwork
Like the federal government, California sponsors a number of programs designed to help small and middle-market businesses, including one that can prove a good source of cheap expansion capital.
The program in question is California’s small-issue industrial development bond program, through which you can finance up to $10 million in new plant construction and equipment purchases.
Like the Small Business Administration’s loan programs, California’s small-issue IDB program offers financing at rates much lower than ordinary bank financing. And like SBA loans, IDBs come with a hefty paperwork load.
But if you fight the paperwork tiger and qualify, the program allows you to borrow at rates starting as low as three-quarters of prime, sometimes less, amortized over as many as 30 years.
That’s cheap capital indeed. Last year 39 California businesses used small-issue IDBs to raise nearly $158 million in capital, according to Fred Smith, an assistant state treasurer who oversees the program in Sacramento.
In essence, Smith says, a small-issue IDB is a corporate bond disguised as a municipal bond. Investors earn tax-exempt interest on small-issue IDBs, so there is a ready supply of capital for them. State and local governments, meanwhile, promote IDBs because they create jobs and expand the supply of capital to small and middle-market businesses. According to Smith, small-issue IDBs created more than 4,100 jobs in California last year.
How do you tap this supply of capital?
The first step is to contact the state Industrial Development Financing Advisory Commission, which has offices in Los Angeles ([213] 620-4467) and Sacramento ([916] 654-5610). The commission, for which Smith serves as executive director, holds approval power over all small-issue IDBs in California.
Assuming you want capital for a plant expansion, you must describe your project in detail in two applications totaling 13 pages, Smith says. You need a bond counsel--a private attorney specializing in public finance--to ensure that your project complies with federal tax law. Smith’s office maintains a list of bond counsels in the state.
You need help from your banker too, along with the bank’s counsel. Banks issue letters of credit, paid for by you, guaranteeing your ability to pay down the bonds.
Lastly, you need an underwriter--usually an investment banker or stock brokerage--if you choose to sell your bonds to the public, or a financial advisor to handle a private-placement deal. It is somewhat cheaper to do a private-placement deal than to sell your bonds to public investors.
The paperwork burden in California isn’t nearly as onerous as it is in many other states, but even so, the documents involved in a small-issue IDB deal here could easily fill a book.
Once it’s in order, the deal goes to a public hearing, usually before your city council, and then crosses Smith’s desk in Sacramento. As a rule, a local industrial development office, operating under city or county authority, actually issues your bonds. It commonly takes 90 days to fund a deal, from start to finish, Smith says.
And the costs? Clearly, an IDB deal passes through the hands of a number of professionals, each of whom takes a fee. Sam Balisy, a partner in law firm Kutak Rock in Pasadena, pegs the cost of a $4-million IDB deal at about 4.5%, and the cost of a $10-million deal at about 2.5%. The smaller the deal, the higher your costs as a percentage of the deal. Any IDB deal under $2.5 million carries costs that begin to outweigh your interest savings, according to Balisy.
The process is simpler, cheaper and faster for equipment-purchase deals, particularly when done as private placements. The application covers less than half a dozen pages, for example, and under a program launched by state Treasurer Matt Fong several years ago to cut costs, you can do an equipment-only deal with minimal bond counsel and underwriter help. A simple equipment-only IDB can fund in 30 days, according to Smith.
The savings make it economical to do an equipment-only deal for as little as $250,000, Smith says. Typically, an equipment-only IDB amortizes over five to seven years at an interest rate of between 5% and 6%.
All in all, it takes some doing to put together an IDB deal, and you have to compete for the capital. For one thing, federal law limits the amount each state can raise using IDBs. For another, local and state governments use some of their allocation to finance such projects as public housing, so if your local city council considers a public housing project more important than your plant expansion, you lose.
All that aside, if you can manage it, an IDB deal can prove an attractive source of capital for your business.
“The bonds help small business expand and create jobs,” Smith says. “The cities and counties benefit from the increased economic activity, and in many instances the attractive financing allows a business to remain competitive--and to remain in California.”
Next: How a Los Angeles metal-plating company raised $6.1 million in expansion capital using small-issue IDBs.
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Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.
