Small-Issue IDBs Can Be Worth Time, Upfront Cost

Want to expand your company but can’t afford an ordinary bank loan?

Do what John and Frank Cullen did several years ago when a customer offered to send them additional business if they expanded their operation: Tap California’s small-issue industrial development bond program for some cheap capital.

The program allows businesses to raise as much as $10 million by selling corporate bonds disguised as municipal bonds. The bonds pay tax-free interest at a very low rate--sometimes as little as half the prime rate.

That makes for cheap capital indeed, and although it takes time, patience and some upfront money to do a small-issue IDB deal, the program can work well for the right business.

The Cullen brothers run Valley Plating Works Inc. in Los Angeles, a family-owned metal plating business founded in 1931 by their father and an uncle. The company employs 105 people doing chrome plating for shopping carts, among other products.

Several years ago one of Valley Plating’s biggest customers, John Ondrasik, whose company, Precision Wire Products Inc., makes shopping carts, wanted to expand his manufacturing operations in the city of Commerce.

One option was to set up his own plating operation to handle the increased business. The better idea, Ondrasik felt, was to strike a deal with the Cullens, who had plated Ondrasik’s shopping carts since 1974, to expand their own plating operations to handle Ondrasik’s growth.

To do that, however, the brothers would have to buy and equip a new building--and for that they needed something like $6 million in capital.

As it happened, in 1994 Ondrasik had raised $3.1 million through a small-issue IDB deal to buy and equip a new plant on Sheila Street in Commerce. And when a second building became available just 2 1/2 blocks away on the same street, he told John and Frank Cullen about it.

He also told them about small-issue industrial bonds as a source of capital, and he introduced them to Sam Ballisy, a partner in the Pasadena law firm Kutak Rock who specializes in public finance. Ballisy’s firm has one of the largest public-finance practices in the country, and Ballisy had put together Ondrasik’s own $3.1-million small-issue IDB for his new plant.

It took Ballisy more than four months to put together a deal for the Cullen brothers. The process generated a great deal of paperwork--typically the downside in any small-issue IDB deal. But when the dust settled, the Cullen brothers had $6.1 million in the bank to finance their expansion.

Of the total, $3 million bought the building on Sheila Street; the rest will buy equipment over a three-year period to keep pace with Ondrasik’s growth. The Cullen brothers pay a floating interest rate on their bonds, currently running at about 4 1/2% payable over 25 years for the real estate, seven years for the equipment.

Administrative fees, plus the cost of a bank letter of credit, bring the total effective interest rate to about 6 1/2%.

From the state’s perspective, the quid pro quo for this cheap capital is the fact that the Cullens’ expansion has already created 25 new jobs, with 100 more in sight.

But the capital isn’t there for the asking. In effect, by making small-issue IDBs available, the state subsidizes the cost of borrowing expansion capital in exchange for the new jobs; indeed, if you can’t show that your bond issue will create jobs, you can’t get the capital.

Last year, California businesses raised nearly $158 million in capital through small-issue IDBs, creating 4,100 new jobs.

“Business owners have to realize that they can’t go to the state and expect to tap this source of capital if their project won’t create jobs,” Ballisy says. “Job creation is the predominant factor in the eyes of the state.

“Sometimes you can get support for a small-issue IDB deal just to save some jobs--if the alternative is for the business to leave the state. But don’t count on that.”

In addition to the time and the paperwork, a small-issue IDB comes with some upfront costs--typically 3% to 4% of the value of the bonds. The money goes to such professionals as the bond counsel who draws up the legal documents generated by the issue, to the underwriter or financial advisor who actually sells the bonds, and to a trustee.

Some business owners, already strapped for capital, balk at these costs, Ballisy says, but in fact the low interest payable on a small-issue IDB makes it possible to recover these costs in two years or less.

The upfront costs aside, John Cullen considers his own deal a good one.

“We chose to go this route because of the low interest,” he says. “Sam Ballisy was very upfront with us about the way things would happen, so we knew it would be time-consuming and expensive.

“But we estimated that conventional bank financing would probably cost us 8% or 9%, and we’re paying about 6 1/2% now, so we thought it was a wonderful deal. In any case, it’s totally out of the question for a business owner to get one of these deals done without professional help.”

John Ondrasik agrees.

“It’s a good program,” he says. “There are large upfront fees, but you make them up in a year and a half. It really worked for us.”

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Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.