Industrial Revolution Once reserved for large corporations, Industrial Development Bonds are now a source of growth capital for BIZ Experiencess.

Jim Middlebrook, the founder and president of VortechEngineering, was feeling the squeeze of success. After founding hisOxnard, California, company in 1990 to develop performance partsand accessories for the automotive aftermarket, by 1997, he'drevved up sales to more than $7 million.

But finding growth capital was still a problem. With thegovernment taking a large portion of a company's earnings rightoff the top and tooling costing a pretty penny as well, Middlebrooksays, "In the end, there's not a lot left to make thecompany grow."

Middlebrook knew he needed growth capital to expand in hisexisting market and enter the marine and industrial markets, but heavoided the usual sources, such as venture capitalists and angelinvestors. "They want too much involvement or too muchequity--or both," says Middlebrook.

In early 1997, a commercial banker suggested Middlebrookconsider an Industrial Development Bond (IDB), which provideslong-term financing at low rates to manufacturing companiesinvesting in fixed assets, such as land, buildings and equipment.The banker put Middlebrook in touch with Dan Bronfman, an IDBconsultant and founder of Santa Monica, California, Growth CapitalAssociates.

Bronfman says IDBs are largely misunderstood and underutilizedbecause prior to tax legislation in 1986, they were the province oflarge corporations, which used them to finance manufacturingfacilities, distribution centers and retail outlets. Today,Bronfman says, IDBs--worth approximately $1.5 billion annuallynationwide--finance companies involved in manufacturing orvalue-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 iscalled Where to Go When the Bank Says No: Alternatives forFinancing Your Business(Bloomberg Press). Call (800) 233-4830for ordering information. Art Beroff, a principal of BeroffAssociates in Howard Beach, New York, helps companies raise capitaland go public.

Profile of a Lender

At the broad-brush level, there are certain key criteria thatwould-be IDB borrowers must consider--and ultimately meet.

First, the "B" in IDB stands for bond, which meansit's a loan. Like other lenders, IDB issuers look for stableand predictable cash flows. Therefore, start-ups, prerevenue-stagecompanies and small independent businesses need not apply.

Next, the proceeds from an IDB must go toward paying for fixedassets and manufacturing operations with no more than 25 percentearmarked for the purchase of land. Finally, the maximum amountthat can be raised is $10 million, a figure furtherconstrained by the borrower's capital expenditures in his orher region. For example, if someone had a company in Ohio that onlymade $100,000 in its immediate area while conducting most of itsmanufacturing in other states, the $100,000 would still impact howmuch the BIZ Experiences could raise in IDB financing.

For those whose needs and profile fit the criteria, the processof acquiring IDB financing can be broken into three distinctphases. But before delving into these steps, it's worthmentioning that, unlike many other sources of financing, IDBsaren't something BIZ Experiencess should pursue on their own;it's analogous to trying your own case in court. A qualifiedconsultant can lead you through the process. The good news is, manyIDB consultants work on a success fee, which means they take theirfees out of the proceeds.

The first phase in obtaining IDB financing, Bronfman says, isprequalification. This is largely a matter of determining whetheryour company and the deal you have in mind will fly according tostate and federal requirements, and whether the business has thefinancial strength to support bond issuance.

During this first phase, the potential borrower and his or herconsultant choose one of two basic credit structures for the deal.The first option is a letter of credit (LOC) structure. Under thisarrangement, a bank guarantees repayment of the bond through theissuance of a letter of credit. Generally, the fee the bank chargesfor this guarantee is 2 percent of the bond issue proceeds.The second option, known as a private placement structure, is tohave an institutional investor buy the bonds directly.

Of the two structures, Bronfman prefers the LOC. "It'sa much more competitive interest rate market, with lower rates andmore opportunity for a flexible structure on the deal, such asinterest-only payment periods or optional balloon payments,"he says.

If attended to diligently, Bronfman believes theprequalification phase can be accomplished in five to 15 days.

The next phase of the process, according to Bronfman, is to getstate and issuer approvals. The language of IDBs can beconfusing--the term "issuer" is a case in point. In mostbond financings, the issuer is the company that receives theproceeds from the deal. In IDBs, the issuer is a city, county orstate agency. In California, for instance, the California Trade andCommerce Agency has statewide issuance authority. Across thefruited plains, there are myriad of agencies BIZ Experiencess mighttap, but, according to Bronfman, it's the consultant's jobto find the one in your state that makes the most sense and willmake the deal work.

The importance of the issuing agency cannot be underestimated.When a government body issues the bond instead of a privatecompany, the bond qualifies for tax exempt status, which means muchlower interest rates for the business owner. This is the heart ofthe IDB's advantage.

Once the right agency is selected, approval must be sought,which in most cases requires a hearing. Each state and issuingauthority has its own conventions, but Bronfman says applicationsand approvals can typically be attained in 30 to 60 days. Approvalcriteria include: the overall viability of the product; potentialfor public benefits, such as job creation; and the financialstrength of the borrower.

After obtaining approval, companies enter what Bronfman callsphase three of the process. Here, the team assembled by theconsultant--consisting of the bond counsel, the corporate counsel,a rating agency, a trustee and a placement agency--goes to workdrafting the bond documentation and completing the sale of thebonds. Once the funds are raised, they're placed with thetrustee, who disburses proceeds to the company and makes paymentsto the bondholders. According to Bronfman, phase three can takefrom 15 to 45 days.

Let's Be Realistic

While IDB financing can sometimes be accomplished in one hundreddays, it can take considerably longer. In Vortech's case, aprocess that began in early 1997 wasn't completed untilSeptember of 1998, when the company was finally funded.

Vortech was actually approved for IDB financing during thelatter half of 1997. But as Middlebrook learned, tax exemptfinancing is a precious thing, and states only have so much fundingto allot. By the time Middlebrook was approved, the state'sallotment had run out. As a result, he deferred his IDB until thenext funding cycle. Meanwhile, problems had begun to surface withthe manufacturing site he'd initially selected. Further delaysensued as he looked for, and eventually found, a new site.

But for Middlebrook, it was worth the wait. The interest rate onhis $3 million IDB averages 5.25 percent, and he has 25 yearsto pay it back. If you could get bank financing for 25 years--whichyou can't--the rate you'd pay would be at least 2percentage points higher. Bronfman says that, doing anapples-to-apples comparison, $4 million in IDB financing,amortizing over 20 years at 5.25 percent, would cost $26,950 permonth. On the other hand, a bank loan amortizing over 20 years at 8percent would cost $33,450 per month--a huge difference over thelife of the loan.

While the first thing everyone will tell you about the IDBprocess is how tricky it is, get past the pessimism. Middlebrookdid. "I wouldn't recommend doing this alone," hesays. "But I can tell you this much: It's a lot easierthan trying to run a business."

Next Step

To find an IDB issuing agency in your state, call the Council ofDevelopment Finance Agencies at (202) 857-1162 or call DanBronfman at (310) 581-8888.

Contact Sources

Growth Capital Associates, (310) 581-8888, fax: (310)581-8890

Vortech Engineering, (805) 529-9330, http://www.vortecheng.com