Industrial Revolution

Entrepreneur, April, 1999 by David R. Evanson, Art Beroff

Once reserved for large corporations. Industrial Development Bonds are now a source of growth capital for entrepreneurs.

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.

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.