Loans That Come Full Circle - revolving loan funds

Nation's Business, June, 1999 by Sharon Nelton

Community-based revolving loan funds offer help to small companies and nonprofit organizations.

One of the best-kept secrets about small-business financing in the United States may be organizations known as revolving loan funds.

These community-based entities use public and private dollars to meet social and economic goals by making loans to small businesses and to nonprofit and community projects at below-market interest rates.

As the money is paid back, it is used to make other loans to other businesses or nonprofits.

In other words, the original grant or loan to the revolving fund is used over and over.

"I think that's a wise use of funds. You seed something once and that seed continues to work for you," says Linda Salmonson, administrator of a three-year-old revolving fund called Rural Electric Economic Development, Inc., (HEED) in Madison, S.D. The $10 million fund has made about 50 loans, 24 of them to small businesses.

Early last year, Arlis Hanson, owner of Ag Services, Inc., a soybean-processing company in Huffton, S.D., obtained a loan of $150,000 from REED. The package included an additional $50,000 from a revolving loan fund run by the Northeast Council of Governments, based in Aberdeen, S.D.

The funds enabled Ag Services to purchase equipment and inventory to further develop the production of soybean oil.

A Variety Of Purposes

Throughout the United States there are more than 7,500 revolving loan funds--or RLFs--controlling assets estimated at more than $8 billion, according to a study conducted last year by the Washington, D.C.-based Corporation for Enterprise Development. In a survey of RLFs in seven states, the organization found that the median RLF loan size was $40,000, the median interest rate was 6 percent, and the median repayment term was five years.

Generally, each RLF has its own purpose and targets its loans to businesses and projects that help fulfill its mission. One fund might focus on serving microbusinesses, for example, while another might seek to revitalize a distressed downtown area.

"Our purpose is to provide financing and help leverage private investment in small communities and rural areas," says Salmonson. "We want to participate in projects that create economic growth, lead to permanent jobs in rural areas, improve rural development capacity and infrastructure, and fill a gap, to some extent, that may not be being filled by private lending."

And the founders hope that the economic growth will lead to increased electricity sales.

REED was initiated by seven nonprofit rural electric cooperatives in 1996. It now has 17 member cooperatives in South Dakota and Minnesota and is administered by the East River Electric Power Cooperative, Inc., which is based in Madison and sells electricity wholesale to the member co-ops.

The Way It Works

REED uses a two-tier approval system, which "is a little unusual for loan funds," says Salmonson. A loan must first be approved by the business owner's local electric cooperative and then by the REED board of directors. The local cooperative must agree to guarantee the loan.

"We try to always partner with banks on a loan," says Salmonson. "If a bank declines to participate, we may still consider a loan." In some instances, such as the Ag Services deal, a nonbank partner may be found.

REED's smallest loan is $11,500; its biggest, approved recently, is in the amount of $750,000, for an ethanol-production plant.

"Our interest rates generally fall between 5 percent and 7 percent," says Salmonson. (Hanson says Ag Services pays 5 percent on its 10-year REED loan.)

And like a bank, REED requires borrowers to provide collateral, such as land, buildings, equipment, or accounts receivable. "We want our borrowers to understand that they need to pay us back in the same manner they would pay the bank back," she says.

Among REED's several sources of funding are grants and loans from various U.S. Department of Agriculture programs; loans from the National Rural Utilities Cooperative Finance Corp., a private lender to co-ops headquartered in Heradon, Va.; and money from the general funds of REED's member co-ops to meet the matching requirements of one of the USDA programs.

Ag Services owner Arlis Hanson and his then-controller, Roger Rozell, first heard about the REED program from Dennis Hagny, general manager of Northern Electric Cooperative in Bath, S.D., who encouraged them to apply for a loan.

Hagny brought in the Northeast Council of Governments, which agreed to be a partner in the package.

Hagny, who is also on the REED board of directors, says he was intrigued by the idea that Ag Services was a "model" for value-added agricultural processing that could be done on a family farm. Hagny also knew that in addition to processing soybeans from the Hanson family farm, Ag Services would purchase soybeans from neighboring farmers-a benefit to the local economy.

Generally, according to Salmonson, it takes up to 90 days to go through the process of applying for and receiving a REED loan, although in some instances it can be done in as little as 60 days.