Colorado Basic Economic Development Course

Economic Development Finance

Mark Barbash, Senior AdvisorCouncil of Development Finance Agencies

mbarbash@cdfa.netEconomic Development Consulting

Mark.Barbash@gmail.com

Economic Development Financing

• Financing as part of the Development Process

• Private Financing & Working with Bankers

• Economic Development Programs

• Types of Public Sector Programs

• Tax Incentives & Tax Increment Financing

Steps in the Development Financing Process

1. Understand the Business

2. Understand the Project

3. Identify Private Financing Options

4. Identify Public Financing Options

7. Close the Deal

5. Identify the Gap

6. Structure the

Financing

Step One: Understand the Business

• Assessing the Health of the Business

• Lifeline of a Business

• Money

• Market

• Management

Business Lifeline

Start UpFast

GrowthStable Mature

?

GROWTH

RISK

Business Management & Financial Condition

Money • Sufficient Equity for growth

• Emphasis on cash flow management

Market • Well identified market

• Good understanding of competition

• Ability to respond to changes in the market

Management • Necessary skills in R & D, production, financial management, inventory control, sales and marketing

Step Two: Understand the Project

• How the Project will Benefit the Business

• How the Project will Benefit the Community

• Project Cost

• Project Timetable

• Project Documentation

How the Project Will Benefit the Business

• Cost Efficiencies / Consolidation

• Expanded Capacity to Meet Existing Sales or Market

• Expanded Capacity to Meet New Sales or Market

• Proximity to Markets, Suppliers or raw material

• Proximity to key skills or technical capacity

How will the project benefit the community?

• Job creation/retention

• High wage/high tech jobs

• Location in an EZ or key development area

• Industry cluster member

• Part of key community initiative

Match the Use of Funds with the Source of Funds

Fixed Assets Land & Building 10-20 Year Financing

Equipment Equipment 7 – 10 Year Financing

Infrastructure Road, Rail, Utilities, Connectivity

Longer Term financing, Bonding, Tax Increment Financing, Grants

Operations Inventory, Payroll Receivables, Payroll

Shorter Term working capital, lines of credit

Growth R & D, working capital, marketing, product development

New equity investment, venture capital, permanent working capital loan

Project Development Issues

• Cost: Be sure that all costs are identified, including infrastructure, moving, installation and carrying costs

• Timetable: Pre-ordering of equipment, necessary environmental studies, site preparation:

• Documentation: Appraisals, environmental assessments, engineering reports

Step Three: Understand Private Financing Options

All lenders and investors are money managers –nothing more and nothing less -- with different goals for return on investment based upon their source of funding.

The Business Lifeline Determines Most Financing Options

Start UpFast

GrowthStable Mature

Personal Assets

Seed Capital

Venture Capital

Conventional Lenders, Banks

Capital Markets: Stocks/Bonds

30%+ VC

6.5%+ Bank

3.5 % Prime

Preseed Capital

Angel Investors

2.3 % Treas

CrowdFunding

Taxable & Tax Exempt Bonds

Private Investor / Lender Profiles

Investors Risk Control Investment

Seed Capital

Individuals, Local funds, Foundation

Extremely high, most lose money

Informal process, Veryhigh control

Ownership, Out quickly to VC

Venture Capital

Managed VC funds & SBICs

Very high (15 –30%), 90% lose money

Formal process, high control

Ownership,Out 5–7 years through IPO

Banks + Commercialbanks and leasing cos.

Medium to low or risk; Prime +

Very formal process, low control

Loans, leasesper asset life, 3–20 yrs.

Capital Markets

Corporate/ Investment banks, insurance, REIT

No risk, Treasury rate return

Highly structured process, no control

Loans, leases, bonds, based on asset life, 7 – 30 yrs.

Financing Principles: How a Bank Manages Risk

Lower Loan to Value

Less bank exposure in event of liquidation, ensures owner commitment, higher equity required

Variable Rates & Higher Fees

Higher rate = Higher Risk, Bank profitability, Link income to market, higher debt service costs

Shorter Term Loans

Reduces risk over time

Personal Guarantees

Additional collateral / security in event of liquidation, ensures owner commitment

Basic Financing Principles: What a Business Needs in Financing

Higher Loan to Value

Decreases cash for down payment, Preserve cash equity for working capital needed for growth

Fixed rates, lower fees

Fixed rates provide for regular loan payment amounts, makes cash flow management easier

Longer Term Loans

Match Loan Term with Life of Asset; Longer term = lower debt service costs

Non-RecourseLoans

No personal guarantee preserves assets for additional borrowing

Bank Needs vs. Business Needs

Bank Needs Business Needs

Lower Loan to Value Higher Loan to Value

Variable Rates & Higher Fees

Fixed Rate and Lower Fees

Shorter Term Loans Longer Term Loans

Personal Guarantees Non Recourse Loans

The Nine Rules for Working with Private (Bank) Financing

1. The Donald Trump / Bernie Sanders Rule

2. The Al Capone’s Safe Rule

3. The Henry F. Potter Rule

4. The George Steinbrenner Rule

5. The Herb Cohen Rule

6. The Berlitz Rule

7. The Scouts Rule

8. The Elephant Rule

9. The Don Quixote Rule

The Nine Rules for Working with Private (Bank) Financing

1. You don’t know what its worth till you try to sell it

2. You never know what you will find under ground

3. Cash flow is key

4. You can’t tell the players without a scorecard

5. Every deal is a negotiation

6. Learn how to talk the language

7. Be prepared

8. Elephants never forget

9. Don’t tilt at windmills.

The Nine Rules for Working with Private (Bank) Financing

1. Banks make loans based on value, not cost

2. Banks are wary of environmental contamination

3. Banks make loans to get paid, not to be liquidated

4. Mergers and acquisitions have changed banking

5. Know how to be a good negotiator

6. Understand how banks make decisions

7. Always be prepared with the facts and arguments

8. Bankers never forget. Be honest, direct & helpful

9. Don’t ask for a loan you know a bank won’t make

Step Four: Understand the Public Sector Financing

• Purpose of Public Sector Programs

• Types of Public Sector Programs

• Tax Incentives and TIFs

• Taxable and Tax Exempt Bonds

• Joint Economic Development Zones +

• Selecting the Public Sector Program

• Rules for Working with Public Sector Programs

Purpose of Public Sector Programs

• Achieve social or economic goals

– Create or retain jobs

– Assist specific groups of citizens or neighborhoods

• Leverage bank financing

• Reduce bank risk

• Finance non-bankable businesses

• Provide incentives for targeted investments

Types of Financing Programs

• Direct Loans

• Loan Guarantees

• Bonds: Taxable and Tax-Exempt

• Tax Increment Financing

• Tax Incentives

• Intermediary Programs

• Hybrid Programs

Direct Loans

• Finance 30-50% of a Project Cost

• Fixed Interest Rates

• Terms Equal to or Longer than the Bank

• Loan is Subordinated to the Bank

• Reduced Business Equity Requirement (10%)

• Generally for Fixed Assets Only

• SBA 504

• Community Development Block Grants

• Intermediary Programs depending on local structure

• Revolving Loan Funds

How a Direct Loan Makes the Deal Better…

Bank 75%

Equity 25%

Bank 50%

Equity 10%

Public 40%

Bank Only Public/Private

Sources of Debt Capital in Colorado

• Community banks make up 45% of all small business loans made by banks

• Community banks make up 93% of all banks, but…

• Community Banks hold 13% of all bank assets

A Word about Crowdfunding…

Reg A+ of the Jobs Act

Loan Guarantees

• Guaranty of Bank’s Loan

• Bank’s Rate and Term

• Guaranty up to 85% of Bank Loan

• Can Finance Working Capital

• Alternative: Provide secured deposit

• SBA 7(a)

• SBA Community Advantage

• Collateral Enhancement Program

• Capital Access

• USDA Business and Industry Loan Program

Public Sector Programs

Start UpFast

GrowthStable Mature

30%+ VC

6.5%+ Bank

3.5 % Prime 2.3 % Treas

SBA 504SBA 7(a) Guarantee

Tax Exempt / Taxable Bonds

USDA B & I

Collateral Enhancement/Cap Access

CDBG / Revolving Loan Funds

Step Five: Determine the Gap and Structure the Deal

1. Can the available private sector financing support the entire project?

2. If not, what is causing the gap?

3. Utilize the public sector program that most efficiently and effectively fill the gap

4. Make sure that the private financing and the public sector programs are compatible.

Financing Gaps

Cash Flow Gap Insufficient cash to make debt service payments on ALL financing

Collateral Gap The collateral doesn’t support the amount of private debt needed

Capital Gap General inability to raise adequate capital for project (either debt or equity)

Credit Gap Start Up Business, Based on projections, Industry issues

Character Gap

Filling the Financing Gaps

Cash Flow Gap Substitute longer term financing for shorter term financing; Substitute lower rate financing for higher rate financing; Add loss reserve account or cash flow guarantee

Collateral Gap Add secondary collateral; Add subordinated debt; Reduce project cost;

Capital Gap Reduce project cost; Obtain subordinated financing that will take greater risk

Credit Gap Use loan guarantee program; reduce debt and increase equity; secondary guarantees; bring in partners

Character Gap

How public sector programs help fill the financing gap

• Provide guarantee of risky credits

• Make up for undervalued collateral

• Provide better terms: rate, term, fixed, collateral

• Lower down payment to preserve cash

• Reduced debt service needs thru longer term, lower rate

• Increased borrowing capacity

• Bring lower rate and long term financing through capital market bond financing (tax exempt or taxable)

Step Six: Close the Deal

• Project Management

• Monitoring progress by team members

• Developing a timetable

• Most public / private projects fail at the deal closing stage

• Why do public/private projects fall apart?

PUBLIC SECTOR AND NONPROFIT DEVELOPING FINANCING PROGAMS

More about Public Financing Tools

• Direct Loans

• Loan Guarantees

• Bonds (Taxable and Tax Exempt)

• Tax Increment Financing (TIF)

• Tax Incentives

• Intermediary Programs

• CDFIs

Bonds

A Bond is a Loan

Bonds

Debt (Bond) issued by local or state authority

Generally larger projects for stable companies

Underwritten and “sold” by Investment Banking Firm

Purchased by capital markets investors

Better credit companies or backed by Letter of credit

Some Key Points about Bonds

• The better the rating, the lower the interest rate

• Improve the rating through a letter of credit or some sort of guarantee

• Right now, little difference between taxable and tax exempt rates

• Tax exempt bonds have higher fees because of the tax complications

• Complicated process lengthens bond timeframe

Taxable and Tax-Exempt Bonds

Taxable Bonds

• Can be used for almost any purpose

• Lenders pay tax on interest income

• No interest savings to the borrower other than the lower national market rates

• Better credits, larger issuances

Tax Exempt Bonds• Public-benefit projects• Jobs, housing,

education, student loans, government,

• Lenders of tax exempt bonds pay no income tax on interest earned

• Savings passed on to the borrower in the form of lower interest rates

• High “cost of issuance”

Bond Programs

• Stand alone Industrial Revenue Bonds

• Port or Redevelopment Authority Bonds

• Air Quality Bonds

• Water Development Bonds

• PACE Financing

Incentives

• Purpose: Reduce “cost of doing business” or provide incentive

• Governed by State Law

• Mostly abatement of real property tax

• Income Tax Credits or Income Tax “refunds”

• Public purpose (job creation or retention, investment)

• Impact on other local taxing authorities (schools) make abatements controversial

• Property Tax Abatement

• Job Creation Tax Credits

• Job Retention Tax Credits

• Income Tax Refunds/Rebates

• Sales Tax Refunds/Rebates

• Closing Grants

Smart Incentives Principles

• Performance Based

• Accountability

• Transparency

• Cost / Benefit Analysis

• Triple Bottom Line Analysis

• “But For…”

Tax Increment Financing

Tax revenue is “frozen” at beginning of TIF period

When new investment is made, property values typically increase

Increased property taxes above the base (increment) are diverted to…

…Fund public improvements included in the TIF legislation

“Increment” can be used directly or to pay off Bonds issued

45

Payments to taxing districts

frozen @ start of

TIF Period

Issues with Tax Increment Financing

• TIF districts are usually in growing areas with increased residents, businesses

• Funds are diverted from other taxing authorities: schools, parks, community services

• Property owners payments continue, redirected to TIF needs

• Governed by State Law

Intermediary Programs

• Funds or tax credits allocated to intermediary

• Intermediary takes responsibility for policy, underwriting, marketing, processing and management of funds

• Intermediary assumes responsibility for funds management and repayment of funds to the government, if a loan

• EB 5 Financing

• SBA Microloan

• CDBG

• New Markets Tax Credits

• Community Development Financial Institutions

• USDA Intermediary Relending

• SBA Intermediary Program

Community Development Financial Institutions

• Federal “seal of approval” that a nonprofit is community based and does good deeds

• Provides access to a range of resources:

– Banks like CDFI’s as investment vehicles

– CDFI Fund: Financial Assistance, Technical Assistance, Healthy Foods, Bank Enterprise Awards

• www.cdfifund.gov

Variations on a Theme

How to Determine If Its A Real Deal on the First Visit

1. Are they willing to provide business and personal financial statements?

2. Are they willing to provide references?

3. How do they respond to challenging “devil’s advocate” questions?

4. Is their answer always “Someone Else is in Charge?” and do they blame everyone else for their problems?

5. Do they expect “free money?”

6. Do they have a realistic assessment of the market, competition and job creation potential?

7. Are they willing to spend money up front?

Rules for Economic Development Professionals

1. Allow the business to tell their story…once

2. Don’t waste time with a dog

3. Not all projects can fit with public sector programs

4. Let the program people represent their program

5. Don’t overpromise what the program can deliver

6. Don’t pile on government programs

7. Explain the strings up front

8. Find a cooperative lender

9. Keep written records of your activities

10. Be prepared to do the paperwork

11. If it sounds too good to be true, it probably is

Take Informed Risk

Questions ?

Thank you.

Contact information

Mark Barbash

Council of Development Finance Agencies

mbarbash@cdfa.net

Mark.barbash@gmail.com

(614) 774-7599

Additional Information

Key questions to ask about project costs

1. Is the site landlocked? Is there room to grow?

2. Are there any potential environmental issues which could drive up cost?

3. Does the site have adequate infrastructure? Sanitary sewer, storm sewer, water, electricity, natural gas, transportation, fibreoptic, etc.

4. Does the site have appropriate zoning for the desired use? What is the community process for changing zoning?

5. Is there evidence of any historic significance for the site or any existing structures?

Questions to ask about the project timetable

1. Does the developer have site control? If an option exists, when does the option expire and what are the terms for renewal?

2. Has an environmental assessment been completed and have all issues been identified?

3. How far in advance does equipment have to be ordered? Does payment have to be made on advance orders?

4. What is the projected time for site preparation? Construction?

5. Does the general contractor have experience with this type of project in this type of community?

Key questions to ask about project documentation

1. Has an appraisal been completed on any real estate or equipment project?

2. Has an engineering assessment of existing and needed infrastructure been completed?

3. Has an environmental assessment or Phase I been completed which shows any remediation that must be completed?

4. Has an engineering assessment on existing buildings been completed to assure that there are no structural issues?

5. Have detailed and documented project cost estimate been done by a third party?

Some questions to ask on an “Incentive” Project

1. Does your ED organization have a goal for incentive projects? What kinds of projects do you want to incentivize?

2. Is your community in competition with another city? Where is that city? Is it in the same marketplace?

3. What is the wage level for jobs to be created?

4. What is the cost-benefit analysis for the project? Will you get more than you spend in the long run?

5. What is the track record of the company being assisted in asking for and meeting the terms of other incentive projects?

Why do public / private deals crash?

• Failure on the part of the public sector lender to understand the level of risk it is willing to take

• The public sector program cannot deliver fast enough

• The public sector program cannot be flexible enough

• Unrealistic expectations of how government programs can help

• Failure to obtain support from every appropriate level necessary for public sector program approval

• Failure on the part of the public sector lender to take INFORMED risk

Why do projects fail?

• Money:

– Inadequate working capital to finance growth needs

– Project costs escalate beyond the business’ ability to afford the project.

– The financial strength of the business deteriorates, causing the lender to withdraw its commitment (either temporarily or permanently).

• Market:

– Defined too broadly

– Expanding into an unfamiliar or inappropriate business line

• Management:

– Inadequate business skills among principals

– Expanding too fast

– Project Issues: Problems with site requirements, costs, etc.