economic development financing 101
TRANSCRIPT
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Ohio Basic Economic Development Course:
Economic Development Finance
Mark BarbashCouncil of Development Financing Agencies
[email protected] Economic Development Consulting
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Economic Development Financing
• Financing as a step in the Development Process
• Private Financing• Working with Bankers• Public Sector & Non profit Financing• Types of Public Sector Programs• Tax Incentives
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Steps in the Development Financing Process
1. Understand the Business
2. Understand the Project
3. Understand the Private Financing
4. Understand the Public Financing
6. Close the Deal
5. Identify the Gap and Structure the Financing
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Step One: Understand the Business
• Assessing the Health of the Business• Lifeline of a Business • Money• Market• Management
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Business Lifeline
Start Up Fast Growth Stable Mature
?
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Analyzing a Business’s Management and Financial Condition
• Money– Sufficient equity at beginning to avoid reliance on borrowed
funds– Management of financial performance to produce cash flow and
a profit (see addendum)• Market
– Identified market for the product or service and ability to respond to changes in the market
– Understanding of competition provided by larger businesses or niche competitors
• Management– Appropriate variety of skills in project development, production,
financial management, inventory control, sales & marketing, technology
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Step Two: Understand the Project
• How the project will benefit the business• Project Cost• Project Timetable• Project Documentation
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How will the project benefit the business?
• Cost Efficiencies / Consolidation
• Expanded Capacity to Meet Existing Sales
• Expanded Capacity to Meet New Sales
• Proximity to Markets, Suppliers or raw material
• New location in a new market• 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
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Detail All Components of the Project CostFixed Assets Land
BuildingEquipment
Infrastructure Road and RailFiber, TelecomSewer, Water, Gas, Electric
Operating Capital InventoryPayrollReceivables and Payables
Growth Capital Working Capital R&DEquipmentReal Estate
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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
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Step Three: Understand the Private Financing
• Business lifeline determines private investment potential
• Financing for Fixed Assets• Financing for Working Capital• Financing for Growth• From the Business’ Perspective• From the Bank’s Perspective
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REMEMBER…
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.
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Private Investor Profiles
Investors Risk Control Investment
Seed Capital Individuals, Local funds, Foundation
Extremely high (20 – 30%), most lose money
Informal process, Very high 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 + Commercial banks and leasing cos.
Medium to low or 0 risk; Prime +
Very formal process, low control
Loans, leases per asset life, 3–20 yrs.
Capital Markets
Corporate/ Investment banks, insurance, REIT
No risk, Treasury rate return
Highly structured process, no control
Loans, leases based on asset life, 7 – 30 yrs.
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The business lifeline determines the private investment available
Start Up Fast Growth Stable Mature
Personal AssetsSeed 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
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Financing Principles: Bank and Business
Business• Longer Term Loans• Lower Interest Rates• Higher Loan/Value• Lower Equity• Fixed Rates• Collateral: Limited to
Business Assets• Non Recourse
Bank• Shorter term loans• Higher Rates & Fees• Lower Loan/Value• Higher Equity• Variable Rates• Collateral: Business and
Personal Assets• Personal Guarantees
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The Nine Rules for Working with Private Lenders
1. The Donald Trump / Bernie Sanders Rule2. The Al Capone’s Safe Rule3. The Henry F. Potter Rule4. The George Steinbrenner Rule5. The Herb Cohen Rule6. The Berlitz Rule7. The Scouts Rule8. The Elephant Rule9. The Don Quixote Rule
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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
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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
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Types of Financing Programs
• Direct Loans• Loan Guarantees• Bonds: Taxable and Tax-Exempt• Tax Incentives • Tax Increment Financing• Intermediary Programs• Hybrid Programs
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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
• JobsOhio• Ohio 166• SBA 504• Community
Development Block Grants
• Intermediary Programs depending on local structure
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How a Direct Loan Makes the Deal Better…
Bank 75%
Equity25%
Bank 50%
Equity 10%
Public 40%
Bank Only Public/Private
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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
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Public Sector Programs
Start Up Fast Growth Stable Mature
Ohio 166 / Enterprise Bond fund
SBA 7A
Collateral Enhancement / Capital Access
SBA 504
USDA B & I
30%+ VC
6.5%+ Bank 3.5 %
Prime
JobsOhio Growth Fund Loan
Innovation Ohio
2.3 % Treas
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Step Five: Determine the Gap and Structure the Deal
• Can the available private sector financing support the entire project?
• If not, what is causing the gap?• Utilize the public sector program that most efficiently and
effectively fill the gap• Make sure that the private financing and the public sector
programs are compatible.
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Financing Gaps
• Cash Flow Gap: Insufficient cash generated to pay debt service on financing
• Collateral Gap: Cash flow is sufficient to make payments, but the collateral doesn’t support the amount of the private sector financing
• Credit Gap: Start up business with insufficient history to support private financing
• Character Gap
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How public sector programs help fill the financing gap
• Guarantee risky credits or lower value collateral• Long Term Financing• Fixed Rate Financing• Lower down payment financing to preserve cash for
working capital • Lower rate financing • Reduced Debt Service Needs• Increased Borrowing Capacity• Bring lower rate and long term financing through
capital market bond financing (tax exempt or taxable)
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Step Six: Close the Deal
• Project Management:– Making sure that each member of the team understands their roles
• 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?
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PUBLIC SECTOR AND NONPROFIT DEVELOPING FINANCING PROGAMS
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• Creation of JobsOhio Growth Fund from funds provided by liquor enterprise
• Current DSA linked with JobsOhio programs• Start with your JobsOhio Regional Partner EARLY• Through a Deal Team, JobsOhio and DSA will evaluate
the project and the program that best fits the need• JobsOhio Growth Fund has much greater flexibility than
existing DSA programs• JobsOhio Growth Fund approval and closing streamlined
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JobsOhio Growth Fund Loan
• Fixed Assets: Land, Building & Equipment• $500,000 to $5,000,000• Generally up to 50% of Total Project Cost• Generally 10% Equity from Borrower• Term: Real Estate – 15 years; Equipment – 10 Years• Interest rate based upon investment risk
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JobsOhio Growth Fund Grant
• Fixed Assets: Land, Building & Equipment• Moving Costs• Demolition• Infrastructure / Rail access / Roadways• Utilities • Generally $100,000 to $500,000
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Financing Continuum
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Key Factors to Consider
• Emphasis on creation of new jobs, increase in payroll• Return on Investment generally by year 3• Targeted Industries • Financial Strength of Company• Average Wage at least 150% of federal minimum wage• Utilities • Generally $100,000 to $500,000
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Players in Development Finance
JobsOhio JobsOhio & Revitalization Fund Loans and Grants; Incentives for larger projects
ODSA Federal Money, Community Development Block Grants
SBA 504 CDCs SBA 504 direct loan, SBA 7a Loan Guarantees, Ohio 166 Regional Program
Port Authorities Finance Authorities; Taxable and Tax Exempt Bond, Bond Funds, Real Estate Development, Aggregating Capital, PACE (Energy Efficiency Financing)Port Authorities: Real Estate Development, Pass thru bonds
Local Government
CBDG Revolving Loan Funds, Tax Increment Financing, Income Tax Incentives, etc.
Network Partner First step on larger projects, negotiation of incentives; Link to JobsOhio
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Bonds
• Debt issued by local authorities• Underwritten by investment banking firms• Purchased by national capital market investors• Better credit companies or• Companies backed by bank Letter of Credit or other
security• Larger projects
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Bond Programs
• Stand alone Industrial Revenue Bonds• Ohio Enterprise Bond Fund• Port Authority Bonds• Ohio Air Quality Development Authority• Ohio Water Quality Bonds
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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• Finance public-benefit
projects• Job creation, housing,
education, government, student loans
• 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
• Typically very high “cost of issuance”
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Tax Incentives• Governed by State Law• Abatement of Real or Personal
Property Tax• Income Tax Credits or Income
Tax “refunds”• Linked to a public purpose (job
creation or retention, investment)
• Purpose: Reduce “cost of doing business” or provide incentive
• Impact on other local taxing authorities (schools) make abatements controversial
• Enterprise Zone (EZ)• Community Reinvestment
Area (CRA)• Job Creation / Retention
Tax Credits • Income Tax Rebates /
Credits
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Tax Increment Financing
• Purpose: To finance public improvements• Source of Funds: Increase in real estate taxes from new
investment (the increment)• Funds are redirected towards other purposes• Method: Direct reimbursement or as debt service on
bonds issued to pay costs• Difficult to combine tax abatements with TIF financing• Impact on other local taxing authorities (schools) make
TIF financing controversial• New Ohio law has restricted the TIF program by
requiring county approval and direction of funds to human service agencies
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40
How does TIF work?
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Collaboration for Economic Development
• Intended as a way for two or more jurisdictions collaborate to support an economic development project
• Municipalities & one or more townships
• Agreement to share revenue and expenses
• Ability to levy an income tax in a township, if partnering with a city that currently has an income tax
• If unanimous trustee vote, no referendum
• Joint Economic Development Districts (JEDDs)
• Joint Economic Development Zones (JEDZs)
• Cooperative Economic Development Agreements (CEDA)
• Annexation Agreements• Community Improvement
Corporation• Other Agreements
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Intermediary Programs
• Government provides funds or allocates tax credits to local economic development for relending
• Local group takes responsibility for policy, underwriting, marketing, processing and management of funds
• Local group assumes responsibility for funds management and repayment of funds to the government, if a loan
• EB 5 Financing• SBA Microloan• Regional 166 • CDBG• New Markets Tax Credits• Community Development
Financial Institutions• USDA Intermediary
Relending• SBA Intermediary Program
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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?
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Rules for Economic Development Finance Professionals
1. Allow the business to tell their story…once2. Don’t waste time with a dog3. Not all projects can fit with public sector programs4. Let the program people represent their program5. Don’t overpromise what the program can deliver6. Don’t pile on government programs7. Explain the strings up front8. Find a cooperative lender9. Keep written records of your activities10. Be prepared to do the paperwork11. If it sounds too good to be true, it probably is12. Take informed risk!
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Additional Information
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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?
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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?
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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?
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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?
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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
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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.