For Entrepreneurs, This Bond May Beat a Loan

Small companies can issue low-interest Industrial Development Bonds, or IDBs, to buy land or equipment or build new facilities

By Jeremy Quittner

Dortch, who issued an IDB to expand his lighting factory, "would absolutely go through this again" Brad Swonetz/Redux

Few entrepreneurs consider bonds when they need major long-term financing. But by using a little-known set-aside in the public finance world called an industrial development bond, or IDB, small companies with strong track records can gain access to as much as $10 million with rates as low as 3%—similar to what large corporations get in the commercial paper market. (Up-front fees range from $70,000 to $200,000, but total costs are still about 20% to 30% less than conventional bank loans.) And while IDBs were designed to be used specifically by small manufacturers, the definition of "manufacturer" may surprise you, as the American Recovery & Reinvestment Act expanded it to include technology companies that manufacture software or other intellectual assets.

The proceeds from such bond issues can be used to buy land or manufacturing equipment, and to build new facilities. To ensure that IDBs contribute to economic development and therefore deserve their tax-exempt status, companies that issue them must promise local finance authorities that they will hire a predetermined number of employees over the life of the bond. About $3 billion in IDBs were issued in 2007, up 158% from 2006, according to the Council of Development Finance Agencies, which represents issuers of IDBs. Although issuance tumbled in 2008 to $1.27 billion, that's still the second-highest level in a decade. In the past year, Steve Eikenberry, senior vice-president of tax-exempt finance at First American Bank in Elk Grove Village, Ill., says he has seen demand for the bonds from new issuers grow about 30%. "I think this should be a very good year" for IDBs, he says.

"There are some headaches, but this is a good deal," says Louis Glunz IV, CEO of Regis Technologies, a $20 million, 80-person biotech company in Morton Grove, Ill. Regis has issued bonds three times since 1996, the most recent being a $7 million offering in 2008. Those bonds have so far funded two additions, for a total of 13,000 square feet, to the original 14,000-square-foot factory Glunz's grandfather built in 1956, and have enabled Glunz to hire 50 workers.

Among the headaches Glunz refers to are the mounds of paperwork and the cat-herding required to get the financing. Issuing an IDB is complex and time-consuming, requires a huge amount of documentation and coordination, and can easily take more than six months. Moreover, companies that use an IDB to acquire property and equipment must take a standard depreciation on those assets, rather than an accelerated one.

Banks are a critical partner, and in the past year the federal government has offered them incentives to issue IDBs. Banks that have up to 2% of their assets in tax-exempt bonds can now write off the cost of funds for issuing those bonds. It also has become easier for smaller banks to issue IDBs, as the Federal Home Loan Bank now stands behind them.

Your first step in issuing bonds is to find a "conduit issuer," typically a state or city industrial development agency. "Any county or city can also do this, and there are a few joint ventures [between them] that do it as well," says Stanton Hazelroth, executive director of the California Infrastructure & Economic Development Bank, or I-Bank, one of the largest issuing agencies in that state. If the agency is convinced that your project will create jobs and further economic development in your area, it can bestow the all-important tax-exempt status on the issue, which is how business owners get lower interest rates. The tax-exempt status may also be attractive to the bank providing the financing, or to bondholders if the issue is sold in the secondary market.

The initial paperwork will ask you to describe your business and how many jobs it provides to the area, but the issuer will also want to know about any union activity, pending lawsuits, details of your proposed project, and your plans to add jobs. One way large companies are prevented from taking advantage of IDBs is a requirement that issuers not spend more than a total of $20 million in the region in the three years prior and three years after the issue.

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