CDFA Spotlight:
Revolving Loan Funds - An Examination of Three Different Programs

Revolving loan funds (RLFs) have become a widely used financing tool, but they are sometimes misunderstood or underutilized. RLFs are a gap financing measure primarily used for development and expansion of small businesses. A RLF is a self-replenishing pool of money, utilizing interest and principal payments on old loans to issue new ones. While the majority of RLFs support local businesses, some target specific areas such as healthcare, minority business development and environmental cleanup.

This article examines three different programs that demonstrate the versatility of RLFs. One case study demonstrates how RLFs can be used to target specific industries in a region. Another example shows how a RLF can be used to help small businesses in a rural community. A third example will demonstrate how a state or federal program can target specific geographic areas to aid economic development projects.

Background

A revolving loan fund (RLF) provides access to a flexible source of capital that can be used in combination with more conventional lending sources. Often the RLF fills a gap between the amount a borrower can obtain in the private market and the amount needed to start or sustain a business. For example, a borrower may obtain 60 to 80 percent of project financing from other sources.

Quality RLFs issue loans at market or otherwise competitive and attractive rates. Many RLF studies have shown that access to capital and flexibility in collateral and terms is more important to borrowers over lower then market interest rates. RLF programs should be build on sound interest rate practices and not perceived as free or easy sources of financing. RLFs must be able to generate enough of an interest rate return to replenish the fund for future loan allocations. With competitive rates and flexible terms, a RLF provides access to new financing sources for the borrower, while lowering overall risk for participating institutional lenders.

Eligible uses for RLF loans can include working capital; acquisition of land and buildings; new construction; facade and building renovation; landscape and property improvements; and machinery and equipment. Each RLF may set different eligibility guidelines depending on the source of their funding or the goals and objectives of the fund.

For the purposes of this article, three different areas of concern will be examined: capitalization, standards/goals and loan characteristics.

Capitalizing a Revolving Loan Fund

Initial funding, or capitalization, of a revolving loan fund usually comes from a combination of public sources, such as the local, state and federal governments, and private ones like financial institutions and philanthropic organizations. Often, funding acquired for capitalization is the equivalent of a grant and does not need to be paid back.

A RLF may have multiple sources of capitalization, however, at least one of these is generally a local funding source. If capitalization is exclusively local, the RLF may have greater flexibility in lending, as state and federal involvement tend to include restrictions that may not fit local business needs.

State and local governments often use one or a combination of the following to capitalize a RLF: tax set-asides, general obligation bonds, direct appropriations from the state legislature, annual dues from participating counties or municipalities and funds directed from the state lottery.

The federal government is another common source of capitalization. Communities may apply for capitalization funding from the United States Department of Agriculture (via the Rural Development Intermediary Relending Program), Housing and Urban Development (via Community Development Block Grants) and the Department of Commerce (via the Economic Development Administration).

Standards and Goals

While RLFs finance projects with above average risk, borrowers are held to standard financial requirements in the application process. Before a loan is issued, a business or prospective business usually supplies the following documentation:

Business plan
Business experience and management information
Credit history and financial statements
Sufficient collateral to repay bank and RLF funding
Other personal or corporate guarantees on the project
Cash flow projections

As a public investment instrument, revolving loan funds are expected to yield public goods – namely projects contributing to economic growth and community revitalization. Borrowers therefore, must address performance measures established by the loan administrator such as:

Number and type of jobs created or retained
Increase in tax revenue
Private funding relative to public investment
Benefits to low and moderate-income citizens, from business ownership to job opportunities

Loan Characteristics

Durations vary according to the use of funds. For instance, a loan used for working capital may require repayment in three to five years, while loans for equipment can last up to 10 years and real estate loans may last 15 to 20 years.

Loan amounts range from small ($1,000 to $10,000) to mid-sized ($25,000 to $75,000), with larger amounts ($100,000 to $250,000 and up) available when the borrower has secured a significant portion from private lenders. The amount available for lending is also dependent on the individual fund’s structuring and requirements.
The interest rate is usually fixed at a very low rate or variable tied to the prime rate. Many RLFs will also build in clauses for partial forgiveness of the debt depending on performance.

Three RLFs, Three Very Different Programs

The following examples demonstrate the diversity of RLF programs and how they handle the issues of capitalization, goals and standards and loan characteristics.

Prince George’s County Economic Development Corporation,
Small Technology Business Revolving Loan Fund
http://www.pgcedc.com/pages/incentives.stbrlf.html

The Small Technology Business Revolving Loan Fund targets specific industries that have the largest growth potential in Prince George’s County, MD. This RLF is meant to foster the retention, attraction and development of new and expanding high-tech firms. A special emphasis is on tech firms that are products of local technology incubators or local corporate spin-offs. The Prince George’s Financial Services Corporation administers the fund for the EDC.

Capitalization: This technology-focused RLF was created in 2003 with a grant from the state of Maryland and received additional matching funds from the county.

Standards and Goals: The RLF targets for-profit organizations with 50 or fewer employees, whose primary sales are generated by engineering, life sciences, computer sciences, electronics and other technology activities as well as companies that provide technical products or services through the commercialization of advanced technology. Both start-up and established companies in the targeted industries are eligible to apply. Other forms of equity must be at least 25% of the total cost of the project, and the debt must be secured through corporate and/or personal guarantees or other forms of collateral.

Funds may be used for:

The purchase of machinery and equipment
Working capital
Inventory
Building renovations or leasehold improvements
Contract financing

Loan Characteristics: Loans are for a three to five year period and can range from $25,000 to $100,000. Loans for equipment acquisition or facility improvements can have longer terms. The interest rate is tied to the prime rate (variable rate at Wall Street Journal Prime Rate plus 2.25%). Interest-only payment periods are available initially for start-up companies (three to six months).

Region XII Council of Governments,
Revolving Loan Program
http://www.cdcia.org/revolving_loan.asp

This RLF program targets rural small business using a combination of federal and local funds in west-central Iowa and is administered by the Region XII Development Corporation. The program is designed to serve as a gap-financing tool for businesses with inadequate access to credit. Funding is available to businesses in Audubon, Carroll, Crawford, Greene, Guthrie, and Sac Counties.

Capitalization: Funding for the RLF originated from three sources: the USDA Rural Development, the U.S. Department of Commerce Economic Development Administration (EDA) and the six Iowa counties participating in the program.

Standards and Goals: This program concentrates on small businesses with 25 employees or less that plan to relocate or expand in the region. The RLF program also finances projects that retain current jobs. However, within two years one job must be created or retained per $10,000 borrowed from the fund. A $5,000:1 job created/retained ratio is preferred. Funding priority is given to the most feasible projects with the largest potential for job growth.

Funding may be used for:

Land acquisition
Building construction/renovation
Equipment purchase/refurbishing
Purchase of inventory

Program funds may also be used for working capital, but working capital loans will be limited to a maximum of 50% of available program funds.

Loan Characteristics: The size of the loan may range from $5,000 to $187,500. Interest rates are generally below market rate, but the actual rate will vary depending on the details of the project. There are also minimum standards for the amount of business-owner investment (10 percent) and traditional bank financing (50 percent), which leaves a maximum of 40 percent of the project cost able to be financed through the fund. A one-year deferment on payment is also available.

Specific standards and loan characteristics will vary depending on the source of funds for the specific loan. This is a major challenge when administering a RLF with multiple capitalization sources.

Ohio Department of Development,
Brownfield Revolving Loan Fund
http://www.odod.state.oh.us/ud/BCRLF.htm

The Ohio Department of Development operates a statewide RLF program. Potential borrowers include both the public and private sector. The state seeks to make loans for projects that will create new jobs and lead to increased economic development. The RLF helps finance the cleanup of a site to allow a new project to continue.

Capitalization: The brownfield RLF was capitalized through a grant from the Environmental Protection Agency (EPA) as part of the EPA Brownfields Cleanup and Redevelopment initiative (http://www.epa.gov/brownfields).

Standards and Goals: The RLF is designed to help with environmental cleanup/remediation of areas that show contamination levels above an applicable standard. To ensure that the goals of the fund are being met, borrowers are required to enroll in appropriate environmental programs. Proper testing and documentation of the site are also required. Borrowers must already own the property in question and not be a potential responsible party liable for the original contamination of the site.

Loan Characteristics: As with many RLFs, the ODOD program offers below market loans. Additional features include deferments for a maximum of two years and possible “forgiveness” of parts of the loans depending on the project and other criteria. There is also no penalty for early payoff. Funds are disbursed only on a reimbursement basis.

Summary

Revolving loan funds provide critical financing when credit access is limited, supporting the development and expansion of local businesses and other special initiatives. While a revolving loan fund cannot finance projects on its own, it is an integral part of the small business loan package. Borrowers benefit from flexible and favorable terms, and financial institutions enjoy lower overall risk. The results include new jobs, new businesses and a healthier local economy.

Given the vast differences in the three examples given here, it is important that communities interested in establishing a RLF do the appropriate research to determine what loan characteristics, goals/standards and sources of capitalization will work best for them.

Additional Resources

Establishing a Revolving Loan Fund (Ohio State University Extension)
http://ohioline.osu.edu/cd-fact/1229.html

Administering a Revolving Loan Fund (Ohio State University Extension)
http://ohioline.osu.edu/cd-fact/1230.html

EDA RLFs Make a Difference (report by NADO)
http://www.nado.org/pubs/rlf02.pdf

State of Georgia – Downtown Development Revolving Loan Fund
http://www.dca.state.ga.us/economic/financing/programs/ddrlf.asp

MassDevelopment – Seafood Revolving Loan Fund
http://www.massdevelopment.com/financing/lg_seafood.aspx

City of Minneapolis – Two Percent Revolving Loan Fund
http://www.ci.minneapolis.mn.us/cped/docs/resource_two_percent_revolving.pdf

Erie County Industrial Development Agency - Business Development Fund
http://www.ecidany.com/loan_bdf.asp

Urban Redevelopment Authority of Pittsburgh – Business Development Center (BDC) Revolving Loan Funds
http://ura.org/business_owners/loan_programs.php

St Louis Development Corporation – Revolving Loan Fund
http://stlouis.missouri.org/sldc/busdev/rlf.html

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.

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