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CDFA Spotlight:
Mini Bond Programs
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For many small businesses, tax-exempt financing has not been practical because upfront and annual fees eliminate the effective interest rate savings relative to conventional loans. In addition, financial tools such as Industrial Development Bonds (IDBs) often target larger businesses seeking multi-million dollar loans. A “Mini Bond” program can significantly lower the upfront and annual fees on tax-exempt loans by providing a streamlined application process, standardizing documents, reducing the number of industry professionals involved, and negotiating lower fees. The reduction in red tape results in lower costs for the borrower. Although this financing tool is ideal for many small businesses and 501(c)(3) organizations, the use of Mini Bond programs is not widespread.
The Tax Reform Act of 1986 created two broad categories of tax-exempt bonds: governmental and private activity bonds. Small issue bonds for manufacturing facilities (commonly known as Industrial Development Bonds and Industrial Revenue Bonds) are one category of qualified private activity bond. IDBs and IRBs were established by Congress to support manufacturers and processors through loans with lower interest rates. For many years, IDBs only supported larger companies needing multi-million dollar loans. The application and approval process for conventional IDBs can take up to six months or more, requires detailed documentation, and often necessitates the involvement of bond professionals. Mini Bond programs have been created by some local authorities to support smaller companies with smaller loans, simplify the application process, and reduce fees.
Banks that purchase Mini Bonds generally price them based on the credit worthiness of the borrower. Typically, the bank rate on the bonds is between 1.5 and 2.5 percent (150 to 250 basis points) below the conventional loan rate. The loan or bond term is no different than a conventional loan. Fewer professionals are involved in the process as a result of the standardized documentation. During the Mini Bond application process, businesses must demonstrate strong financial standing and sufficient collateral for the loan. Additional evaluation criteria may established by the local authority.
The process for receiving a Mini Bond generally follows three phases:
1. Qualification: The lender determines if the borrower is eligible and in accordance with program guidelines. The loan terms are set up based on the characteristics of the project.
2. Application and Approval: The borrower completes the necessary application materials and the lending agency obtains approval to issue the bond. Generally, detailed financial statements and project descriptions are required from the borrower. State authorities often have specific evaluation criteria for projects such as job creation.
3. Closing: During the closing, the bonds funds are place in an escrow account and the borrower can access funds as needed.
Mini Bonds are generally sold to investors with a guarantee of tax-exempt interest. This allows private investment to support projects benefiting the public. The bonds may or may not be “bank-qualified.” Certain financial institutions, particularly commercial banks, are allowed to deduct 80% of the interest expense associated with the purchase of bank-qualified issues. Unfortunately, if a lender issues more than $10 million in tax-exempt obligations annually, it cannot issue bank-qualified bonds. In this case, the direct purchase of non-bank-qualified, private activity bonds may be an attractive method of sale for Mini Bond programs. With the direct purchase of non-bank-qualified bonds, an issuer directly places bonds with a commercial bank. Professional fees, which can make smaller deals less economical, are substantially reduced. For example, the need for a placement agent, remarketing agent, letter of credit bank (with associated legal fees), rating, and trustee is reduced or eliminated on these transactions. Although bond pricing may be higher, it is offset by lower fees which have a significant impact on the effective cost of borrowing for smaller loans.
Local Mini Bond Programs
In St. Louis County, Missouri, the Mini Bond Program of the Industrial Development Authority (IDA) provides cost-effective, tax-exempt financing for smaller projects in amounts ranging from $500,000 - $2 million. The bonds are offered to eligible manufacturers and 501(c)(3) organizations. The program requires the use of one bond counsel firm, which developed the standardized application and closing documents at no charge. Since the program documents are pre-approved by the IDA and bond counsel and the required documentation is limited for the borrower and the bank, the cost and time generally associated with customized bond issues is reduced. Although the program requires the use of a single bond counsel firm, any bank can participate in the program. Information about the Mini Bond program is available through the St. Louis County Economic Council (http://www.slcec.com).
In Nevada, the Department of Business and Industry has partnered with financial institutions to offer Mini Bonds from $500,000 to $3 million. The Mini Bond program requires less time, effort, and expense from the applicant. Borrowers complete a standard application form to demonstrate their creditworthiness and a financially sound business plan. Applications for Mini Bonds are reviewed by the partners and the institution interested in financing the project negotiates directly with the borrower. Sample materials including the application form and promotional brochure are available online (http://dbi.state.nv.us/bfp/MiniBonds.htm).
The City of Minneapolis offers the Bank Qualified Bank Direct Tax-Exempt Loan Program to help finance capital projects for smaller manufacturing companies and 501(c)(3) organizations (http://www.ci.minneapolis.mn.us/cped/business_finance_home.asp). This Mini Bond program supports capital projects in the $1 - $2 million range. Because the banks purchasing the bonds are provided tax-exempt interest, the rates are lower than conventional loans. In addition, the time from application to receipt of funds is reduced for the borrower because the program documents are pre-approved by the City of Minneapolis and Bond Counsel. The fees incurred by the borrower for bond counsel and/or financial advisors can be fully or partially covered by the bonds. The City assigns a staff person to work with the borrower throughout the entire process. In addition to previous financial statements, appraisals and environmental reports related to the project must be submitted with the program application. Once the application is submitted to the City and a bank agrees to purchase the bonds, the approval takes 45-60 days.
Mini Bond Program Links
National Resources
Municipal Securities Rulemaking Board's (MSRB): http://www.msrb.org
State and Local Resources
St. Louis County, MO Economic Council: http://www.slcec.com
Nevada Department of Business and Industry, Office of Business Finance and Planning:
http://dbi.state.nv.us/bfp/
City of Minneapolis Community Planning and Economic Development Department:
http://www.ci.minneapolis.mn.us/cped/business_finance_home.asp
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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