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Finance Flashcards
What is the public sector involvement in finance? 3-4
The role of the public sector is to invest in ventures or projects where the economic and social benefits outweigh the risk of financing. The public sector should consider a number of factors, including job creation potential, neighborhood development, potential for tax revenue increases, and so on. The public sector should not supplant private sector financing. Econ Developers should only provide gap financing or take a subordinate position to a bank or otherr private sector lender.
Technical assistance for finance generally focuses on the following; 5-6
- Financial Administration
- Business or Strategic Planning
- Management Assitance
- Marketing/Selling Strategies
- Product Design & Development
What is equity financing? 11
Equity finance is a capital investment that does not obligate the repayment of the investment. In return for the investment, equity investors receive partial ownership in the venture. The investor also expects to benefit from an expected appreciation in the value of their share of the entity and the payment of a portion of the earnings or dividends when the entity is profitable. Businesses, however, are not obligated to pay regular dividends. Equity investments are primarily in the form of stocks. However, any capital that an owner invests in his operation is considered an equity investment. Private sources of equity include the following: ✓ Friends, associates, and relatives ✓ Angel Investors ✓ Seed capital ✓ Limited partnerships ✓ Mezzanine financiers ✓ Venture capital companies ✓ Grants ✓ Private or corporate investors ✓ Common or preferred stock issue
Working Capital Definition and more glossary 187
Current assets of an entity including cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Net working capital is current assest less current liabilities. It is synonymous with current assets and current liabilities on the balance sheet of an entity: cash, marketable securities, accounts receivable, accounts payable, accruals, short-term loans, inventory & prepaid expenses, such as rent or insurance. Working capital is also used to meet current debt obligations (debt due within the next 12 months) & to cover other unexpected expenses. A business may need capital to finance temporary increases in working capital needs, for example, to meet cyclical increases in sales demand such as during the winter holidays. Businesses typically will use short-term financing such as a short-term bank loans (up to 1 year), lines of credit, or trade credit to finance tempora1y increases in working capital.
Equity financing also is critical as it provides a capital base on which debt can be leveraged. In other words, - 14
the more equity a business has, the easier it is to secure loan financing.
Small businesses, especially start-ups, that have been able to secure debt, often have too large a portion of their business financed by debt and too little by equity. Banks view a high debt/ equity ratio…. 16
negatively as it increases the likelihood that the business will have difficulty meeting its regular debt payments. Banks also want collateral to back loans. Equity is an important source of collateral.
Financing Steady Growth Small businesses face a gap in private financing markets when trying to obtain long-term financing of fixed assets. There are several reasons for this: 16-17
✓ Many commercial banks do not provide loans for less than $100,000 & even fewer banks consider loan applications for less than $50,000. Microloans, typically loans of $25,000 or less, are very scarce in the commercial market. ✓ Commercial banks are short to medium-term lenders and prefer not to lend for periods of more than 10 years and often for no longer than 7 years. A commercial loan for a new plant that must be repaid over a 7 to 10 year period requires prohibitively large principal and interest payments. ✓ Long-term mortgages that run 25 to 30 years more closely parallel the useful life of the structure, & reduce the monthly principal & interest payments to a manageable amount for the business. Insurance companies are long-term lenders. However, they tend to limit their investments to commercial and industrial projects of more than $1 million.
Financing Growth Needs 16-18 Financing Distruptive Phases of a Business 18
Facing Growth Needs ✓ Financing Steady Growth ✓ Short-term financing ✓ Sharp temporary increases ✓ Financing cyclical or seasoned Demand ✓ small business contracting ✓ Sharp sustained increase ✓ Expansion into Exporting Financing Disruptive Phases of a Business When a business’ activity declines or the continuity of its operations is disrupted, special financing needs arise. ✓ Temporary Loss of Sales ✓ Loss of Sales for Indefinite Period
Loans are the most common form of debt financing. There are four main types of loans: 19
✓ Recourse ✓ Nonrecourse ✓ Secured Loans that are backed by collateral o Secured loans can have a short, medium, or long-term loan repayment schedule. ✓ Unsecured
Short-term secured loans: Short-term secured loans, typically for less than one year, are used for working capital. The following are the most common types of short-term loans. They are usually financed through commercial banks.
✓ Accounts Receivable Financing ✓ Inventory Loans ✓ Time Sales or Lease Sales Financing
Medium and Long-term Secured Loans Medium and long-term secured loans are the most common type of loans issued by EDOs. Medium-term loans (3-7 years) are used to fund assets such as permanent increases in receivables and inventory and fixed assets. Long-term loans are used to finance longer-lived fixed assets such as plants, property, and equipment.
✓ Term Loans Loans that are made to a business over a medium term and secured by any asset such as machinery and equipment, furnishings, and fixtures. ✓ Construction Loans ✓ Real Estate Mortgage Loans
Unsecured Loans Unsecured Loans are similar to promissory notes. They often finance specific assets, the proceeds from which are used to pay off the loan. Since there is no collateral, assets are freed for other borrowing needs, which makes them a popular financing tool. The bulk of unsecured loans are short-term loans. Longer-term unsecured loans are far less common and typically have protective covenants that require the borrower to refrain from activities that might interfere with repayment, such as additional borrowing, payment of dividends, etc. Types of unsecured loans are
✓ Trade Credit ✓ Line of Credit ✓ Commercial Paper
What is trade credit?
An arrangement between a goods or services supplier and its customer, whereby the supplier does not demand advance or simultaneous payment for its sales. It is the largest single source of short-term financing for businesses, open to all but the newest customers, and the most informal. It is also more readily available to small firms than bank credit. There are three types of trade credit: 1 Open account: The buyer is given a set number of days, usually less than 50 days, to pay off the invoice after receiving the goods or service. It is called an account receivable for the firm extending the credit and an account payable for the buyer. 2. Notes payable: Written evidence of the purchaser’s liability to the seller; the note requires payment at some specific date. 3 Trade acceptances: The seller draws a draft (a request for payment) directly on the purchaser’s bank, ordering payment of the draft at a future date.
What is a line of credit? 21
An agreement between a borrower & a bank, whereby a bank provides access to money, typically for a stipulated annual maximum, for a set term usually 1-4 years. The borrower only pays interest on an actual amount borrowed, not the max loan amount. Generally, banks require borrowers to “clean up” their line of credit by reducing balances due on the loans to zero for 1 or 2 months of the year. Lines of credit can also be secured.
There are several structures for equity investment: 23
- purchase of stock
- limited partnerships
- venture capital
- seed capital
- straight grants
Equity -Seed Capital 23
Seed capital is similar to venture capital but occurs at the pre-production phase of business. Opportunities for benefit & losses are very high. More and more states are setting up seed capital to fund promising start-up companies.
Equity - Limited Partnerships 23
These partnerships were discussed at the beginning of our material. Limited Partners invest their funds in projects. In exchange for investment, investors directly receive income and tax benefits accruing from a project. The investors’ liability is limited in that their other assets are protected from the losses of the project. By law there must be at least one partner that is fully liable. Most limited partnerships are real estate development projects.
Equity - Venture Capital 24
Venture capital is an equity investment in a small business’s future made with the expectation of a high rate of return. The venture capitalist typically receives between 25% and 50% of the entity’s value in exchange for the capital. The payoff from this investment occurs when the entity goes public by issuing stock to be sold on the market or when the firm is acquired. Venture capitalists aim to receive six to ten times their initial investment in five to seven years. If the business fails, the venture capitalist loses the entire investment.
Equity -Mezzanine Financing 24
Mezzanine financing is typically used to finance the expansion of existing companies. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. To attract mezzanine financing, a company usually must demonstrate a track record in the industry with a history of profitability and a viable expansion plan for the business (expansions, acquisitions, IPO).
Equity - Common Stock Purchase 24
This is the ownership of stock that does not promise future dividends to shareholders. Payment of dividends depends on the future success of the venture. Unlike preferred stocks, common stock dividends are not fixed and are typically higher than the market interest rate. Holders of common stock have a claim on all profits of a venture after the claims of creditors and preferred stockholders have been satisfied. They also have the right to elect the board of directors who, in turn, control the venture.
Equity - Preferred Stock Purchase 24
Buying preferred stock is similar to purchasing bonds. The investor receives a fixed annual dividend, either a fixed dollar amount or a fixed percentage of the par value of the stock per year. Preferred stockholders have a prior claim to dividends over common stockholders. Like common stockholders, preferred stockholders are second to lenders in terms of repayment in the case of default. Most preferred stock issues are callable, which means that the venture may retire or purchase the stock at a pre-negotiated price at its option. Preferred stock may also have a conversion clause that entitles the holder to convert the stock to common stock. Preferred stock is generally sold to raise funds on a temporary basis when additional debt or issuance of common stock is not feasible or desirable. This may occur when a company 1) is already carrying a large debt burden and does not want to take on additional debt obligations, 2) does not want to dilute the value of the common stock, or 3) finds market conditions unfavorable to issue new common stock. Because of the risk of nonpayment borne by the investor, dividend rates tend to be higher than the market interest rate.
What is the basic equation of a balance sheet? 30
Assets=Liabilities + Equity Like a balanced seesaw.
ere are three types of financial statements that are used by creditors, equity investors, and others to evaluate the strength of a business. They are 29
balance sheet income statement statement of cash flows
Net sales 30
Revenues and sales minus any minor deductions, such as sales returns.
Revenues 30
Total earnings accrued by the sales of goods and services. A services firm’s sole source of revenue would be the services they sold. They would not have a net sale recording.
Costs of Goods Sold 30
The direct costs associated with the generation of revenue. For merchandising companies, it involves the price of goods purchased for their inventory. For manufacturing companies, cost of goods sold includes raw materials, labor, machining, shipping, etc.
Gross Profit 30
Net sales minus the cost of goods sold. Merchandising entities use gross profit to measure profitability of the inventory they are selling.
Other Income 30
Includes any other monies earned, such as interest revenue.
Sales and General Administrative Expenses
Any other operating expenses that are accrued in the period of the income statement, including officers’ salaries, rent, utilities, fringe benefits, advertising, and so on.
Net Income
The excess of revenues over the related expenses for the period of the income statement.
The Statement of Cash Flows provides information about a company’s
cash receipts (inflows of monies to the business) and cash payments (outflows of monies). In essence, it shows the sources and uses of cash. The statement of cash flows reconciles the net cash flow from the period with the cash category in the company’s balance sheet. Classification of cash flows corresponds to specific business activities
Types of cash flow activities 33
- Operating activities Cash Receipts (inflows) ✓ Cash payments from customers: both cash sales and collection of accounts receivable ✓ Interest and dividends received from outside investments ✓ Other miscellaneous receipts from business operations Cash Payments (outflows) ✓ Payments to suppliers ✓ Payment of salaries (often combined with payments to suppliers) ✓ Interest payment ✓ Annual (or quarterly) income tax payment ✓ Other miscellaneous expenses from business operations Investing Activities - Investing activities refer to the cash flows that arise from purchases and disposals of plant assets or investment. Cash Receipts (inflows) ✓ Proceeds from selling investments ✓ Proceeds from the sale of equipment or other plant assets ✓ If a lender, proceeds from collecting principal on loans Cash Payments (outflows) ✓ Purchase of investments ✓ Expenditures to acquire equipment or other assets ✓ If a lender, amounts given to borrowers - Financing Activities Cash Receipts (inflows) ✓ Short and long-term loan amounts ✓ Increases in stockholder’s/ owner’s equity Cash Payments (outflows) ✓ Payments of dividends ✓ Payment of loan obligations
The following is general criteria banks use in the decision making process to lend to businesses 35-36
Management ability Lending institutions review resumes and qualifications of principals and many banks conduct interviews of each potential borrower. Repayment Ability Lending institutions use a number of measures, detailed below, to determine a business’s ability to repay its debts. Collateral Most banks look for a one-to-one collateral ratio, (that is, for every $100,000 borrowed, there is $100,000 pledged by the business) to secure loans. Equity in Business Lending institutions will almost never finance 100% of a business. Therefore, they look for an owner’s debt to equity ratio of approximately 2 to 1 or less - that is, $1 invested by owners for every $2 borrowed. In addition, banks may also consider the overall environment of the borrower or its industry when making loan decisions. The following are the criteria of a larger bank for their small business loan practice, which is generally defined as loans of$250,000 or less ✓ A minimum net worth of $50,000. ✓ At least two years in business (no start-ups), with profitable operations. ✓ Debt to equity ratios of 2 to 1 or less. ✓ An advance rate of 50% of the inventory (if a business has $100,000 in inventory, they will lend $50,000), 75% of accounts receivable, and 80% of equipment.
Current Assets 39 and slide 42
Assets that can easily be converted into cash to pay bills within 12 months. Cash, cash equivalents, accounts receivable, inventory, prepaid expenses The quality of current assets gives a relative indication of the ability of a company to meet its current obligations. Cash, not current assets, pays off obligations. The quality must be high to meet a company’s obligations. hat requires an understanding about the operations of the company and its business. It is possible, however, to look at whether or not a company has had cash flow problems, such as: ✓ Has it been late paying its bills? ✓ Has it always met the payroll? ✓ Has it used its available lines of credit?
Activity Ratios 40-43
Rations Accounts Receivable Turnover=Net Sales/Accounts Receivable - Accounts Receivable Turnover is the number of times receivables are collected during the year. Days Receivable= (Accounts Receivable/Sales)*365 -Accounts Receivable Turnover is the number of times receivables are collected during the year. In general, the collection period should not be more than one- third higher than net selling terms. Days Payable=(accounts payable/COGS)*365 Days payable measures the average length of time between purchase of goods and payment for them. To analyze the company’s payable position and relationship with suppliers, there are two quality indicators: ✓Actual Days payable should not exceed payable terms. ✓ Payable levels should not exceed inventory levels. Inventory Days = (Inventory/COGS)* 365 - Days inventory is a measure of the average number of days it takes for a company to sell its inventory. Inventory Turnover Ratio = COGS/Inventory for period The Inventory Turnover Ratio indicates the number of times per year that the inventory is sold or turned over.
Just in Time inventory 42
JIT inventory is a practice by which manufacturers cut costs by ordering inventory (whether that inventory be raw materials or parts) so that it arrives right before it is used in a manufacturing cycle.
Types of current liabilities 43
Current liabilities include: • Short-term notes payable • Accounts payable • Accruals • Income tax payable • Current portion of long-term debt
Current Liability Ratios 42-43
Days Payable = (Accounts Payable/COGS)*365 - Result shows the number of days it takes a business to pay accounts payable
What are accruals? 44
Accruals are money owed to providers of goods or services for which no official bill exists or billing process takes place. Accruals are important because they can be overstated or understated to distort a company’s true picture of profitability. Accruals include: Wages ✓ Payroll taxes ✓ Fringe benefits and pension funds deposits ✓ Rent (building and equipment) ✓ Interest due on loans
Current Portion of Long-term 44
This is the principal portion of long-term debt that is due within the next 12 months; it is reported as a current liability. Note that disclosures help indicate which portion of long-term debt is the current portion.
Liquidity Ratios measures the ability to meet short term obligations as they come due. What are the liquidity ratios?
Current Ratio = Current Assets/Current Liabilities - The higher the current ratio is, the more solvent the business. Many creditors use a general criterion of 2 to 1 Quick Ratio = (Cash+Accounts Receivable)/Current Liabilities A general rule of thumb is that the quick ratio should be at least 1 :1, however, this again will vary by industry.
Working Capital 46
Working capital is current assets minus current liabilities. Working capital measures how much in liquid assets a company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations. Companies with negative working capital may lack the funds necessary for growth. Working Capital=Current Assets – Current Liabilities Working capital can be generated in three ways: ✓ Profits ✓ Long-term borrowing including new equity ✓ Reduction in long-term assets (through depreciation or sale) Working Capital Ratio=Net Sales/Working Capital -Working Capital Ratio: gives an overall indication of how well a business is managing its working capital. To find out how this translates into days, simply divide the number of days in the period (for a year it will usually be 360) by the ratio. 365/Working Capital Ratio= Working capital turnonver in days
What is the operating cycle? 45
The Operating Cycle is the period of time elapsing between the acquisition of good and services involved in the retail, commercial, or manufacturing process and the final cash realization. Cash ➔ Inventory ➔sales ➔ Accounts Receivable ➔ Cash Cash Conversion cycle Cash Conversion Cycle = Days Accounts Receivable + Days Inventory - Days Accounts Payable
Non-Current Assets (Long Term Assets)
Assets with a life longer than one year, and are important because they can help secure long-term loans. - Not liquid ❑ Land, building, furniture, fixtures, machinery and leasehold improvements
Debt Ratios 48 -
Debt Ratio = Total Liabilities/Total Assets The Debt-to-Equity Ratio determines how safe a loan is, specifically the ability of the lender to recoup its investment. The lower the debt ratio, the better the risk for the lending institution. The general rule-of- thumb is that a financially stable firm will have a debt ratio of 60% or lower. Debt to Equity Ratio= (Total Liabilities -Sub. Debt) / (Equity-Intangibl+ Sub. Debt) As you can see, the H&H company’s debt relative to equity is less than 1 to 1. For every $0.76 that is put into the business by borrowing, the owners invest one dollar. This ratio is useful for lenders, because it gives a concise picture of how the applicant’s business is financed. Banks tend to prefer that small businesses do not exceed debt ratios of 3:1.
Measures of Profitability Ratios 50-53
Cost Of Goods Sold (COGS) = Beginning Inventory + Purchases -Ending Inventory (class used different formula) Cost of Goods Sold are the costs that vary directly with sales. They are the production related expenses and typically the greatest single expense category a company faces and thus it is a major determinent of profit. Increases in percent ratios of COG to sales may indicate a sharp increase in supplies or wages or that a company is having trouble maintaining its margms. Gross Profit = Sales -COGS Sharp decreases in the ratio may indicate some reduction in production costs such as a cheaper source of supplies, improvement in production, or that a company is overstating its ending inventory to show, falsely, higher profits Margins – firms ability to translate sales dollars into profits • Gross Profit Margin = Gross Profit/Sales • Operating Margin = Operating Income/Sales Return – measures the ability of the company to generate returns for its shareholders • Return on Assets (ROA) = Net Profit/Total Assets Return on Assets evaluates whether management has earned a reasonable return with the assets under its control. • Return on Sales (ROS) = Net Profit/Net Sales Return on Sales (ROS) indicates the degree of efficiency to which a company utilizes its financial resources. • Return on Equity (ROE) = Net Income/Total Equity Return on Equity (ROE) is a criterion with which investors evaluate whether a company has successfully utilized the equity in the company. Average annual return on equity in financially stable companies is approximately 10 -20%, although the return can be much higher in fast- growing companies with a popular product.
Revenues and expenses 50
Revenue is the inflow of assets that results from sales of goods and services and earnings from dividends, interest, and rent. Revenue is often received in the form of cash but also may be in the form of receivables to be turned into cash at a later date. Expenses are the outgoings such as costs associated with production (raw material, labor, and delivery), rent, salaries, utilities, interest, and insurance. Correct calculation of revenue and expenses are critical to get true values of profit that a company makes.
Selling, General, and Administrative Expenses 51
Selling, General, and Administrative Expenses (SGA) include variable and fixed expenses, as well as production and selling and period expenses. It generally consists of officer salaries, sales, rent, utilities, insurance, interest, depreciation, and other dues.
Fixed and Variable expenses
COGS, SGA, and other costs can be broken out into fixed and variable expenses. The composition of fixed and variable expenses will affect a company’s profitability. Fixed expenses are those that do not vary as production varies; these are typically expenses related to operating the business. types of fixed expenses: ✓ Rent ✓ Insurance ✓ Debt service payments ✓ Salaries Variable expenses are those expenses that change proportionately with the amount of production or sales. These are typically expenses related to the cost of goods sold. Variable expenses can be further broken out into discretionary and non-discretionary expenses. Types of variable expenses include: ✓ Supplies ✓ Advertising ✓ Officer compensation
Forecast and Pro-forma Finance Statements 53-56
Forecast and Pro-forma Finance Statements: investors look for a business forecast to sale and to prepare pro-forma financial statements that realistically estimate the business’s future over a set period of time. Forecast Statements ❑The Income Statement Forecast • Sales Projections • Cost of Goods Sold • Operating Expenses • Interest and other Expense • Income Tax Expense • Analysis ❑The Balance Sheet Forecast • Assets ➢ Cash and Marketable Securities ➢ Accounts Receivable ➢ Inventory ➢ Fixed Assets ➢ Liability and Net Worth o Accounts Payable o Current Maturities of Long Term Debt o Long Term Debt o Net Worth o Balancing the Asset, Liabilities, and Net Worth Accounts • Analysis
Forecast and Pro-forma Finance Statements Ratios 55
Net fixed Asset Value= Gross Fixed Asset Value -Accumulated Depreciation - Depreciation on existing fixed assets + cost of new fixed assets (any planned purchases) - Depreciation on new fixed assets= Projected Net Fixed Assets
This requires a credit analysis of all potential deals. Credit analysis considers four factors: 57
✓ The debt coverage ratio ✓ The loan to value ratios (collateral) ✓ The validity of guarantees ✓ The personal integrity of the borrower
Credit Analysis Ratios 57-58
Debt Coverage Ratio (DCR) = Net operating Income or Cash Flow/ Total Debt Serice The debt coverage ratio (DCR) compares the cash flow income of a business to the cost of a loan. The DCR can be used to determine the largest loan that a borrower could afford given a particular income. Loan to Value Ratio LVR=Loan Amount/Money Value of Collateral Assets The loan to value ratio (LVR) establishes the ability of a lender to recapture a loan given the value of collateral put up by the borrower. It is simply the amount of loan over the value of the borrower’s collateral. An LVR should not be greater than one, which is a 100% loan to value ratio. In such a case, even if the lender were to recoup the full value of collateral from a defaulted borrower, the full value of the loan would not be recovered.
Intangibles in credit analysis 58
The intangible measure of the character and integrity of the borrower serves as final, but by no means less important, evaluation criteria of credit analysis. The lender must feel at ease with the borrower, & confident that the client will work to repay the debt. A loan that may appear to be no risk on paper, could be quite risky if the borrower is untrustworthy, or is of questionable character. Good loans are made to borrowers of the highest trust and esteem.
Credit, Debt, and Maturity 58-59
Credit MOst lenders want predictable outcomes. In financial arenas, there is no risk-free proposition. They are dealing with a range of possible outcomes. Their goal is to reconcile the risks with the rewards. Thus, the higher the risk of financing, the higher the return expected. The financial institution will rely on a number of factors to determine whether there is a reasonable chance that the loan will be repaid, all of which have been discussed previously: the current ratio, the quick ratio, the debt ratio, and the amount of working capital available. For the most part, these measurements need to show that a business can cover its bills. Debt How the company has financed its operations is important to understand how much of a risk the business might be. A business can finance its assets and operations from a number of sources, including earnings from profitable operations retained in the business, invested capital from stockholders, & debt capital. If a company has a great deal of debt capital, then it is “highly leveraged.” This is a red flag: the business may not be able to pay off its existing debt and could be forced into bankruptcy. Maturity Maturity is the length of time until an investment is scheduled to be repaid. Maturity risk is the chance that an investor will forego a more profitable future investment opportunity because his investment funds are committed to another investment and inflation will lower the value of the investment. The longer the maturity is, the greater the risk. For example, if the interest rates rise after a loan is approved, an investor will miss out on investment opportunities yielding a higher return because its funds are tied up. The basis of this risk is rising inflation, an overall increase in the rate of increase in general prices, which erodes the purchasing power of money. In a period of inflation, the return on the investment will decrease because the income on the debt investment is fixed in terms of money, not purchasing power.
Market Risk There are always risks that even the strongest business will be adversely affected by a competitor, new technology, or an industry downturn. The best business planners will do all that they can to minimize that risk. The company needs to study the marketplace to determine what factors may impact its business. Some questions to ask include: 59-60
✓ Who are the company’s competitors? How many are there? ✓ Can new competitors enter the market easily? ✓ Can the company control how its products are priced or are their strategy tied to their competitor’s pricing strategies? ✓ What are the demographics and consumer trends in the firm’s marketplace? ✓ Is the market expanding or contracting? Is it stable? ✓ Is the firm an industry leader or follower? ✓ Is there a great deal of product differentiation in this market? Has the company capitalized on this? The business has to also examine its industry environment to determine if there are factors that will affect its viability. Some questions include: ✓ Is this a cyclical industry, such as automobiles? (Cyclical industries are those whose sales are affected by the fluctuations in the national economy) ✓ How have new tax policies affected the industry as a whole? ✓ Is the industry on the verge of new technologies? (A question of considerable importance in fields such as computers) ✓ Are there new regulations on the horizon that will affect businesses?
The lending screening process involves four major functions: 62
• Marketing • Screening • Underwriting or approving (denying) a loan application, and structuring the loan including setting fees and interest rates, securitization, and repayment terms • Loan documentation and servicing
Marketing is designed to target two groups: 63
• Potential borrowers • Potential Lenders
There are several ways to market: 63
• One-on-one meetings • Meeting other service providers • Presentations to business groups • Mass mailing • Advertising and media relations
The underwriting process needs to be structured to achieve some key objectives. 65- 66
First, it must provide a thorough assessment of whether the proposed firm or project is viable in the marketplace and has the ability to repay the requested loan ( or provide a return for an equity investment). Second, the applicant’s business and financial risks need to be evaluated in order to secure, if appropriate, technical and management assistance. The third objective is to produce a financing plan that addresses the applicant’s needs while meeting the financial objectives of the finance entity, and the fourth goal is to establish checks and balances to minimize errors. Finally, the process should document all decisions, giving all parties a clear understanding of their obligations and legal rights.
Underwriting: five c’s 5 C’s of Credit: 66
- Cash Flow – Does sufficient Cash Flow exist to repay the loan? 2. Character – Does the borrower have the capability, maturity and character to repay the loan? 3. Capacity – Does the company’s past records demonstrate the capacity to manage the debt service? 4. Collateral – Does the borrower have adequate collateral? 5. Conditions – How does the economic environment and trends in an industry impact the level of risk?
Structuring the Loan - Maturity 67
Maturity This refers to the length or term of the debt repayment period. Maturities range from: ✓ Short-term, often less than one year. Short-term maturities are often used in lines of credit secured by inventory or accounts receivable. ✓ Medium-term, from one to five years. ✓ Long-term, more than five years.
Loan Servicing - Indicators of potential problems with borrower include:
✓ Payment pattern changes ✓ Bounced checks ✓ Change in loan payment account ✓ Financial record keeping deteriorates ✓ Income stream fluctuates greatly ✓ Borrower conceals information If the borrower is having trouble meeting its debt payments the lender may want to refinance or restructure the loan to avoid further deterioration of the loan. Restructuring options include: ✓ Lengthening the amortization of the loan; ✓ Requiring only payment of interest over the life of the loan and a balloon payment of the principal at maturity; and ✓ Lower interest payments. If these courses of action fail, the lender may be forced to foreclose on the loan. This may require liquidation of pledged collateral. If there is no collateral, the lender can take legal action against the borrower and sue for repayment. To avoid problems, loans should be reviewed at least annually. The review should assess the financial health of the borrower, compliance with loan covenants, and assess if there is any change in collateral.
Other factors to examine when making decision to lend. 71
To augment financial analysis, an experienced lender looks at the status and prospects of the industry in general; the character, skills, and track record of the entrepreneur or management team; the quality and reliability of the product produced or services rendered by the entity; physical condition and usefulness of the plant and equipment; likely future demand for the product; quality and liquidation value of assets; and sensitivity of the entity to cyclical downturns. Meeting with the owner or manager can be as important as looking at financial statements. Personal interviews with the entity can help in determining the adaptability and stability of its management as well as provide insight to its strategy and experience in managing its operations and preparing for future growth. In fact, many lending institutions that make loans to entrepreneurs will not make a loan without personally interviewing the applicant.
To receive assistance from a LDC, 74-75
a small business must meet either SBA’s industry size standards or the maximum net worth and net income criteria. Before a small business can receive SBA 504 assistance, it must be unable to obtain the financing on reasonable terms through banks or other private lenders.
Financing continuum
Sources of Equity Financing
Seed Capital
Seed capital is the money that young high-growth firms need long before they can access traditional sources of funding (debt from banks or equity from the stock market).
It’s the earliest stage of venture capital V/C), making it the riskiest investment. Making dozens of investments of $50,000 to $500,000, which are typical quantities for seed funding, is a lot more trouble than making a handful of multi-million dollar investments.
At the seed stage, the investment is smaller and the risk is much greater.
Venture Capital
Venture capitalists are professional financiers that seek companies where there will be a possibility of substantial returns on their investment, as much as 40%, typically within 3 to 7 years. Frequently these are companies with proprietary information or tech but they can be any company with a high growth product or service. Venture capitalists provide initial equity capital & 2nd and 3rd round financing typically in excess of $3-$5 million. Venture capitalist firms typically require a voice in the decision making process of how a firm is run; they will often require a board seat. To make a profit, the venture capital firm plans an exit strategy. 3 common forms of investment exit are an initial public stock offering (IPO), selling the firm to another company, and a buyback of stock by the business.
Community Developmet Venture
Community development venture capital (CDVC) uses equity finance to build businesses that benefit low-income people and distressed communities. Unlike traditional venture capital funds, CDVC funds look to invest in businesses whose growth has the potential to create good jobs for people with limited job opportunities. This means that while traditional venture capital funds and CDVC funds use the same financing techniques, their investment portfolios ultimately look quite different. CDVC funds invest in geographic areas that are not typical VC hotspots. CDVC funds also invest in industry sectors that are atypical for traditional venture capital funds. CDVC funds typically focus on manufacturing businesses and service-related businesses, both of which are sectors that offer good employment for people without advanced degrees.
EDOs and Venture Capital
Economic developers can best provide assistance by acting in a brokerage role, matching up entrepreneurs with both public and private sources of venture capital. There are several steps to take in doing this:
- Get to know you venture capital providers
- Develop a mechanism for identifying possible business start-ups & new products
- link entrepreneurs with sources of technical assistance
- remember that it is the entrepreneur who must close the deal in the end
Expanded - don’t study past this
Get to know your venture capital providers
Personally meet with both public and private sources of venture capital in your region. Learn what types of investment opportunities they are looking for across several dimensions, including industry(s), preferred size of investment, and degree of control desired (is the venture capitalist a fairly passive investor or will he/ she wants to have substantive input in the new firm or product line). It also may be necessary to network with venture capitalists nationally, especially if certain VC companies specialize in investing in your specific economic clusters or if there is not adequate venture capital available in your state.
Develop a mechanism for identifying possible business start-ups and new products
Within the context of a business retention and expansion strategy, the best way of doing this is through a business network. In this way, entrepreneurs can be linked both with public and private venture capitalists, but also with larger businesses in the network that may be interested in taking an equity stake in a new product that would complement their existing product line.
Link entrepreneurs with sources of technical assistance
Frequently, an entrepreneur with little or no business experience will develop a potentially viable new product. Such entrepreneurs should be linked to sources of technical assistance that can help with the development of a business plan. This assistance can be provided through the business network. Be aware, however, that some of the more standard business service providers such as SBDCS may not be skilled in providing technical assistance to companies requiring venture capital. Try to get to know which of your local business se1vice providers know how to assist businesses with the particular audience.
Remember that it is the entrepreneur who must close the deal in the end
No amount of technical assistance or persuasion is going to convince a seasoned venture capitalist that doesn’t see market potential for the new product. Keep in mind that it is the entrepreneur who ultimately must defend the business plan before the venture capitalist.
Direct Lending
- Don’t Study - For Test
83-84
Again, direct financing programs should only provide gap financing or leverage private sector financing for projects that are unable to secure private sector financing on their own. Often, public sector loans take a subordinate position to private sector loans assuming second or possibly third lien position. Granting the private lender the primary right to the principal and interest repayments creates a strong safety net for private capital. Instead of distributing the returns equally between all groups that capitalized the loan, the private investors collect their share of each repayment first. The public sector receives its portion of the retmns only after all of the private investors have collected their dues. The public sector portion of the loan se1ves as a buffer for the private sector investments, bearing the brunt of any i1’tegular payments or delinquencies that may occur. Creating a relatively risk free venture is the impetus to attracting private investment to businesses that normally would not receive consideration.
Debt subordination will attract private sector participation to these loans because it reduces the risk of many otherwise attractive deals. From the lender’s perspective, subordinated debt may be attractive as it is similar to equity. From the borrower’s perspective, subordinated debt may be attractive as it is debt and not equity, thatis, it does not compromise the entrepreneur’s ownership in the firm.
By setting realistic leverage ratios, subordinating the debt, and marketing the program effectively to the local banking community, you will be able to leverage significant amounts of private sector capital.
Revoling Loan Funds
For test - don’t study
85-86
Ill. RevoMng Loan Funds
Revolving loans funds (RLFs) are one of the oldest and most widely used development finance tools, emerging in the 1970s. RLFs operate on a simple basis: the repayment ofloans made is recycled into future lending. As loans are repaid, the principal and interest return to a loan pool can be lent to other businesses. The continuation of the fund depends on the collection of existing loans. As a result, RLFs often need to be recapitalized to sustain the program. Although the overall industry’s economic development role is substantial, most RLFs are modest in size and impact.
RLFs can be used for a variety of lending purposes including providing direct loans to start-up and growing businesses. However, as a public development tool, the goals of an RLF are different than those of private lenders. One of the major criteria is job creation. Another is to combat decline in urban economic areas, whether that be to counteract economic dislocation through the loss of a major employer or mass layoffs, or for commercial and industrial renovation. The purpose of the RFs is to both complete capital assembly and precipitate capital formation, not to serve as a substitute for commercial lenders. RLFs typically fill the gap between the amount of capital needed by a business and the amount of capital provided by conventional lending sources. RLFs can indeed provide the amount of capital to businesses to promote leveraging of funds from teh private sector.
The administrators of a RLF need to set priorities and then determine the best allocation of funds based on those priorities and returns on investment, thus customizing loans to each individual business. While RLFs exist to meet needs not being met by the commercial market, profitability is a consideration in terms of breaking even. That is, the RLF can be structured to meet any sort of need, but the fund must be profitable enough to return money to the fund in time to lend it out again. In order to become a valuable source of development finance, RLFs need an economic development and finance, RLFs need an economic development & financial strategy that targets key market segments & allows them to grow in scale.
One of the advantages RLFs offer business owners is their terms: typically, a lower rate and longer term to meet start-up and growing business needs. RLFs can offer below market interest rate loans, loan guarantees, micro-loans, loans for startup, and working capital loans. RLFs can also be used to leverage private sector funding by using the RLF dollars as subordinate financing for a loan package instead of 100 % direct financing.
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RLFs can be capitalized through private funds and public funds which include state and local appropriations or federal grants, with the three most common sources being HUD’s Community Development Block Grant program (CDBG), the Department of Commerce’s Economic Development Administration (EDA) Public Works and Economic Adjustment Assistance Program, and the United States Department of Agriculture (USDA). In the face of declining federal funding, many RLFs are turning to private sector leveraging. Public funds can leverage ftuther private investments, sometimes producing loan pools with as large a ratio as five or six private dollars to each public dollar. Through the revolving mechanism, with loan repayments recycled or revolved, a RLF services as an ongoing source of debt capital for a community. A one-time grant of capital can allow a RLF to make several generations of loans.
Grant Debt vs. Capitalization
The RLF receives capital from both grant and debt sources. Borrowers repay their loans to the RLFs that then use the loan repayments to make new loans. If the RLF borrowed money to partially capitalize the fund, then some of the cash flow from loan repayments will go to repay debt sources. All grant proceeds can be revolved within the RLF, since grants are not repaid. Grants require no return of capit.’ll or interest payments, allowing for RLFs to make higher risk loans and set flexible repayment, enabling them to lend to earlier stage firms, with less collateral and debt coverage. Grants provide a subsidy to absorb lower financial returns that are justified by social benefits. Social return goals can in turn attract non-grant funding from investors that seek both a financial and social return. The effect of debt sources on RLF lending capacity is dependent on the repayment schedule. Long-term loans will allow repeated recycling of capital while a short-or medium-tetm loan provides a one-time infusion of funds that will not be revolved within the RLF.
Lack of Regulation Compared to Banks
An important RLF feature is their unregulated status. Conventional financial institutions and banks are constrained due to regulations on asset quality and leverage. In addition, information and transaction costs may hinder the pursuit of and competition within lending markets.
However, the unregulated status of the RLFs has both benefits and disadvantages. RLFs do not need federal or state government charters to operate and are not subject to regulatoty supervision. Thus, they can be established without the time and cost of meeting those hurdles. A RLF can set financing policies based on economic development goals and organizational needs, instead of having to meet regulato1y standards. Nevertheless, lack of regulations could also be a drawback, as accountability and public oversight are reduced. RLFs can consequently be est.’lblished and operate without adequate expertise, policies, or systems to manage the funds, which in tum increases the risk for poor credit decisions and unnecessa1y losses. Instead of regulations, RLF performance is guided by the policies and oversight practices of their funding sources and local governance bodies, which fluctuate more than national bank standards.
Specifically Targeted RLF’s
Communities use RLFs to maximize economic growth, but they may have special issues and goals to address and use RLFs accordingly. These goals may include helping companies diversify from defense contracting, increase their expo1ts, comply with environmental requirements, reduce energy costs, or to modemize their operations to become more efficient and competitive. Other special RLFs are created to assist minorityor women-owned businesses. Some communities may target RLFs on specific geographic areas in efforts to generate business development in economically distressed neighborhoods, such as those designated as state enterprise zones or federal empowerment zones or enterprise communities. RLFs can also be used for historic preservation as a way to support tourism efforts in an area.
V. Microloan Programs
Don’t study - for test
87-90
11icroloan programs - also called microcredit programs - provide small loans to new and existing small businesses. Loans are made to eligible borrowers in amounts up to a maximum of $50,000. The average loan size is about $13,000. Loans are short-term and unsecured and made to people without the credit history and/ or collateral necessary to obtain a conventional loan. The maximum term allowed for a loan tends to be less than six years; the average loan term is 40 months. Loan terms vary according to the size of the loan, the planned use of the funds, and the needs of the small business borrower. Interest rates also vary; however, rates are generally between 8-13%. Loan recipients are generally entrepreneurs from disadvantaged populations who want to start up or expand a small business, often home-based and minority-owned.
Micro-enterprise development programs (MEPs) serve both individuals seeking to create a new business and existing small firms with few employees, usually five or less, thus providing credit and business development assistance. MEPs serve mostly nontraditional business owners who are often overlooked by mainstream banking and economic development programs, often immigrants, minorities, women, and low-income individuals. In the US, almost two-thirds of micro-enterprise programs setve women with over half from low-income households.
Technical assistance and training is provided through these programs. Business training is crucial to the 1\1EPs; they often devote more resources to training than to lending. Additionally, since the majority of these micro-enterprises begin on a very small-scale, often as self-employment to supplement income, they only require modest initial capital to start-up. Therefore, micro-enterprise finance programs provide small loans, usually not more than $50,000.
Three models are used in MEPs: peer group lending, individual-based lending, and training-based programs. Both the peer group and individual lending models are credit-led programs, meaning that they place emphasis on helping entrepreneurs to secure loans to start or expand a business.
Peer group lending
Peer group lending is a strategy whereby banks and other lending institutions can limit their risk when doing business with entrepreneurs. Instead of depending upon the abilities, resources, and luck of one businessperson, the lender brings together several independent businesses (usually between four and six) under the umbrella of a single loan. Peer group participants are convened through individual networking activities, or through the efforts of formal neighborhood organizations, informal neighborhood groups, or banks themselves. Once a loan is disbursed, each business is generally equally responsible for ensuring that the loan payments are made. Since group members are dependent on the success of their peers, they work together to support each other. Participants share helpful business practices, alert each other to business opportunities, and may provide direct assistance (cash, work hours) at critical moments.
Individual Lending
The individual lending model provides loans on an individual basis, serving entrepreneurs who would not qualify for traditional loans by applying less stringent credit standards and giving more weight to the nonfinancial aspects of the business. They also usually offer training and technical assistance. The loans are usually larger and have longer terms than those made by peer group lending programs. This model has the advantage of being relatively easy to administer, easier to establish, and can grow to scale more readily. They also have the advantage of being able to respond to individual business needs without the constraints of group lending. They are therefore well suited for established businesses, and those that need larger loans. However, they do not provide the social support found in peer groups, and thus can be less effective in assisting those entrepreneurs who rely on such support to succeed.
Training Led
This model recognizes training as the primary tool to foster micro-enterprise development. Most of these programs include formal classes and assistance on creating a business plan, as well as training for skills such as accounting, market analysis, and marketing. Not all of these programs offer credit, but some do through partnerships with lenders or through their own program. Training-based assistance is advantageous in that it develops core business knowledge and skills that are essential in economically distressed low-income communities. Since these programs serve entrepreneurs who may not be seeking credit, they reach more people. However, it is costly to train, given the small class sizes, new methods, and specialized materials used to teach MEP target groups.
Indirect Financing
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Linked Deposits
Linked deposits are a means of providing low interest loans to targeted populations through local commercial lending institutions. Linked deposits systems tie deposits of public funds to the lending behavior of depository institutions (banks). In these programs, money is invested in banks with lending policies that can or do contribute to economic development. At the local level, these programs are frequently used to combat redlining, while at the state level they serve to direct loans to specific geographic areas as well as to specific types of borrowers.
Linked deposits have several advantages. The main advantage is that the conventional lender does underwriting and servicing of the loans.
There are four main steps in establishing a linked deposit program:
✓ Determine which public funds are available for deposit into the participating bank.
✓ Identify eligible depository institutions.
✓ Set criteria and procedures for commercial bank allocating funds.
✓ Monitor lending practices of the bank.
The local economic development agency makes a long-term, reduced rate deposit, generally a certificate of deposit, with the lending institution. The rate is generally between two or four percentage points below the prevailing market rate for a similar deposit. The agency may also secure the deposit with public collateral. The lending institution then agrees to make below-market rate loans, generally at a rate “linked” to the development agency’s return on their deposit, to eligible business. The lending institution is charged with applying all “usual lending standards” to determine the applicant’s credit worthiness.
Loan Guarantees
Loan guarantees are similar to collateral, in that it backs or insures all or a portion of a loan against default, and thereby lowers the risk incurred by potential lenders. With this “insurance,” banks are more willing to lend funds for risky investments. Loan guarantees allow the public sector to leverage limited dollars by encouraging private sector investment in “non-bankable” projects. Guarantees also may allow companies to obtain capital below the prevailing market rate.
Unlike direct loans, the government does not have to make a direct payment, or hold in reserve funding to cover the entire dollar value of the guarantee. Rather, it only needs to set aside a certain percentage of funds to cover its obligation. The deposit would be forfeited in the event of a foreclosure on the loan.
The guarantee usually does not cover the full value of the loan. Typically, the lending institution sets the loan guarantee requirement. The guarantee requirements can be as much as 100% of the full value of the loan. However, they tend to be no more than 25% of the approved loan. Often the guarantee is limited to the first several years of the loan term. The responsibility for originating, evaluating, and servicing the loan remains with the private sector lending institution.
For example, a project costs $1 million and is valued at $1 million. The lender provides 80% of the project costs, or $800,000. The borrower supplies the remaining 20% in equity. The guaranteeing agency insures the riskiest 25% of the loan. The lender’s exposure is then $600,000. In the event of default, the lender has the first claim on the collateral. Any collateral that remains after the lender takes his or her share goes to the guarantor.
If, after default, assets are sold (liquidated) for $550,000, the lender receives the value of the collateral, incurring a loss of $50,000 and the guaranteeing agency loses $200,000 paid to the lender. If the collateral sold yields $650,000, the lender gets $600,000 from the sale and $200,000 from the guarantor. The guarantor in return receives the remaining $50,000 and suffers a net loss of $150,000.
There are two types of loan guarantees; 1) the public sector can guarantee the value of the collateral, or 2) it can guarantee the loan against default. When guaranteeing the collateral, the public sector is responsible for any loss in value in the collateral incurred by the lending institution. When guaranteeing against default, the public sector is responsible for the amount of the loan that was guaranteed.
The development agency generally places the “guaranteed funds” in reserve in a lending institution, earning interest until a loan defaults. These funds may be reused for future loan guarantees.
The guarantee program has several advantages. The conventional lender does underwriting and servicing of the loans and the guarantor does not necessarily have to duplicate these efforts. If the guarantee is for some portion of the total loan dollars, a guarantee wiJJ allow the economic development organization to utilize less capital than in the case of direct lending. Guarantees, however, are difficult to administer, particularly for smaller banks.
Advantages of loan gaurantee programs:
✓ No cash outlays - they can increase credit availability with lower capital funding than direct loan programs, as capital is only expended when loan losses occur. As there are very few loan losses witl1 a guaranteed loan, each dollar of loan guarantee capital generates a large multiple in private loans.
✓ They can function on a wholesale level without negotiating transactions on an individual basis with borrowers. Thus, they can delegate the details of reviewing and structuring loans to lenders and limit their role to either a review of the proposed loan or post-loan audits to ensure compliance with the program and guarantee terms.
✓ They require interaction between borrowers and private lenders, which is helpful for establishing banking relationships and thus expanding future access to capital.
Disadvantages of loan gaurantee program:
✓ They are complex to implement since they are a three-party arrangement. Programs must balance incentives between the borrower, lender, and guarantor to be effective.
✓ They depend on lender acceptance and commitment to succeed. Thus, if lenders resist using a guarantee, then the program will not have a significant impact.
✓ The guarantor must have sufficient financial strength and credibility to be accepted by lenders.
✓ Guarantees create an incentive to use debt and thus, may lead firms to substitute debt for equity capital or to borrow more funds than they need
Industrial Bond Gaurantees
Industrial bond guarantees are similar to loan guarantees. The aim of the guarantee is to improve the financing terms for sound companies with projects that are too small to attract investors. In the case of bond guarantees, a third party - the state or local economic development authority- provides additional security by guaranteeing the marketability of the bonds.
Loan Pools
Loan pools are a pool of capital, pledged by consortia of banks or lending institutions, to make loans to businesses based on some agreed upon goals or other criteria. The pledge of capital can be in many forms including loans, informal and formal letters of commitment, and stock purchases. In contrast to loan guarantees that place all of the risk on a single third party, a loan pool spreads the risk among several participating lenders that contribute funds to the pool. The pooling helps to reduce the risk of an individual creditor. Pools can operate at the state, local, and regional levels, based on informal and binding legal agreements (see Bank CDCs, Chapter 7).
The public sector’s role generally is to arrange the loan pool agreement between the contributing private financial institutions. It may participate in a pool by guaranteeing some loans or by subsidizing interest rates for the potential borrower.
Loan pools have several advantages. The conventional lender does underwriting and servicing of the loans. The participant organization also reduces or diversifies its risk, allowing the economic development organization to utilize less capital than in the case of direct lending.
VII.Other Local Financing Tool
for test - don’t study
Economically Targeted Investments
Economically Targeted Investments direct funds to opportuntttes that earn competitive financial returns while producing economic development benefits. Pension funds for state and city governments are sometimes partially designated for ETis. For example, pension funds may be invested in loan programs for small businesses or to modernize facilities.
In recent years, pension fund ETis have expanded from housing and real estate projects to small and minority-sized businesses, community development financial institutions, revolving loan funds, and even infrastructure projects. However, ETis require economic development projects to generate market rates of return. Commonly, pension funds will underwrite small and minority-owned businesses by providing direct loans, purchasing the loans from private sector lenders, or investing directly in the businesses.
Technology Incubators & Research
Localities can also be involved in the process of funding, marketing, or participating in some other manner in the development or management of a technology incubator or research park. Strategies and best practices for this financing tool are discussed in detail in the IEDC training manual “Tech-Led Economic Development.”
Community Development Loan Funds
Community Development Loan Funds (CDLF) are locally organized and controlled nonprofit organizations that provide credit to businesses, affordable housing projects, and nonprofit organizations to advance local community development goals. They provide debt to fill gaps in credit markets and use loan repayments to cover operating costs. Their board and governance structure emphasizes accountability to target communities rather than elected government officials. CDLFs are not primarily grant funded; they raise most of their funding by borrowing from social investors who invest to achieve both social and financial objectives (see IEDC “Neighborhood Development Strategies” manual for further information).
Assessment Districts
In assessment district financing, a special charge is levied on property holders or businesses in a certain geographic location to fund infrastructure or services. Instead of raising cash through municipal-wide tax increases, assessment district financing generates revenue from a smaller area. Unlike TIF, the revenues are not dependent on increases in property values. Another advantageous quality of assessment district financing is its linkage of costs with beneficiaries; those benefiting from the improvements or services pay the expenses. Because of this, fees are often based on property value, square footage, or some other formula connected to the advantages created by the area’s funded activities. Common applications of an assessment district are financing infrastructure to open new areas for development or to improve existing development. For example, industrial area fums may agree to a special assessment to improve utilities or roads. The assessment may be set up as a separate authority or operated by the local municipality.
VIII.State Financing Programs
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Each state exercises the power to implement its own tax code and designate the uses of collected revenues. Furthermore, numerous state governments have developed financial programs, whether they are tax incentives, grants, or otherwise, meant to tackle the problems and opportunities present in the sphere of economic development.
Development Authorities
In a number of states, a separate state authority loan fund is established to assist firms with working capital needs and in purchasing fixed assets. Eligible fums vary. However, most state authority loans are targeted at small fums. How the fund is administered depends on the economic developer. Possibilities include direct loans, and equity investment. For example, the Connecticut Development Authority set its funds up in the following way:
✓ A job creation fund of $1 billion
✓ A set-aside of $50,000 to $4 million for buildings, equipment and working capital loans
✓ Investment finance up to $500,000
✓ A business assistance fund for buildings of up to $250,000
✓ An environmental assistance fund for pollution-prevention projects that reduce the use of hazardous materials in manufacturing.
Additionally, separate local authorities have been established within some states to provide direct loans and loan guarantees to local jurisdictions to attract new industry and assist in the expansion of existing operations. In many cases, these loans can be used for infrastructure, industrial buildings and parks, or can be re-lent to private co
mpanies with below market rates for equipment, land, and buildings.
Each state’s loan authority varies, but in general, available loans range from $50,000 to $500,000 depending on the purpose and the amount in the fund’s reserve. Eligibility will also vary, depending on the purposes and goals of the state funds.
Many states have established quasi-public agencies to provide capital to companies in need of funds for new ventures or products. These state venture capital corporations are similar to the Small Business Administration’s Small Business Investment Company (SBIC) program. In general, the corporation does not assume partial ownership of the company in return for their investment. Instead, the corporation shares with the company the cost of developing the new product and usually receives royalty payments from the company on sales of the sponsored product.
State Tax Credits
Most states offer tax credit programs to assist businesses within their boundaries. The variety and value of tax credits differs enormously from one state to another. For the most accurate and up-to-date information on tax policy affecting you, contact the Department of Revenue in your state. Categories of credits provided at the state level may include:
✓ Business facility
✓ Capital investment
✓ Community bank
✓ Enterprise zone
✓ Historic prese1vation
✓ Distressed Community
✓ Research
✓ Seed Capital
Also, many states offer tax abatements (e.g. Real Estate Developer Accelerator Tax Abatements), for a number of designated activities and recipients. The vast majority of state funds allocated to economic development activities are still in the form of incentive packages for corporations. An extensive discussion of the relative merits of various incentive packages is included 111 the IEDC Economic Development Marketing and Attraction Manual.
State Venture & Angel Fund Networks
A critical element to growing businesses within a state is the availability of equity capital. States use three approaches to expand venture capital supply. The first option is to directly invest in firms through state-controlled institutions. With the second approach, states invest in privately managed funds to expand local venture capital. Some of these funds are only able to invest within the state, but others operate outside the state as well. The third approach provides incentives through tax credits that increase private investment in venture capital funds committed to financing firms within the state.
Most states rely on privately managed funds to expand venture capital. Some state funding for venture capital investment comes from state appropriations, or from fiduciary funds. There is considerable variation in how states implement these approaches, however.
States provide seed funding for incubators at state-funded institutions of higher education. Recently, states have moved into the business of creating larger pools of capital for their developing and expanding businesses. States without a decisive block of successful entrepreneurs and/ or technology-based firms need a feasible plan to foster the creation and success of high-growth firms. By demonstrating that good deals exist within their borders, state funds can attract private venture capital funds to tl1eir economies. Many states, including Iowa and West Virginia, have designated state money for the creation of investment in venture funds that make economically targeted investments in their state or region. These funds provide start-up and mezzanine financing capital to growing local businesses as well as technical assistance to those businesses. States have also sponsored tl1e creation of angel investor networks, bringing together high net-worth individuals to invest seed capital in startup businesses.
State Export Financing
State Trade and Export Promotion
States use many different programs and incentives to encourage exports and foreign direct investment. For example, State Trade and Export Promotion (STEP) is a program funded by the federal Small Business Administration, and administered by state trade promotion agencies. STEP is a competitive program–in any given year, fewer than half the states win ilie right to participate. Winning states match SBA funding on a 3:1 basis, meaning they are responsible for 25 percent of program costs. Administering state trade promotion agencies offer STEP grants to exporters for the putposes of:
✓ Traveling abroad;
✓ Setting up exhibits at trade shows;
✓ Purchasing research and information;
✓ Translating info1mation or marketing materials;
✓ Designing promotional materials; and
✓ Buyng private and government-provided consulting services, such as the U.S. Commercial Service’s Gold Key export matching program.
States have discretion in how they administer STEP funds. For example, the Michigan Economic Development Corporation has chosen to awards grants of up to $25,000 to exporters, while Massachusetts limits grants to $10,000. Oregon has elected to offer grants to trade associations and cluster organizations that organize international business missions for SMEs. Many states also restrict the recipients in other ways, such as limits on fitm size and stipulations that the company must be profitable.
State Export Financing
State and Local Export Grants
Some states and localities have developed grants to assist exporters with export readiness and planning. For example, the Bluegrass Economic Advancement Movement BEAM, in Western Kentucky, awards grants of $4,500 to small companies wishing to increase their export activity. BEAM grants can be used to buy business development services, identify new markets, execute new international sales oppo1tunities, conduct cash-flow analysis, do B2B matchmaking, upgrade web design, attend educational courses, and purchase translation services.
✓ The Export Express Program, administered by the Rhode Island Economic Development Corporation and the state’s Workforce Board, offers grants of up to $5,000 to companies seeking export-specific training at qualified providers. For example, a medical devices manufacturer recently received a grant to fund its compliance with the European Medical Device Directives, a regulato1y requirement to sell in tl1e European Union.
✓ The Virginia Economic Development Partnership offers $30,000 grants to business participants in the Virginia Leaders in Export Trade 01 ALET) accelerator program. Twenty-five businesses per year are awarded VALET grants that can be used to purchase reduced-fee legal, freight fonvarding, and banking se1vices.
✓ As part of its Global NY Development Fund, New York State has invested $10 million to offer grants of up to $25,000 for expott readiness, including developing business plans, website upgrades, and achieving ce1tain ce1tifications.
✓ Export \Vashington provides vouchers to reduce the cost of ex potting. Vouchers are available to cover the costs of flights, trade show fees, interpreter fees, and international certifications.
✓ Building off its STEP program, South Carolina has developed an initiative called South Carolina Opportunities for Promoting Exports (SCOPE). SCOPE funds grants export readiness, planning, and research se1vices, including International Trade Administration fees, trade show exhibit costs, international partners search, and translations.
State Export Financing
Conventional Export Loans
Developing export capacity often requires large capital outlays. Several state and local EDOs have developed loan programs to supplement the long-te1m capital loans available from private and federal financiers. Many state loan programs are designed as revolving Loan Funds (RLFs), which are pools of loans that are disbursed to companies for gap financing loans. As companies repay their loans, the RLF is recapitalized, allowing the EDO to offer another round of loans.
For example, MassDevelopment, an EDO in Massachusetts, offers the “100% Export Loan,” which provides exporters up to $2,000,000, with no down payment, for equipment and working capital for expo1ters. Borrowers do not pay interest for the first year. Loans are amortized over seven years.
State Export Financing
Export Credit Insurance
As part of its Global NY Development Fund, New Yor.k State invested $25 million into a loan facility, leveraging $50 million in private sector loans from 20 lenders. These loans are targeted to companies that wish to build capacity for export markets but that have had difficulty accessing credit in private capital markets.
Given the risks of collecting payment on exported goods, some EDOs have developed loan guarantees and insurance. For instance, MassDevelopment offers export loan guarantees, with inventory and foreign accounts receivable accepted as collateral. The agency also provides insurance on foreign account receivables.
ED Os can also offer a number of incentives that reduce taxes or duties on exporters. Export incentives include:
✓ Foreign Trade Zones;
✓ Freeport exemptions;
✓ Income tax reductions; and
✓ Other incentives that often apply to goods and services exporters.
State Export Financing
Foreign Trade Zones
Foreign Trade Zones (FTZ), known internationally as free trade zones or export zones, are designated, secure areas in which foreign and domestic merchandise can be stored, packaged, assembled, manufactured, or shipped, deferring U.S. duties and excise taxes. FTZs are supervised by U.S. Customs and Border Protection (CBP), but are legally outside of the U.S. territory for customs purposes. Goods that are reexported from an FTZ do not pay duties. Manufacturers can also benefit, if they export to countries where components are subject to high tariffs but assembled goods are not, goods are assembled in the zones. According to CBP, approximately 3000 firms use FTZs, and $80 billion worth of goods are annually exported from U.S. FTZs.
Across the U.S., there are about 250 FTZs. EDOs that wish to designate an area as an FTZ must apply to the Foreign Trade Zones Board, a federal organization. Some argue that FTZs reduce tax incomes without increasing exporting or creating jobs. According to The Eco11omist, In order to be effective, FTZs need to be supported with adequate infrastructure, such as ports, to link the zone with the outside world.
State Export Financing
Freeports
Freeports are incentives, available in some states, which exempt finished goods in transit to a destination out of state from personal property and invento1y taxes. In some states, such as Georgia, local jurisdictions must apply for a Freeport exemption.
State Export Financing
Income Tax Reductions
Some territories have also reduced income tax rates for exporters. For example, the U.S. Territory of Pue1to Rico has capped the corporate tax rate to four percent for services exporters, and also exempts them from 60 percent of their municipal property taxes. The Territoty offers services exporters a 20-year guarantee of these rates.
State Export Financing
Other State Export Incentives
Many common incentives, while not available exclusively to exporters, are geared towards activities and firms that export outside of a region, often to foreign markets. Common export-oriented incentives include:
✓ Film production tax credits;
✓ Tourism tax incentives; and
✓ Manufacturing construction project incentives.
Economic development professionals should consider how incentives may be best designed to encourage firms investing in their communities to initiate or increase their exporting.
State Export Financing
Technology Commercialization
States often provide development finance that supports technology commercialization. This financing takes the form of venture funds and seed capital. More frequently, this financing takes the form of support from public institutions of higher learning. The research and development that occurs within the science and engineering departments at state universities can be converted into viable businesses for the region. States can also invest specifically in business incubators or research parks. The leading example of this is the Research Triangle in North Carolina. State funding was used to develop this area that is now a hub for high tech and biotechnology businesses. The Research Triangle is supported by a cluster of worldclass universities, which includes Duke, the University of North Carolina at Chapel Hill and North Carolina State University. An extensive discussion of incubators and research parks is included in the “Tech-Led Economic Development” manual.
According to SBA, small businesses are eligible for 7(a) loans if they meet the following criteria:
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✓ Operate for profit
✓ Be small, as defined by SBA
✓ Be engaged in, or propose to do business in, the United States or its possessions
✓ Have reasonable invested equity
✓ Use alternative financial resources, including personal assets, before seeking financial assistance
✓ Be able to demonstrate a need for the loan proceeds
✓ Use the funds for a sound business purpose
✓ Not be delinquent on any existing debt obligations to the U.S. government
SBA’s lending partners look at slightly different criteria, including:
✓ Opportunities in the applicant’s market
✓ The business’s reputation
✓ Strength of the business
✓ Financial statements
✓ Projections
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There are four distinct short-term working capital loan programs for small businesses under the CAPLines umbrella, including:
The Contract Loan Program finances the cost associated with contracts, subcontracts or purchase orders. Proceeds can be disbursed before the work begins. If used for one contract or subcontract when all the expenses are incurred before the buyer pays, it will generally not revolve. If used for more than one contract or subcontract, or for contracts and subcontracts where the buyer pays before all work is done, the line of credit can revolve. The loan maturity is usually based on the length of the contract, but no more than 10 years. Contract payments are generally sent directly to the lender, but alternative structures are available.
The Seasonal Line of Credit Program supports the buildup of inventory, accounts receivable or labor and materials above normal usage for seasonal inventory. The business must have been in business for a period of 12 montl1s and must be able to demonstrate that it has a definite established seasonal pattern. The loan may be used over again after a “clean up” period of 30 days to finance activity for a new season. These loans also may have a maturity of up to five years. The business may not have another seasonal line of credit outstanding, but may have other lines for non-seasonal working capital needs.
The Builders Line Program provides financing for small contractors or developers to construct or rehabilitate residential or commercial property that will be sold to a third party that is not known at the time construction/ rehabilitation begins. Loan maturity is generally three years, but can be extended up to five years, if necessary, to facilitate the sale of the property. Proceeds are used solely for direct expenses of acquisition, immediate construction and/ or significant rehabilitation of the residential or commercial structures. Land purchase can be included if it does not exceed 20 percent of the loan proceeds. Up to five percent of the proceeds can be used for community improvements that benefit the
overall property.
The Working Capital Line of Credit Program is a revolving line of
credit (up to $5,000,000) that provides short-term working capital.
Businesses that generally use these lines provide credit to their customers or have inventory as their major asset. Disbursements are generally based on the size of a borrower’s accounts receivable and/ or inventory.
Repayment comes from the collection of accounts receivable or sale of inventory. The specific structure is negotiated with the lender. There may be extra servicing and monitoring of the collateral for which the lender can charge additional fees to the borrower.
7(a) SBA Export Loan Programs
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The Export Working Capital Program
The Export Working Capital Program is another program under the 7(a) Loan Program, designed to provide financial assistance to export-ready companies. This program is designed to make securing working capital easier for businesses that may not typically be able to secure it to support their export sales. These loans provide up to a 90% guaranty to lenders on an export loan so that they will open up working capital for export businesses. The program is administered by SBA Senior International Credit Officers, who are located at U.S. Export Assistance Centers around the country.
Exporting businesses can apply for EWCP loans before finalizing an export sale or contract. This gives them more flexibility in negotiating export payment terms, since they can be sure that there will be adequate financing available.
Eligible recipients apply for the EWCP directly to lenders, who then review the application and submit the request to the SBA for final approval. Loans using Preferred Lender Program or SBA Express processing cannot be used for this program.
In addition to regular EWCP loans, eligible exporters can apply for the SBA and Export-Import Bank Co-Guarantee Program. This provides a guarantee for much larger loans that the SBA cannot support on its own. These guarantees typically have a maturity of 12 months, though an exporter can reapply after 12 months. Under tl1is guarantee, the total working capital line cannot exceed $5 million.
This loan provides short-term financing to exporters and is intended to be selfliquidating through the orderly collection of proceeds from export sales. Because this loan is repaid on completion of the cash conversion cycle of a particular transaction or series of transactions, the program encourages private sector lenders to provide capital for small business exporter deals. The EWCP uses a one-page application form witl1 turnaround usually within 10 working days.
Export Express Loan Program
Export express loans are special kind of financing, up to $500,000, that is provided within 36 hours. A business that has been open at least 12 month, not necessarily with export experience, is eligible for this type of loan. Applications should demonstrate that the loan will support the business’s export activity. The loan can take the form of either a term loan or revolving credit.
International Trade Loan Program
SBA’s International Trade Loan program provides long-term financing to help small businesses compete more effectively and significantly expand or develop expo1t markets. With a maximum loan of$5 million, International Trade Loans may be used to buy land and builclings, build new facilities, renovate, improve or expand existing facilities, and purchase or recondition machinery, equipment, and fL-xtures. For equipment, loan maturites tend not to exceed 10 years, while for real estate, maturities up to 25 years are available. The working capital po1tion of the loan, which has maturities up to 10 years, can be in the fo1m of the Export Working Capital Program loan or a portion of the term loan. The loan proceeds can also be used to refinance past loans used for the same purposes. Depending on the loan’s maturity and size, interest rates rnn between 2.25 and 2.75% higher than the prime rate. The SBA guarantees 90% of a loan, at a maximum of $4.5 million, but any working capital loans count against this maximum.
Applicants must meet the general 7(a) loan guarantee requirement and one of the two following criteria:
✓ Loan proceeds will significantly expand existing export markets or develop new ones, or
✓ The applicant’s business is adversely affected by import competition
Loan Program Collateral
Only collateral located in the United States, its territories and possessions is acceptable as collateral under this program. The lender must take a first lien position (or first mortgage) on items financed under an international trade loan. Additional collateral may be required, including personal guarantees, subordinate liens, or items that are not financed by the loan proceeds.
Community Advantage Loans
The main clifference between regula1· 7(a) loans and Community Advantage Loans is that in the Advantage Loan program, only approved lenders can get guarantees. Advantage loans are not revolving, and the amount of underwriting some lenders must conduct before providing the guarantee is different.
Community Advantage Loans are available for small businesses in underserved markets and help companies meet credit, management, and technical assistance needs. The Community Advantage program provides mission-based lenders access to 7(a) loan guaranties as high as 85% for loans up to $250,000.
MicroLoan Program
MicroLoans can be used for the purchase of machinery and equipment, furniture and fixtures, inventory, supplies, and working cap.ital. The maximum amount of the loan is $50,000. They cannot be used to pay off existing debts or to purchase real estate. Loan terms vary according to the size of the loan, the planned use of funds, the requirements of the .intermediary lender, and the needs of the small business borrower. Interest rates va1y, depending upon the .intermediary lender and costs to the intermediary from the U.S. Treasuty. In general, rates are between 8 and 13 percent.
The MicroLoan must be paid on the shortest term possible, no longer than six years, depending on the earnings of the business. All loan applicants must demonstrate the following eligibility requirements:
✓ Good character
✓ Enough management expertise and commitment for a successful operation
✓ Reasonable assurance that the loan will be repaid
Each nonprofit organization has its own requirements about collateral. However, the organization must take assets bought with the Micro Loan as collateral. In most cases, the personal guarantees of the business owners are also required.
Real Estaet & Equipment Loans
The 504 program prov.ides long-term, fixed-rate financing to small businesses for major fixed assets such as land, buildings, and equipment. Typically, a 504 project includes a loan secured with a senior lien from a private-sector lender that covers up to 50 percent of the project cost, a loan secured with the junior lien from the CDC (Certified Development Company) (backed by a 100 percent SBA-guaranteed debenture) covering up to 40 percent of the cost, and a conu·.ibut.ion of at least 10 percent equity from the small business.
The SBA loan is provided by the CDC, which raises its cap.ital by selling SBAguaranteed bonds in the private market. Although the bonds generally carry belowmarket interest rates, the SBA guarantee .increases their attractiveness to investors. The maximum SBA/CDC loan varies by the type of the borrower and the purpose of the loan.
Disaster Loans
SBA provides low-interest disaster loans to businesses of all sizes, private non-profit organizations, homeowners, and renters. SBA disaster loans can be used to repair or replace the following items damaged or destroyed in a declared disaster: real estate, personal property, machinery and equipment, and inventory and business assets.
There are four types of disaster loans:
- Home and Personal Property Loans are for individuals who have experienced home or personal property damage in declared disaster areas. Homeowners may apply for up to $200,000 to replace or repair their primary residence and $40,000 to replace or repair personal property.
- Business Physical Disaster Loans are for owners whose businesses were damaged in declared disaster areas. Businesses of any size, and most nonprofits, are eligible to apply after a disaster. This type ofloan may be up to $2 million, and must be used for repair or replacement of real property, machinery, equipment, fixtures, inventory or leasehold improvements.
- Economic Injury Disaster Loans are for business owners who suffered substantial economic injuty in declared disaster areas. Eligible business types are small businesses, small agricultural cooperatives, and most private nonprofit organizations. Substantial economic injury means the business is unable to meet its obligations to pay its ordinary and necessary operating expenses. EIDLs provide the working capital to help small businesses survive until normal operations can resume. The loan has cap of $2 million and is based on actual economic injury and financial needs.
- Military Reservists Economic Injury Loans help small businesses meet ordinary and necessary operating expenses that they are unable to because an essential employee has been called to active duty as a military reservist. The maximum loan amount is $2 million.
SBIC Investments
The SBA licenses Small Business Investment Companies (SBIC) and supplements their capital with U.S. government-guaranteed debt. SBICs are private venture capital firms that make equity investments and long-term loans to small businesses.
Small Business Surety Bonds
The Surety Bond Guarantee (SBG) Program helps small and emerging contractors obtain bonding that would otherwise be unavailable to them. Under this program, SBA guarantees bid, payment, and performance bonds that are issued by privatesector surety companies, so that small contractors can compete for contract awards up to $6.5 million. The surety guarantee provides that the SBA will assume a predetermined percentage loss in the event of the contractor breaching the terms of the contract.
Construction contractors and homebuilders who meet SBA’s size and policy standards are eligible for surety bond guarantees if their average annual receipts, including those of their affiliates, for the last three fiscal years do not exceed $6.5 million.
Small Business Innovation Research Program
The Small Business Innovation Research (SBIR) program funds high-risk research and development (R&D) efforts with excellent commercial potential. The purpose of the program is to 1) stimulate technological innovation, 2) bring small businesses into the federal R&D process, 3) encourage participation by disadvantaged and minority persons in technological innovation, and 4) increase private sector commercialization of federal R&D.
The federal SBIR program provides funding to stimulate technological innovation in small businesses to meet federal agency research and development needs. Twelve participating agencies set aside 2.5% of their extramural research and development budgets for competitions among small businesses only. Small businesses that win awards in these programs keep the rights to any technology developed and are encouraged to commercialize the technology. Eligible businesses must meet the following criteria:
✓ Be at least 51 % American-owned and independently operated;
✓ Be located in the U.S.;
✓ Be for-profit and employ no more than 500 employees; and
✓ Have the principal researcher’s primaty employment be with the small business during the project.
Because of SBIR, every federal agency with an R&D budget of over $100 million must establish an SBIR program. The agencies currently participating in the program include:
✓ Department of Agriculture
✓ Department of Commerce (including the National Institute of Standards and Technology and the National Atmospheric and Oceanic Administration)
✓ Department of Defense
✓ Department of Education
✓ Department of Energy
✓ Department of Health and Human Services (National Institute of Health)
✓ Department of Homeland Security
✓ Department of Transportation
✓ Environmental Protection Agency
✓ National Aeronautics and Space Administration
✓ National Science Foundation
Through tl1e SBIR program, each agency develops R&D topics related to their work and solicits proposals for research on those topics. Proposals are submitted to the individual agencies where they are reviewed and evaluated on a competitive basis. Each of the agencies makes awards using contracts, grants, or cooperative agreements.
EDA loan programs
The Economic Development Administration (EDA) was established in 1965 to generate new jobs, help protect existing jobs and stimulate commercial and industrial growth in economically distressed areas of the United States. EDA is housed in the Department of Commerce under the Public \Vorks and Economic Development Act. Assistance is available for rural and urban areas in the nation experiencing high unemployment, lowincome levels, or sudden and severe economic distress.
V.EDA Programs
Public Works Programs
Public Works helps distressed communities expand, revitalize and upgrade their physical infrastructure. Public '{forks helps communities attract new businesses, generate and retain jobs, attract investment, facilitate business expansion, and encourage economic diversification. It does this through acquisition and development of land, improvement of infrastructure, and expansion of industrial or commercial enterprises.
Possible projects for development of public infrastructure may include technologybased facilities that utilize distance learning networks, smart rooms, and smart buildings; multitenant manufacturing and other facilities; business and industrial parks with fiber optic cable; and telecommunications and development facilities. In addition, EDA invests in traditional public works projects, including water and sewer systems improvements, industrial parks, business incubator facilities, expansion of port and harbor facilities, skills training facilities, and brownfields redevelopment.”
Economic Adjustment Assistance Program
Economic change may occur suddenly or over time, and generally results from industrial or corporate restructuring, natural disaster, reduction in defense expenditures, depletion of natural resources, or new federal laws or requirements. The Economic Adjustment Assistance Program assists state and local entities design and implement strategies to adjust or bring about change to an economy. The program focuses on areas that threaten serious structural damage to the underlying economic base. The Economic Adjustment Program receives annual appropriations for its Regular Economic Adjustment Programs and Defense Adjustment activities. In addition, the Program receives special appropriations to assist communities with economic recovery from specific industry changes and/ or natural disasters.
The Economic Adjustment Assistance Program funds are used primarily to support projects that: build on or create new industry clusters to enhance the competitiveness of that region, support technology-led development, or advance community and faith-based social entrepreneurship in redevelopment strategies for regions of chronic economic distress. These grants are meant to enhance private investment in distressed communities to make them more competitive economically. Strategy grants help organize and carry out planning processes, resulting in a Comprehensive Economic Development Strategy (CEDS), tailored to the community’s specific economic problems and opportunities. Implementation grants support one or more activities identified in an EDA-approved CEDS. Activities may include, but are not limited to, the creation/ expansion of strategically targeted business development and financing programs such as construction or infrastructure improvements, organizational development, and market or industLy research and analysis.
The guidelines for developing a CEDS include effective general planning practices that can be used by any community to design and implement a plan to guide its economic growth. Revolving Loan Fund (RLF) grants may also be used to implement a CEDS. These grants capitalize a locally administered fund and are used for making loans to local businesses, which in turn create jobs and leverage other private investment while helping a community to diversify and stabilize its economy.
Planning Assistance Programs
The Economic Development Planning Assistance program provides financial support to district organizations, Native American organizations, states, sub-state planning regions, urban counties, cities and other to assist in planning. There are two types of assistance programs:
✓ “Planning investments for District Organizations, Indian Tribes and other eligible applicants”
✓ “Short term planning investments to states, sub-state planning region and urban areas”
The program assists in developing, maintaining, and implementing Comprehensive Economic Development Strategy (CEDS) and other related short-term planning projects.
Trade Adjustment Assistance
The program was established in 197 4 and provides assistance to import impacted and economically distressed U.S. firms in strengthening their competitiveness globally through developing and implementing business recovery strategies. Particularly the program provides cost-sharing technical assistance in Finance and General :Management, Marketing, and Manufacturing and Engineering. TAAF provides up to 75% in matching funds for the associated costs. The assistance is provided through 11 non-profit or university-affiliated Trade Adjustment Assistance Centers.
VI. US Department pf Housin & Urban Development (HUD)
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The Department of Housing and Urban Development (HUD), established in 1965 by the Housing and Urban Development Act, administers programs that provide assistance for housing and for the development of the nation’s communities. HUD also coordinates other federal efforts that impact community preservation and development.
Although HUD administers many programs, its major functions can be grouped into six categories:
- Insuring mortgages for single-family and multi-family dwellings, loans for home improvement, and the purchase of mobile homes.
- Channeling funds from investors into the mortgage industry through the Government National Mortgage Association.
- Making direct loans for the construction or rehabilfration of housing projects for the elderly and people with disabilities.
- Providing federal housing subsidies for low and moderate-income families.
- Providing grants to states and communities for community development activities.
- Promoting and enforcing fair housing and equal housing opportunity.
VII. HUD Programs
CDBG
The Department of Housing and Urban Development’s Community Development Block Grant program (CDBG) provides funds to states and localities for local economic development efforts. HUD determines the amount of each grant by a formula, which uses several objective measures to gauge the community and its needs, including the extent of poverty and housing overcrowding, total population, population change, and the age of the local housing stock. Local officials, in concert with citizen participants, determine how the money is spent.
To receive CDBG funding a project must meet one of the following three criteria:
✓ Benefit low and moderate-income persons
✓ Aid in the elimination or prevention of slums and blight
✓ Meet a serious and immediate community health or welfare need.
CDBG funds may be used for a variety of projects that aim to revitalize neighborhoods, provide improved community facilities and services, and generally promote economic development. Some examples include:
✓ Acquisition of real property
✓ Relocation and demolition of certain facilities
✓ Rehabilitation of residential and non-residential structures
✓ Construction and/ or improvement of water and sewer facilities, streets, neighborhood centers, and the conversion of school buildings for eigible l
purposes
✓ Assist nonprofits in the provision of certain public services
✓ Activities relating to energy conservation and renewable energy resources
✓ Activities relating to energy conservation and renewable energy resources; and provision of assistance to profit-motivated businesses to carry out economic development and job creation/ retention activities
✓ Efforts on the part of profit-motivated businesses to carry out economic development and job creation/ retention programs
✓ Recovery efforts from presidentially declared disasters, especially in low income areas.
Eligibility
All states are eligible, as are cities with 50,000 or more residents, municipalities defined as “principal cities” of Metropolitan Statistical Areas, and urban counties (excluding qualified cities) with at least 200,000 residents. Depending on supplemental appropriations, HUD may make disaster relief funds available to affected cities, counties and states.
State CDBG programs
States that participate in the program award CDBG grants only to general local government that carry out community development activities. Each state develops funding priorities and criteria for selecting projects. HUD ensures that states comply with federal laws and regulations. Participating states have three major responsibilities:
✓ Formulating community development objectives
✓ Deciding how to distribute funds among communities in non-entitlement areas
✓ Ensuring that recipient communities comply with applicable state and
federal laws and requirements.
Local governments consider local needs, prepare gant applications for submission to the state, and carry out the funded community development activities. At least 70% of the funds administered must benefit low and moderate-income persons.
Section 108 Loan Gaurantee
The Section 108 is the loan guarantee provision of the CDBG. It allows transformation of a small portion of CDBG funds into federally guaranteed loans large enough (typically $500,000 to $140 million) to pursue substantial physical and economic revitalization projects. In addition to the activities allowed under the Entitlement and State CDBG Programs, the Section 108 Program allows for limited new housing construction, rehabilitation of publicly owned facilities, and debt servicing of the guaranteed loan and related public offerings. Again, all projects and activities must either principally benefit low and moderate-income persons, aid in the elimination or prevention of slums and blight, and/ or meet urgent needs of the community.
Empowerment Zones Renewal & Enterprise Communities
The EZ/RC program designates certain economically distressed urban and rural areas across the country for a series of federal tax breaks, grants, loans, and technical assistance. The financial support is designed to help local residents and businesses in these areas implement particular cooperative revitalization programs. The program focuses particularly on promoting economic opportunity, botl1 by streamlining government regulations and providing tax incentives for companies to locate there and hire local residents.
Other HUD Econ Development Programs
- Appalachia Economic Development Initiative is coordinated by three federal agencies, including the Department of Housing and Urban Development (HUD), the Department of the Treasury - Community Development Financial Institutions Fund (CDFI Fund), and the Department of Agriculture - Rural Development (USDA-RD). The program aims to increase capital access for business lending and development in the Appalachian region. The program provides direct investment and technical assistance to lending and investing institutions that focus on community development in the region. Eligible participants are state community or economic development agencies that apply on behalf of local, rural nonprofit organizations in the region. The maximum amount of $1 million is available for up to 36 months.
- Border Community Capital Initiative is administered by the same three agencies listed above and aimed at increasing capital access for affordable housing, business lending and community facilities in the underserved
U. S/Mexico border region. The program provides direct investment and technical assistance to community development lending and investment institutions that work on affordable housing and with small businesses and community facilities for residents of colonias. Community development lenders and investors in local areas may apply for two categories of funds -either up to $200,000 or up to $1 million, available for up to 36 months. - Delta Community Capital Initiative is another program of the three agencies listed above and has similar goals and eligibility as above, serving the Lower Mississippi Delta Region. The maximum available funding is $1 million, with a grant amount up to $200,000, available for up to 36 months.
- Rural Housing and Economic Development supports state and local capacity-building for housing and economic development projects in rural areas. Rural areas are defined as communities with fewer than 2,500 residents, a county or parish with a population of less than 20,000, or any place with population not in excess of 20,000 inhabitants and not located in a metropolitan statistical area. Eligible applicants are local nonprofits, community development corporations, federally recognized Indian tribes, state housing finance agencies, and state community and econ_omic development agencies. The program is administered by HUD and supports activities such as preparation of plans, architectural drawings, acquisition of land and buildings, demolition, provision of infrastructure, purchase of materials and construction costs, use of local labor markets, job training and counseling for beneficiaries of financial services.
- Rural Innovation Fund helps distressed rural communities improve their quality of life through assistance for activities such as business development and expansion, job training and education, and expansion of affordable housing”. There are three types of grants: Comprehensive (up to $2 million); single-purpose ($300,000) and Indian Economic Development and Entrepreneurship ($800,000).
- The Brownfields Economic Development Initiative (BEDI) is a HUDadministered grant program that assists cities to redevelop abandoned, idled, or underused industrial and commercial facilities. The grant must be used together with a Section 108 loan guarantee. BEDI can be used for: land write-downs, site remediation costs, fonding reserves, over-collateralizing the Section 108 loan, direct enhancement of the security of the Section 108 loan, or provision of financing to for-profit businesses at a below-market interest rate.”
UDA Programs
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VIII.The United States Department of Agriculture
(USDA)
The USDA has a number of financing mechanisms available to help rural businesses. These programs are designed to provide financial resources that encourage growth and sustainability in rural communities. The USDA has a number ofloan and grant programs available for small business and entrepreneurial development. The USDA programs are a valuable source to consider when promoting small business development in rnral communities and on tribal lands. All USDA loans must be applied for at the Rural Development Office for your state.
USDA Rural Development Programs
Business & Industry Loan Guaranttes
The Business and Indusuy (B&I) Loan Guarantee Program of the USDA helps create jobs and stimulates rnral economies by providing financial backing for rural businesses. This program guarantees up to 80 percent of loans under $5 million, 70 percent of loans between $5 and $10 million, and 60 percent ofloans over $10 million up to $25 million. Loan proceeds may be used for working capital, machinery and equipment, buildings and real estate, and certain types of debt refinancing. The primaty purpose is to create and maintain employment and improve the economic climate in rural communities. This is achieved by expanding the lending capability of private lenders in rural areas by helping them make and service quality loans that provide lasting community benefits. This program represents a true private-public partnership.
B&I loan guarantees can be extended to loans made by recognized commercial lenders or other authorized lenders in rural areas (this includes all areas other than cities or unincorporated areas of more than 50,000 people and their immediately adjacent urban or urbanizing areas). Generally, recognized lenders include federal or state chartered banks, credit unions, insurance companies, savings and loan associations, Farm Credit Banks or other Farm Credit System institutions with direct lending authority, a mortgage company that is part of a bank holding company, and the National Rural Utilities Finance Corporation. Other loan sources include eligible Rural Utilities Service electric and telecommunications borrowers and other lenders approved by RBS who have met the designated criteria.
Intermediary Relending Program
The purpose of the Intermediary Relending Program (IRP) is to finance business facilities and community development projects in rural areas. The IRP is a revolving, 1 % interest loan program where Rural Business Programs lend money to nonprofit organizations or public entities with at least 51 percent rural membership. The borrower then relends the funds to eligible businesses at a reduced rate. Loans made by the Rural Business-Cooperative Service (RBS) of the USDA to intermediaries relend funds to ultimate recipients for business facilities or community development. Intermediary Relending Program Loans finance business facilities and community development projects in rural areas, including cities of less than 50,000. Intermediaries also establish revolving loan funds so collections from loans made to ultimate recipients in excess of necessary operating expenses and debt payments will be used to make new loans.
Rural Business Development Grants
The Rural Business-Cooperative Se1vice (RBS) of the USDA makes grants under the Rural Business Development Grants (RBDG) Program to public bodies, private nonprofit corporations, and federally recognized Indian tribal groups. The grants are intended to facilitate the development of small businesses in areas outside the boundary of a city - or unincorporated areas of 50,000 or more - immediately adjacent to urbanized or urbanizing areas.
Funds are used for the financing or development of a small and emerging business. These businesses are defined as employing fewer than 50 employees and earning less than $1million in gross revenue. Eligible uses are: technical assistance (providing assistance for marketing studies, feasibility studies, business plans, training etc.); purchasing machinery and equipment to lease; creating a revolving loan fund (providing partial funding as a loan for the purchase of equipment, working capital, or real estate); or constructing a building for a business incubator.
Rural Development Loans (Utilities)
Rural Economic Development Loans (REDL) provide zero-interest loans up to $1 million, to electric and telephone utilities financed by the Rural Utilities Service (RUS), an agency of the USDA, to promote sustainable rural economic development and job creation projects. Zero-interest loans can be made, at the discretion of the Administrator of the Rural Business-Cooperative Service (RBS), to any RUS electric or telephone utility that is not delinquent on any federal debt or undergoing bankruptcy proceedings. The RUS utility is required to re-lend, at zero-percent interest, the loan proceeds to an eligible third-party recipient for the purpose of financing job creation projects and sustainable economic development in rural areas. (This includes all areas other than cities, or unincorporated areas of more than 50,000 people and their immediately adjacent urban or urbanizing areas). The RUS utility receiving the zero-interest loan is responsible for repaying the loan to RBS in the event of delinquency or default by the third-party recipient. Third-party recipients may be private or public organizations that have corporate and legal authority to incur debt.
Zero-interest loans are provided to third-party recipients to finance projects that promote economic development and job creation in rural areas. Examples include but are not limited to:
- Business expansions and business start-ups, including the cost of buildings, equipment, machinery, land, site development, and working capital.
- Community infrastructure and facilities for economic development and job creation purposes.
- Medical facilities and equipment to provide medical care to rural residents.
- Educational facilities and equipment to provide training and job enhancement skills to rural residents to facilitate economic development.
- Business incubator projects to assist in developing emerging enterprises.
Rural Entrepreneur Program
The program provides grants to Microenterprise Development Organizations (i’vlDOs) to offer loans for microenterprise startup and expansion through Rural Microloan Revolving Funds. The grant can also be used to provide training and technical assistance to microenterprise borrowers and entrepreneurs. Non-profits, federally-recognized tribes, and institutions of higher learning are eligible to be MDOs, and businesses with fewer than 10 employees in rural areas are eligible for loans.
Value-Added Producer Grants
V APG was first authorized in 2001. Grants are awarded to applications for planning activities and for working capital for marketing value-added agricultural products and for farm-based renewable energy. Eligible applicants are independent producers, farmer and rancher cooperatives, agricultural producer groups, and majority-controlled producerbased business ventures.
Rural Economic Area Partnership Zones
The Rural Economic Area Partnership (REAP) Zones were established to address critical constraints in economic activity and growth, low density settlement patterns, stagnant or declining employment, and isolation that has led to disconnection from markets, suppliers, and centers of information and finance. There are currently 5 designated REAP Zones located in North Dakota, New York and Vermont.
Assistance is available for the following objectives:
✓ Improving economic viability, diversity, and competitiveness of tl1e local economy and enhancing its participation in state, national and global markets
✓ Assisting local communities to develop cooperative strategies that will maintain and expand essential community functions, basic infrastructure, education, health care, housing, and telecommunications
✓ Assisting families with crises resulting from displaced employees and joblessness
✓ Providing financial and technical assistance to implement a citizen-built strategic plan.
Rural Energy for America Guaranteed Loan Program
This program encourages tl1e commercial financing of renewable energy sources, including wind, solar, biofuel, geothermal, hydrogen, and hydro power. This loan guarantee program is similar to the B&I Guaranteed Loans program, and applicants may need to spend time determining which program is best for their particular needs. Eligible borrowers must be rural small businesses or agricultural producers. Funds can be used for land acquisition, construction or expansion of existing renewable energy facilities, business plans, professional service fees, feasibility studies and technical reports, working capital and/ or retrofitting.
Export Credit Guarantee Program
The Export Credit Guarantee Program offers credit guarantees to support commercial exports of U.S. agricultural products. This program is meant to encourage financing of these exports by reducing the risks to lenders. Producers of high-value processed goods, intermediate products, and bulk products are eligible to use this program. The Foreign Agricultural Service operates the program in conjunction with the Commodity Credit Corporation (CCC), which acts as the credit guarantor. To ensure the success of their credit guarantees, CCC evaluates each potential country’s ability to service debts. Participating foreign financial institutions must also be approved by CCC.
Facility Guarantee Program
Aiming to encourage U.S. agricultural sales in areas lacking sufficient infrastructure, equipment, and distribution capabilities, the Facility Guarantee Program provides credit guarantees to finance such initiatives. Like the Export Guarantee Program, credit is guaranteed by the CCC. To qualify, agricultural exporters must work to improve capabilities such as marketing, processing, storage, handling, and distribution. Priority is g1ven to exports focused on privatizing agriculture in emerging markets. The financial strength of participating countries must also be evaluated, ensuring their ability to make scheduled payments.
Export Sales Reporting Program
The Export Sales Reporting Program obligates U.S. agricultural exporters to report specified commodity sales, such as wheat, corn, rice, beef, and more. This program monitors these export reports, generally on a daily and weekly basis. The Foreign Agricultural Service releases a summary of sales every Thursday. Daily reports are published when exporters make large sales, over 100,000 or 20,000 metric tons depending on the product.
Market Access Program
Essentially creating cost-sharing partnerships, the Foreign Agricultural Service works with agricultural trade associations and regional trade groups to develop export markets through the Market Access Program. Approved U.S. agricultural exporters can receive assistance with marketing, research, and technical support. A minimum 10 percent funding match is required from participants for general marketing services, and a full match is required for branding services.
Made in Rural America
Made in Rural America is an initiative that brings the full resources of the federal government together to help rural businesses grow through exports. It began in 2014; going forward, there are plans to work with federal, state, and local lending institutions to increase access to capital for rnral businesses, to bolster federal staff dedicated to this issue, and to lead reverse trade missions in rural areas.
Export- Import Bank of the US
X. Export-Import Bank of the United States
The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency of the United States. Ex-Im Bank’s mission is to help generate domestic job growth by helping to finance the export of U.S. goods and services to international markets. The bank does not finance exports that are likely to yield a net adverse economic impact on U.S. production and employment or would result in the production of the same product that is the subject of specified trade measures.
Ex-Im Bank does not compete with private sector lenders, but rather provides export financing products that fill gaps in trade financing. It assumes credit and counuy risks that the private sector is unable or unwilling to accept. It also helps level the playing field for U.S. exporters by matching the financing that other governments provide to their exporters. No transaction is too large or too small. In particular, Ex-Im Bank provides working capital guarantees (pre-export financing); export credit insurance; and loan guarantees and direct loans (buyer financing).
Working Capital Financing
The bank’s working capital financing helps exporters obtain loan capital to facilitate the export of goods and services. The Ex-Im Bank guarantees 90% of the principal and interest of bank-originated commercial loans, up to 100% of the value of the U.S. export. Loan maturities may extend to 36 months, and the debts are secured by export-related accounts receivable and inventory (including work-in-process) tied to an export order. In addition to the interest charged by the commercial lender, the borrower must pay an up-front fee of 1.5% of the total loan amount to the Ex-Im Bank. Loans may be either transaction-specific or revolving.
Exporters may use the Ex-Im Bank’s guaranteed financing to:
✓ Purchase finished products for export
✓ Pay for raw materials, equipment, supplies, labor, and overhead to produce goods and/ or provide services for export
✓ Cover standby letters of credit serving as bid bonds, performance bonds, or payment guarantees
✓ Finance foreign receivables
Ex-Im Bank’s insurance covers the risk of buyer nonpayment for commercial risks (e.g., bankruptcy) and certain political risks (e.g., war or the inconvertibility of currency). This product can replace cash-in-advance, letters of credit, and other documentary sales. The insurance also allows exporters to provide qualifying international buyers with advantageous credit terms. Ex-Im Bank’s insurance enhances the quality of exporters’ balance sheet by transforming export-related accounts receivable into receivables insured by the U.S. government.
Export Credit Insurance
The Bank offers both short and medium-term insurance to limit risk, provide credit to international buyers, and to open up access to working capital funds.
Short-Term Insurance
The insurance covers a wide range of goods, raw materials, spare parts, components, and most services on terms up to 180 days. The Bank also covers capital goods, consumer durables (e.g., refrigerators) and bulk agricultural commodities. In exceptional cases, these exports may be covered on terms up to 360 days.
Medium-Term Insurance
The bank’s medium-term insurance protects longer-term financing to international buyers of capital equipment or se1vices, covering one or a series of shipments. It covers up to 85% of the net U.S. contract value. (If the foreign content is more than 15%, the Bank will support only the U.S. portion.)
Ex-Im Bank has an Environmental Exp01ts Program that provides enhanced support for a broad range of environmentally beneficial exports, including exports related to renewable energy sources. These enhancements apply to both short-term and mediumterm policies.
Ex-Im Bank assists exporters by guaranteeing term financing to creditworthy international buyers, both private and public sector, for purchases of U.S. goods and services. With Ex-Im Bank’s loan guarantee, international buyers are able to obtain competitive term financing from lenders when financing is otherwise not available, or there are no economically viable interest rates on terms over 1-2 years.
Ex-Im Bank supports competitive medium-term financing structured as finance leases in addition to financing structured as insta!Jment loans. The Bank guarantees lease financing of U.S. goods and services to creditworthy international lessees, both private and public sector, when financing is otherwise not available or applicable interest rates are not economica!Jy viable. In general, the bank guarantees leases of U.S. capital equipment and related services. Financing may also be available for refurbished equipment, software, certain banking and legal fees, and certain local costs and expenses. Goods eligible for Ex-Im Bank financing must meet the bank’s foreign content requirements.
Only finance leases (as defined under International Accounting Standards) are eligible for Ex-Im Bank guarantee support. Under IAS 17, a lease is classified as a finance lease if it transfers all the risks and benefits of ownership to the lessee. FuU payout leases (i.e., those with no residual value) and transactions that are essentia!Jy “conditional sales” contracts often qualify as finance leases.
The Ex-Im Bank can offer insurance to most markets. The Country Limitation Schedule on the www.exim.gov website explains which countries are not eligible. Militaty or defense items are generally not able to be covered under this program.
Financial Institution Buyer Credit Insurance Policy
Through this program, also referred to as the Bank Buyer Credit Policy, a loan is extended to a foreign entity by a financial institution for the importation of U.S. manufactured or produced goods. The guarantee suppo1ts either medium-tetm financing ( one to five years for repayment after delive1y or equipment installation) or long-term financing (up to 10 years for repayment) for capital projects. The difference between these two terms is explained below.
Medium-term guarantees cover the sale of capital items such as trucks and construction equipment, scientific apparatus, food processing machine1y, medical equipment or project-related services - including architectural, industrial design, and engineering services.
Long-term guarantees are available for major projects, large capital goods, and project related services.
Guarantees and medium-term insurance cover 85 percent of the contract price (100 percent of the financed portion). Foreign buyers are required to make a 15 percent cash payment. This program is for amounts of $10 million or less.
Ex-IM bank Financing for Small Businesses
Since 2011, an initiative called “Global Access for Small Business” has been a top priority of the Ex-Im Bank, and is a part of the NEI. Through this initiative, the ExIm Bank is reaching out to women-, minority-, and veteran-owned business. It also has designed financing to specifically assist businesses in the following sectors: renewable energy, environmental, medical technologies, and businesses targeting subSaharan Africa.
Global Credit Express Working Capital Loan
This program provides direct financing to eligible small businesses to assist cash flow and increase international sales through the Ex-Im Bank. This financing can be used to develop exports. Activities that can be funded through this program include:
✓ Attending trade shows;
✓ Securing international patents and trademarks;
✓ Meeting and vetting business partners, agents and distributors; and
✓ Translation of website/product literature and other marketing costs.
Qualified businesses may be eligible for a 6- or 12-month revolving line of credit of up to $500,000. The Ex-Im Bank works with existing banks, known as originators, to find businesses eligible for the Global Credit Express Working Capital Loan program. One criterion for obtaining this loan is having an existing relationship or being solicited by one of these originators.
Other qualifications include meeting the Small Business Administration’s definition of a “small business,” having a minimum of three years of revenue-producing operations and one year of exporting experience, and exporting goods which are made in the U.S. and/or exporting a service produced by U.S.-based personnel.
Ex-Im Bank’s Working Capital
When small businesses ask U.S. banks for working capital to expand their production for exports, domestic banks often balk at issuing credit based on the collateral of future exports. The Ex-Im Bank’s Working Capital Guarantee backs up a U.S. bank’s loan to a business, with the promise that Ex-Im Bank will pay up to 90 percent of the loan if the exporter defaults. These loans are to actually make the products that the exporter will sell, not to develop exporting capability. Costs included under these loans include:
✓ Inventory, materials, labor and other production costs;
✓ Foreign accounts receivable insurance;
✓ Insurance and freight costs;
✓ Bank fees related to the transactions; and
✓ Standby letters of credit to guarantee bid, performance, or advance payment.
For qualified minority, women-owned, or rural businesses, the Ex-Im Bank will back 100 percent. These loans are appropriate for projects over $500,000 or those exporters who do not qualify as small businesses, and are therefore able to take advantage of the Global Credit Express Working Capital Loan program discussed above.
This program offers generous advance rates so exporters can increase their borrowing capacity. Exporters are allowed to use 75 percent advance rate on their inventory, including work in progress. They can also count as collateral up to 90 percent of foreign accounts receivable.
These lines of credit allow small businesses to cover costs like payroll, overhead, and inputs while they wait to get paid by overseas customers. U.S. companies using the Ex-Im Bank’s program must have been in business for at least one year and have a positive net worth. Furthermore, products must be shipped from the U.S. and have at least 50 percent U.S. content. If used for service exports, those services must have been performed by U.S.-based personnel.
What is the difference between dilutive and non-dilutive investment
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A non-dilutive investment does not require the business owner to give up any level of ownership of the business. Debt financing is almost always non-dilutive.
An equity investment is a dilutive investment because it requires the entrepreneur to give up a portion of ownership.
