Industrial Development Bond vs. Small Business Administration 504 Financing
SBA 504 is better for younger companies, that are not as strong financially, who have less equity (10% for SBA vs. 20-25% for IDBs) and have smaller projects (under $3 million). The application process maybe slightly faster and qualification generally easier for SBA, though IDB projects can receive financing in three months.
IDB’s much lower interest rate (IDB's APR has been 4.6 pts lower than the 504 rate), longer repayment period 30 vs 20, no pre-payment penalties, no ownership structure conditions and much less stringent collateral requirements enable financially stronger, manufacturing companies to grow much faster and often purchase larger facilities (that they will not outgrow as quickly). Equipment can be included in an IDB or a fixed rate, useful life bond can be issued.
If it is at all possible for a business to qualify and come up with the additional 15% equity for an IDB, the IDB will be by far the best financing option, especially over the long term.
How does an Industrial Development Bond (IDB) work?
These bonds are only available for manufacturing businesses to purchase lands, buildings (or construct new ones) and new equipment.
State and Federal Tax Exempt bonds are sold on behalf of a business to bond purchasers (typically money market funds) by an Industrial Development Authority (in our case, the County of Alameda) who sells shares of these double tax exempt, very safe and liquid bonds, to money market and investment funds.
Security is provided to the bond purchasers by a bank with a credit rating of “A” or better (rated by Moody's or Standard and Poor’s). This Letter of Credit (LOC) bank guarantees repayment of the bonds and the bank actually makes the principal and interest payments to the bond purchasers. As a result, business disclosure is limited to a short description, and the bonds are very safe, short-term investments. The bank protects itself with a loan agreement with the business/borrower for collateral and repayment, for an annual fee of about 1.5 %.
When the bonds are sold, the funds are placed in a Trustee Bank, who will disburse the funds to the business/borrower upon receipt of a requisition signed by the LOC bank. The Trustee Bank invests the funds to equal the cost of interest plus the bank’s Letter of Credit fee, so there is no “cost of carry” until purchases/expenditures are made and businesses have over 3 years to draw down the proceeds.
Because the bonds are State and Federal Tax exempt, the federal government limits how much can be can be approved in each state, each year (about $1.9 billion in California) and how the funds can be used. California has a process for approving projects and apportioning its allocation, and that approval process takes about 2 months to complete. Total time from application to dollars in hand is usually about 3 months.
Our IDB team prepares the application, up-front application fees totaling $3,100 and the business will have a fixed quote, time-table and structure for the project. A deposit is also required by the State that is collected upon completion of the application, and becomes only after the bond is approved by the State and is not sold.
How does an SBA 504 Loan work?
This loan is only available for businesses falling under the SBA's definition of a small business (in this case net worth under $7 million, and net revenue for the past two years of less than $2.5 million).
An SBA 504 loan is a loan in which a private lender (a bank usually) recommends a loan candidate for government money through the SBA (Small Business Administration). Generally speaking, the private lender will recommend candidates who fulfill the application requirements and who are looking to purchase fixed assets. These assets may include purchasing land and making improvements, buying long-term equipment and machinery, making street improvements and building parking lots, and renovating or converting existing facilities.
While 50% of the 504 loan is funded by the private lender, 40% comes from a CDC (Certified Development Company) and 10% is produced by the borrower. In addition to this, personal guarantees are required from the principal borrowers, along with financial records for both the company and the borrowers. A further condition for an SBA 504 loan is that it must create or retain a job for every $50,000 of money borrowed.
Collateral is generally the equipment and project assets purchased are used as collateral.
An SBA 504 loan has fees attached to it usually amounting to 3% of the loan, which can be paid off using the loan itself.
The interest rate is tied to an increment above the rate of current 5 and 10 year treasury bonds.
In some cases it may be possible to receive more than $1,500,000, by tailoring your business plan to meet a public policy goal in your community. These goals may include:
In addition, this benefit is also made available to certain businesses owned by veterans (especially service-disabled veterans) and women.
If your business meets one of these criteria, it may be possible to increase the loan amount to $2,000,000.
If your business falls under classifications 31, 32, and 33 of the North American Industrial Classification system, and all of its production facilities are located in the United States, then the debenture (amount of loan) may be increased to $4,000,000. In this case one job must be retained or created for every $100,000 of the loan.