Building the Ideal Financing Toolbox

by Toby Rittner, Executive Director, Council of Development Finance Agencies

Economic developers require a comprehensive set of financing tools to support their work. From debt tools such as industrial development bonds, tax increment financing and loan programs to tax credits, small business lending and seed and venture capital funds, a community must be proactive in providing financing for the range of its economy’s needs.

Whether the goal is brownfields redevelopment or assistance to manufacturing, technology or service industries, the financing options should be tailored and specific.What works for one industry sector (such as tax-exempt industrial development bonds for manufacturing) may not work for another (technology companies are more likely to require venture capital tax credits).

Ideally, agencies can provide targeted financing tools for special purposes and geographic areas while maintaining an overall financing toolbox that serves broader needs. Cities such as Minneapolis,Washington, D.C., and St. Louis, and states such as New Jersey, California and Ohio have been successful using this formula for their financing programs.

Yet many communities do not take advantage of all the financing tools available to them. This article outlines a menu of options available for communities looking to build the ideal financing toolbox – programs that can be replicated nearly everywhere.While this article is not an exhaustive review of every available financing tool, it provides an overview of the importance of a comprehensive approach to finance.

Broad-based financing tools

Bond finance is the cornerstone of development finance. The Tax Reform Act of 1986 distinguishes between two types of municipal bonds, general obligation (GO) bonds and private activity bonds (PABs), and outlines the requirements for each. Interest on GO bonds is exempt from federal taxation, while interest on PABs is exempt only for “qualified” bonds.

The federal interest exemption on GO and PABs is a significant asset in making bond finance attractive. Investors, either institutional or individual, gain a federal tax exemption by purchasing tax-exempt bonds, thus reducing the cost of lending on those bonds. This allows the bond financing to be more affordable to borrowers by providing a lower interest rate and more flexible payment terms. Compared to traditional lending techniques such as bank loans, tax-exempt bonds can save borrowers millions in interest and fees.

GO bonds work as the name implies, to finance the development of facilities that serve an “essential government function.” Nearly all communities employ GO bonds to maintain their general infrastructure and provide necessary capital improvements. PABs, however, serve secondary purposes and are a key source of financing often overlooked by economic developers.

PABs are broken down into seven categories, of which four kinds – exempt facilities, redevelopment, 501(c)(3) and qualified small issue bonds – are the most useful in the development finance industry.

• Exempt facilities bonds are available to finance a number critical needs, including airports, docks, commuting facilities, sewage facilities and a host of energy, water, gas and power projects.

• Qualified redevelopment bonds are for infrastructure projects that do not meet GO bond requirements. These may qualify for a tax exemption if they meet several tests, such as the proceeds being used for redevelopment of a designated blighted area.

• 501(c)(3) bonds have gained considerable popularity over the past decade for projects owned and used by nonprofit organizations (such as religious, charitable, scientific, and educational entities). Many economic development departments have established 501(c)(3) Revenue Bonds and Bank Qualified Bank Direct loan programs to capitalize on the availability of this financing option.

• Qualified small issue bonds, also referred to as industrial revenue bonds (IRBs), industrial development bonds (IDBs) and manufacturing bonds, have been the primary source of affordable lending for the manufacturing industry for the past 50 years.

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