Bonds | Loans | Debt/Equity Investments | Tax Policy
Business Improvement Districts (BIDs) | Grants/Direct Subsidies

FINANCE

Capital finance refers to the flow of investment dollars. Economic development programs that focus on finance issues generally seek to increase the flow of investment dollars by assigning public funds or providing incentives for private investment. Programs that grant or facilitate project financing, funding for start-up businesses, or other forms of revenue are included here.

Many capital finance programs are administered through community development financial institutions (CDFIs) or other intermediaries. CDFIs are organizations with the specific purpose of granting loans and other forms of financial assistance to ventures that might be considered high risk by the conventional banking industry. Intermediaries often take the form of nonprofit organizations or government agencies that administer state or federal programs.

Bonds

The issuance of bonds is a form of debt finance commonly used to raise the capital necessary for large development projects. The debt and the terms of the debt are dependent on the credit of the issuing government or institution.

General Obligation Bonds

General obligation bonds are legally backed by the full faith and credit of the issuing government. In other words, the government is obligated to use its taxing power, if necessary, to repay the debt. Voters must approve a bond referendum before the debt can be issued.

Revenue Bonds

Revenue bonds, also referred to as limited obligation bonds, are legally secured only by a specified revenue source. If that specified revenue source is insufficient to make debt service payments, the state is not legally obligated to appropriate other revenues for debt repayment. Revenue bonds are not subject to the state constitutional prohibition against debt and therefore do not require a constitutional amendment to be approved by voters. Interest rates are often higher than those for general obligation bonds, because the risk is greater. Administrative fees may also be higher since revenue bonds are generally more complex than general obligation bonds.

Examples:

- Industrial Revenue Bond Program, Wash.

Tax-exempt bond financing for industrial facilities is available in Washington state through the Industrial Revenue Bond (IRB) program. Administered by the Washington State Business Assistance Center, a division of the Department of Community, Trade and Economic Development, the IRB program permits public corporations to issue federal tax-exempt bonds on behalf of private companies. This means that interest payments to IRB bond buyers are not subject to U.S. income tax. As a result, bond buyers are willing to accept lower rates of interest on these bonds, thus reducing project-financing costs for the participating companies.

A wide range of project costs may be financed with bond proceeds, including land acquisition, construction and/or improvement of manufacturing or processing facilities, new machinery and equipment, architectural designs, engineering work, feasibility studies, consulting, accounting and legal fees, and financing arrangements and interest accrued during construction. Up to $10 million in bonds may be issued to finance one project. Washington State Department of Community, Trade & Economic Development [online]. For more information: http://www.owt.com/tri-cities/business/irb.html.

- Industrial Revenue Bond Program, Wis.

The Wisconsin Department of Commerce grants municipalities the authority to issue bonds on behalf of a business. Bonds offer businesses long-term, low-interest financing and can be used to finance an entire project, including land acquisition, building construction and new equipment. Municipalities that issue bonds expect to create or retain jobs and expand their tax base.

In a two-year period (1999 and 2000), 97 manufacturing expansion projects received bond financing totaling over $170 million. These projects are expected to create more than 5,800 jobs and help maintain over 10,000 jobs. While the bonds issued equaled approximately $170 million, the total investment by the companies receiving assistance was more than $740 million. Wisconsin Department of Commerce, Bureau of Enterprise Development [online], 1999/2000 Report on Industrial Bond Activity. For more information: www.commerce.state.wi.us/CD/CD-bed-irb-99-00percent20report.pdf.

Loans

Special loan programs are tools commonly used by agencies with economic development interests. Such loan programs seek to address gaps in the financial market by offering more affordable rates or by lending to companies that, for a number of reasons, may not qualify for standard commercial loans.

Revolving Loan Funds

In a revolving loan fund (RLF) the capital base is replenished by the periodic return of principal and interest from past loans. While local governments or intermediaries often administer RLFs, many types of organizations may have revolving loan programs for a number of purposes. The initial capitalization of RLFs can come from various sources. Federal funds (from a variety of agencies) are a common source of capitalization, but state and local governments or private donors may also provide funds. RLF loans are generally smaller or riskier than those issued by conventional lending institutions or are part of unconventional deals. However, conventional lending institutions sometimes become involved as a partner if a RLF loan is issued. Such institutions often will get first claim on any collateral should the loan default, reducing the amount of risk incurred.

RLFs are intended to create jobs and spur economic development, and thus may offer flexible financing responsive to the unique needs of local businesses. Because the primary goal of RLFs is job creation (rather than profit), loans can be made at interest rates lower than banks offer. This makes the loan more affordable to businesses. In some cases, the lower interest rate makes the difference between a business' success and failure. RLFs enable many job-creating businesses to get the financing needed to start up or expand operations. Because of their ability to replenish themselves, RLFs have the potential to create long-term economic self-sufficiency for state or local government projects.

Example:

- Northeast Council of Governments, Aberdeen, S.D.

The Northeast Council of Governments administers a revolving loan fund in a 10-county region in South Dakota. Loan funds may be used for business start-up, business expansion or business purchase. The loan fund is capitalized with money from the U.S. Economic Development Administration, U.S. Department of Agriculture and local matches. A number of eligibility criteria have been established for businesses seeking funding, including demonstration of job creation and $2 of private investment for every $1 of public investment. Northeast Council of Governments [online]. For more information: http://home.midco.net/~necog/.

Microloans

Microloan programs provide credit to small businesses with difficult access to credit. Microloan funds differ from revolving loan funds in that they generally are very small, short-term unsecured loans that help address immediate needs. They are usually issued to new entrepreneurs having trouble obtaining conventional loans for lacking credit history and/or collateral.

Examples:

- ACCION New York, Brooklyn, N.Y.

ACCION partners with microfinance organizations throughout Latin America, Africa and the United States. ACCION New York is a Brooklyn-based organization that provides credit and other support services to "micro" entrepreneurs who cannot get needed business credit because they lack credit history or their businesses are too small or informal.

ACCION New York practices "stepped" lending, which means that clients begin with smaller loan amounts and graduate to larger amounts as their businesses grow. Loans, ranging from $500 to $25,000, are available as either individual or group loans. Loan applicants who lack collateral or a cosigner can team up in a group of three to five entrepreneurs to take out a loan. "Solidarity group lending" allows members to cross-guarantee one another's loans in lieu of collateral. Group loans are a unique option for entrepreneurs committed to working together and providing each other with mutual assistance and support. ACCION [online]. For more information: http://www.accionnewyork.org.

- Northern California Reinvestment Consortium, Sacramento, Calif.

The Northern California Reinvestment Consortium's microloan fund (the EnterFund) is designed to meet the financing needs of very small businesses - those with fewer than 10 full-time employees and a gross revenue of less than $500,000 in the year prior to receiving the loan. Loan amounts range from as little as $250 to as much as $25,000. The EnterFund micro loan program's mission is "to empower under-served individuals of the Sacramento region to achieve economic independence by facilitating the creation, growth and vitality of micro and small businesses." Northern California Reinvestment Consortium [online]. For more information: www.ncrc.as/.

Loan Guarantees

Loan programs can be designed to reduce the risk level lending institutions assume when providing financing. Thus banks may approve loans for riskier ventures and increase opportunities for business development. Public funds can be used to guarantee private sector debt or loans may be structured to provide reserve funds that protect lending institutions from losses.

Examples:

- Small Business Administration, national

As one of the Small Business Administration's (SBA) primary lending programs, the 7(A) Loan Guarantee Program is one of the better-known examples of a loan guarantee program. It grants loans to small businesses unable to secure financing on reasonable terms through normal lending channels. The program operates through private-sector lenders that offer loans, which are, in turn, guaranteed by the SBA.

The agency does not provide funds for direct lending or grants. Loans can be used for most business purposes, including the purchase of real estate to house the business operations; construction, renovation or leasehold improvements; acquisition of furniture, fixtures, machinery and equipment; purchase of inventory, and working capital. Small Business Administration [online]. For more information: http://www.sba.gov/financing/fr7aloan.html.

- Michigan Capital Access Program, Michigan

Capitals Access Programs (CAP) exist in many states. They are designed to reduce risks to lending institutions and expand business development opportunities. The Michigan program utilizes a special loss reserve to assist banks in covering losses from a portfolio of loans that a bank makes under the program. The program is very broad-based and can be used to finance most types of Michigan businesses. Because these loans carry a premium payment ranging from three to 7 percent of the amount borrowed (to help fund the special loss reserve), they are generally more expensive than conventional bank loans.

The key point is that, through the program, banks can provide access to bank financing for many businesses that otherwise might not qualify. Over 8,800 businesses have received loans under this program since it began in 1986. Although there are no loan size limits, the average loan is approximately $53,000. James D. Laughlin, J.D. & Digirolamo, V.A. (1994). A Market-Based Approach to Development Finance: Case Study of the Capital Access Program. Economic Development Quarterly, 8 (4), 315-324.

Debt/Equity Investments

Equity capital is an investment that does not require a firm to repay the debt. Instead, investors assume partial ownership of the business. Debt financing involves the provision of long-term loans to small business concerns in exchange for debt securities or a note.

Venture Capital Funds

Venture capital funds are usually invested in dynamic, growing and developing enterprises; however, some firms will invest in start-ups. Venture capital firms are pools of capital typically organized as a limited partnership to invest in a number of companies. Substantial returns on the investment are possible-- as much as 40 percent within a short period-- but the capital is subject to considerable risk and uncertainty.

Examples:

- African-American Venture Capital Fund, Louisville, Ky.

The African-American Venture Capital Fund, LLC (AAVCF) is a nonprofit corporation established in 1993 to bring equity capital investment to African-American-owned businesses in the greater Louisville area. The fund offers equity capital for entrepreneurs who plan to own their business, expand an existing business, acquiring a business, or need capital for other business reasons. Several major Louisville corporations are shareholders of AAVCF. The Venture Capital Fund invests $1.5 million annually in new deals. African-American Venture Capital Fund [online]. For more information: www.aavcf.org.

- River Cities Capital Funds, Cincinnati, Ohio

River Cities Capital Funds consists of three venture capital funds that invest primarily in early-to middle-stage businesses in information technology, healthcare/biotech/life sciences, business services, telecommunications, and high- tech manufacturing located in the Midwest and Southeast. Their stated mission is "to help exceptional entrepreneurs build leading companies for the New Economy in the Old Economy heartland, through investing our intellectual, organizational and financial capital." River Cities has invested approximately $300 million over a three-year period. River Cities Capital Funds [online]. For more information: www.rccf.com/.

Angel Finance

Business angels are anonymous, private investors who invest in start-up companies that need capital. Angel investors are individuals who supply capital; they are unlike venture capital funds that generally are pools of capital invested by an organization. In addition, angel investors will often mentor a company, providing expertise to help the business develop. A number of mechanisms have been created to match angel investors with investment opportunities.

Examples:

- Angel Capital Electronic Network (ACE-Net), national

Capital Electronic Network (ACE-Net) seeks to help individual accredited investors, Small Business Investment Companies (SBICs) and institutional venture capitalists find small, growing companies through a secure Internet database. It also offers ongoing training and research to enhance the business skills of entrepreneurs and small investors. In addition, ACE-Net seeks to be the premiere clearinghouse of such information through its network connections to expanded capital opportunities. The Angel Capital Electronic Network [online]. For more information: https://ace-net.sr.unh.edu./pub/.

- UniversityAngels.com international

UniversityAngels.com is an online angel investor network where alumni from the world's top universities can come together to launch, invest in and grow viable business concepts into industry-leading organizations. Angel investors can register for free and review a steady stream of high quality start-ups at their convenience. Companies founded or led by alumni of the world's top universities can register by filling out the entrepreneur application. Entrepreneurs pay only a small listing fee unless they are successful in raising capital. UniversityAngels.com [online]. For more information: www.universityangels.com.

Mezzanine Finance

Mezzanine lenders have capital available for private-company acquirers that have exhausted financial resources available through traditional lenders. Mezzanine finance is a hybrid of debt and equity and is especially useful to a company whose bank borrowings have exceeded its bank's comfort zone yet still has sufficient cash flow to service more debt.

Loans are unsecured and are secondary to the capital of secured creditors in the event of bankruptcy. The borrower must pay interest and use stock warrants (a financial instrument with specified conditions) or another mechanism to give the lender a stake in the company's upside potential. When the lender exercises the warrants, the borrower is required to buy back the stock and cash the lender out of the deal.

Examples:

- Darby Overseas Investments, Ltd. Latin American Mezzanine Finance, Washington, D.C.

Darby Overseas Investments, Ltd. is a leading private investment firm that invests its own and client capital in emerging markets. In 1999, it launched the Darby Latin American Mezzanine Fund, L.P. (DLAMF). Investment activities are concentrated primarily, but not exclusively, in traditional infrastructure sectors, including power, telecommunications, transportation and water.

In its first two years of operation, DLAMF made five investments, aggregating more than $85 million of commitments to companies located in Mexico, Argentina, Brazil and Colombia. Borrowers have relied on the mezzanine instrument to play a crucial role in filling the gaps in financing plans between the amounts of senior debt and equity that are available from traditional sources. Darby Overseas Investments [online]. For more information: www.darbyoverseas.com/mezzanine_finance.html.

- Alliance Mezzanine Investors, L.P., Verona, N.J.
Alliance Mezzanine Investors, L.P. (AMI) provides mezzanine capital to successful small and mid-sized businesses located principally in New Jersey, Pennsylvania, New York and Connecticut. Funds may be used to finance growth, new product development, acquisitions, recapitalizations, ownership transitions or management buyouts. AMI will provide funding to companies in manufacturing, service or distribution industries and restricts lending to establishments that have been in business at least five years with at least three years of prior financial statements. Alliance Mezzanine Investors [online]. For more information: www.mezcap.com/.

Tax Policy

Economic development strategies may seek to affect tax policy at the federal, state and local levels in an effort to provide project financing or as an incentive for others to provide capital to businesses.

New Market Tax Credit

The New Market Tax Credit is included in the Community Renewal Tax Relief Act of 2000, signed into law in December 2000. By making an equity investment in an eligible community development entity, individual and corporate investors can receive a tax credit worth more than 30 percent of the amount invested over the life of the credit. The goal is to increase the capital base of community development entities and allow them to lend and invest more, to attract additional outside capital, and to attract more private sector investment.

Tax Increment Financing (TIF)

Tax Increment Financing (TIF) allows governments to use property tax receipts from new development or property improvements in a defined area for that same area's future needs. A city formally designates a specific geographic area for improvement and designates it as a TIF district. Any future growth in property tax revenues is used to pay for initial and ongoing economic development.

Once the district has been formally designated, the initial assessed property valuation is held constant for a specified period, typically 20-plus years. The city, or a separate TIF authority, depending on the state, uses its power of land assembly and sale, site clearance, relocation, utility installation and street construction and repair to improve the district and offers subsidized financing to businesses and developers. As private investment is attracted to the area, the assessed value of property and its taxes are expected to rise.

The difference between the taxes on the base value (property when the TIF district was established) and new assessed value is the "tax increment." Instead of the increment tax revenues going into the city's general fund and to other taxing bodies with jurisdictions over the area (e.g., school district, county), the increments go back into the TIF to pay for the bonds that were issued to finance the improvements. In other words, the increase in property tax revenue generated by redevelopment of an area is dedicated to financing development-related costs. Each taxing body keeps taxes on the pre-development value of the tax base, while the taxes from the property's increased value due to the redevelopment are deposited in a tax increment fund, which is used to pay off bonds issued to purchase and prepare sites for development.

Examples:

- Stockyard Area, Chicago, Ill.

The Chicago's Stockyard was once home to packing and butchering industries. By 1980, that industry was gone, leaving large numbers of parcels of vacant land and blighted buildings. Large-scale redevelopment was not possible because the land was divided into small lots, many roads were privately owned and the soil was unstable. The city of Chicago partnered with the Back of the Yards Council to redevelop the area. The creation of commercial and industrial TIF districts structured the funding to clean up the stockyards and prepare the land for redevelopment. Today, the Stockyard Industrial Park is a location for up-to-date industrial facilities and a retail center. City of Chicago, Department of Planning & Development [online]. For more information: www.ci.chi.il.us/PlanAndDevelop/Programs/TIF/Stockyards.html.

- The Central Loop, Chicago, Ill.

In the early 1980s, the Loop area was losing businesses to new office development in outlying areas. Although buildings in the Loop had beautiful architecture, they were aging and could not compete with new facilities. Chicago created the North Loop TIF in 1984. In 1997, the city expanded the area under TIF and renamed it Central Loop TIF. Seven taxing entities, including schools and parks, are affected by the TIF. The TIF helped with the restoration of landmark buildings, construction of new office buildings and parking structures, and the creation of a new downtown theater district. City of Chicago, Department of Planning & Development [online]. For more information: www.ci.chi.il.us/PlanAndDevelop/Programs/TIF/CentralLoop.html.

- Station Square, Pittsburgh, Pa.

Station Square is located in downtown Pittsburgh's South Shore. The owner of Station Square, Forrest City Enterprises, Inc., was planning major improvements to its existing property, including a festival center with new restaurants, a historic riverfront trail, a public marina, an entertainment amphitheater and an expanded hotel. This continued development of Station Square was the result of a comprehensive planning process that included Forest City, various city departments, community groups and other nonprofits.

Once Station Square TIF District was designated, the Urban Redevelopment Authority of Pittsburgh issued taxable bonds that generated proceeds of about $7.3 million, of which $6.5 million was available for direct project costs. The total development costs were estimated to be $71 million. The TIF was expected to contribute $6.5 million, or 9.2 percent of the costs. Forest City Enterprises was expected to contribute almost $51 million.

The bonds are being repaid by 60 percent of the real estate tax increments realized by the School District of Pittsburgh, by the city and by the county from the new development. In addition, 75 percent of the parking tax increments from the increased parking capacity within the TIF district were promised by the city toward the repayment of the bonds. Austrian, A. & Bingham, R. (2002). The Devolution/Evolution of Urban Economic Development. Working Paper. Maxine Goodman Levin College of Urban Affairs, Cleveland State University.

Business Improvement Districts (BIDs)

BIDs are referred to in many ways, depending on the state or city. Terms used include special improvement districts, special assessment districts, business assistance districts, business improvement zones and special services district. BIDs are areas (generally in central cities) defined by state and local legislation in which the businesses and/or property owners pay a special tax or assessment to cover the cost of providing additional services to the district.

While BIDs may be formed from the perception of opportunity, many result from the perception of threat or decline. Examples can be cited where BIDs were formed to address gradual decline in a central business district or to respond to plans for competing development. BID revenues may be used to finance costs associated with urban design services, marketing, research and planning, sidewalk improvements, façade improvements, special signage, pedestrian lights or additional maintenance or security services, among other things.

Examples:

- Alliance for Downtown New York Inc., New York, N.Y.

The Alliance for Downtown New York, Inc. manages the Downtown-Lower Manhattan Business Improvement District (BID). It provides supplemental sanitation and security, economic development, streetscape and transportation improvements, marketing and enhanced tourist services. The Alliance's mission is to create and promote a safe, clean, residential, commerce-friendly, totally wired community that showcases the historic neighborhood that houses the nation's financial capital. Alliance for Downtown New York [online]. For more information: www.downtownny.newyork.citysearch.com/1.html.

- Business Improvement District Program, San Diego, Calif.

The city of San Diego has created 18 separate BIDs since 1970. These 18 districts include more than 11,000 small businesses and raise more than $1 million annually. The San Diego BIDs channel resources to develop marketing campaigns, increase awareness and lobbying efforts, secure additional funding, and enhance public improvement and beautification projects in partnership with the city. The BIDs work closely with elected officials and city staff to voice collective concerns, monitor business regulations, and obtains funding and support for their business development projects. City of San Diego, Office of Small Business [online]. For more information: www.sannet.gov/economic-development/business-assistance/small-business/bids.shtml.

- Cleveland Theatre District Development Corporation, Cleveland, Ohio

The Cleveland Theatre District Development Corporation (CTDDC) was created in 1995 to keep the theater district clean, safe and well marketed. The organization was an outgrowth of the Committee for the Improvement of Playhouse Square, a group that had been meeting since 1990 to address concerns about the condition of the theater district. In 1998, CTDDC received authorization from the city to operate as a BID. The ability to collect revenue from area property owners has helped CTDDC meet its key objects, which are to develop a collective marketing strategy, provide planning and design services and contract for additional maintenance and security services. Fact sheet provided by Cleveland Theatre District Development Corporation.

Grants/Direct Subsidies

Numerous programs provide dollars in the form of grants or direct subsidies. Funds may be available through various sources, including government agencies, foundations and corporations.

Examples:

- Public Works Program, Economic Development Administration, National

The Economic Development Administration (EDA) of the U.S. Department of Commerce administers several grant programs. The Public Works Program is intended to assist distressed communities in revitalizing, expanding and upgrading their physical infrastructure to attract new industry, encourage business expansion, diversify their economy and generate long-term private sector jobs and investment.

Examples of infrastructure improvement projects funded through this program include water and sewer facilities, industrial access roads, rail spurs, port improvements, skill-training facilities, and technology-related infrastructure. Economic Development Administration, U.S. Department of Commerce [online]. Interim Investments Guide. For more information: www.osec.doc.gov/eda/pdf/GPO26198.PDF.

- Appalachian Regional Commission, Appalachian Region

Since 1965, the Appalachian Regional Commission (ARC) has funded infrastructure improvements in the Appalachian mountain region. Projects include highway corridors, access roads and water and sewer projects, among others. The funding program's goal is to stimulate business investment in the predominately rural region. Appalachian Regional Commission [online]. For more information: www.arc.gov/programs/progmain.htm.

see corresponding section in What Works