Development Finance Toolbox

Question 1

What is development finance?

Answer 1

Development finance is the effort of local communities to support, encourage, and catalyze economic growth.

It is a tool used to enable the success of development projects or agreements intended to benefit a community.

Question 2

What does development finance include?

Answer 2

It includes a variety of direct tools such as loans, equity, tax abatements, and tax credits.

It also includes indirect tools such as loan guarantees, collateral, or other forms of credit enhancement to support complex funding arrangements.

It may be provided to serve as gap financing, to achieve project financial feasibility.

It can take the form of financial assistance with environmental remediation.

In general, development finance leverages public resources to advance private sector investment.

Question 3

What are common constraints and conditions of development finance?

Answer 3

It is not “free ride” financial assistance. It requires boundaries and accountability measures.

It should be tied to performance measures and tangible project achievements.

It should avoid competing directly with private finance. Rather, it should be complementary and enhancing.

It should bring public benefits that justify the level of public investment.

Question 4

Why is development finance important?

Answer 4

Development finance is critical to economic development because it has the potential to make or break a project.

Development finance can help businesses to generate working capital and invest in their ideas.

A proposal to use development finance tools may act as a catalyst for development led by the private sector.

Question 5

What is equitable finance?

Answer 5

Equitable finance involves the use of development finance tools in a manner that addresses social, racial, and economic inequities. It is particularly focused on removing barriers to capital and unlocking capital for borrowers of all demographic and socio-economic backgrounds.

Question 6

What are the basic principles of development finance?

Answer 6

1. Finance only cares about how the project will repay its debt. It is agnostic about the purpose.
2. Finance wants to know all the details and project feasibility details.
3. Finance requires identifying all revenue streams.
4. Finance requires embracing alternatives.
5. Finance involves removing barriers to capital and evaluating all valid sources of capital.
6. Finance involves identifying how financing can do good by advancing social, racial, and community economic goals.

Question 7

What is a development finance agency?

Answer 7

A public or quasi-public authority that supports economic development through various direct and indirect financing programs.

DFAs can be formed at the state, county, township, borough, municipal, or multi-jurisdictional level.

Question 8

How do public DFAs differ from public-private DFAs?

Answer 8

Public DFAs are directed by government employees and use generally conventional financing tools.

Public-Private DFAs are governed by a board of appointed members that represent various stakeholder and funder groups. They are often publicly chartered and empowered to act on behalf of governments without being subject to all the oversight and controls of government agencies. They often use more innovative financing tools and arrangements such as venture capital and loan funds.

Question 9

What is the “toolbox approach” to development finance?

Answer 9

The toolbox approach to development finance brings together the best financing concepts and techniques to provide a comprehensive response to capital and resource needs. It offers programs and resources that harness the full spectrum of financing options. It requires a commitment to public-private partnerships and the creation of niche programs to assist different types of industries and enterprises.

Question 10

What are the core areas of the development financing spectrum?

Answer 10

1. Bedrock tools: bonds
2. Targeted tools: TIF, tax abatements, special assessment districts, government districts, project-specific districts
3. Investment tools: federal and state tax credits, opportunity zones, and EB-5
4. Access to capital lending tools: revolving loan funds, mezzanine funds, loan guarantees, microenterprise programs, seed and venture capital, and angel funds.
5. Federal support tools: federal economic development programs.

Question 11

What are the five major types of project financings?

Answer 11

1. Government projects
2. Established industry projects
3. Development and redevelopment projects
4. Small business and micro-enterprises
5. Entrepreneurs

Question 12

What is a bond ?

Answer 12

A bond is an instrument of debt. That gets sold to the investing public.

Question 13

How do bonds work?

Answer 13

1. Government bond issues regularly borrow in the tax exempt bond market by pledging revenue to pay back the bonds.
2. Bond buyers fund these loans and provide the principal capital.
3. The bond buyer sets the terms, interest rate, and repayment schedule.
4. A bond-buyer of a tax-exempt bond receives an exemption from income tax on interest earned.
5. The investor does not pay income tax on interest earnings.
6. The bond-buyer typically offers a lower interest rate to the borrower.

Question 14

What is conduit bond financing?

Answer 14

The issuer and the borrower are not always the same entity. In certain instances, select borrowers (such as hospitals, nonprofits, small manufacturers, first-time farmers, etc) can borrow using the tax-exempt bond powers of an issuer. This allows the private sector to access affordable bond rates and terms. This type of issuance is called a conduit bond issuance.

Conduit bonds are not backed by the issuer. They are solely the responsibility of the borrower.

Question 15

What are the two major types of bonds?

Answer 15

1. Governmental Bonds - maybe used for public purposes that address an essential government function such as development of transportation infrastructure, schools, sewers, parks, etc. Private entities may not use or own the financed facilities.
2. Qualified Private Activity Bonds (PABs) - may be used for private sector purposes but carry a higher interest rate than governmental bonds. Typically used for public-private partnership projects.

For both Governmental Bonds and Qualified Private Activity Bonds, accrued interest is tax deductible.

Question 16

What are small issue industrial development bonds?

Answer 16

A.K.A., Small Issue Manufacturing Bonds.

These PABs are the single most actively used bond tool for financing manufacturing facility investment or equipment acquisition. Have an issuance limit of $10 million.

Question 17

What are Aggie Bonds?

Answer 17

These bonds help finance agricultural investment and are commonly targeted to first-time farmers.

Question 18

What are 501(c)(3) Bonds?

Answer 18

These bonds are used to finance projects owned and used by not-for-profit corporations that qualify as 501(c)(3) organizations. Two sub-types: hospital bonds and non-hospital bonds (used by educational and charitable institutions). No state volume cap.

Question 19

What are exempt facility bonds?

Answer 19

Exempt facility bonds are type of qualified private activity bond.. They are used to finance any of a specified group of various types of infrastructure facility projects such as airports, docks and wharves, and water and sewage facilities. Can also be used for energy and waste management projects.

To qualify as an exempt facility bond, at least 95% of the net proceeds of the bonds must be used to finance the facilities described in Internal Revenue Code section 142.

Question 20

What are qualified redevelopment bonds?

Answer 20

These bonds are used for infrastructure projects that do not meet statutory requirements for governmental bonds, if they are used for redevelopment in blighted areas.

Question 21

What are qualified mortgage bonds?

Answer 21

These bonds provide below-market interest rate mortgages to first-time homebuyers.

Question 22

What are mini bond programs?

Answer 22

These are bonds targeted to the needs of smaller PAB users. They feature lower upfront and annual costs, a streamlined application process, and less staffing.

Question 23

What are bond banks?

Answer 23

Bond banks are state-sponsored enterprises that issue bonds that provide access to municipal markets for local infrastructure projects. They issue their own debt securities with the support of a state credit enhancement. They seek to do multiple issuances and relending cycles before requiring funding for recapitalization.

Question 24

What is Public-Private Partnership (P3) Bond Financing?

Answer 24

Most P3s use bond financing. P3s are contractual relationships between private and public entities. The private entity is hired to develop a facility that the public entity retains ownership over. Both entities may share income resulting from the project.

Question 25

What is Taxable Bond Financing?

Answer 25

Taxable bond financing is bond financing that lacks federal tax exemption or federal tax credit benefits. Are attractive as gap financing and may be tax-exempt at the state level.

Question 26

Who are the important supporting players in the bond financing process?

Answer 26

Bond Counsel -- bond issues require bond counsel to provide an approving legal opinion assuring the validity and security of the bonds and their tax-exempt status. They represent the bond issuer. Underwriter's Counsel -- is responsible for preparing various documents on behalf of the underwriter relating to the purchase and sale of the bonds such as any offering disclosure documents. Trustee -- is responsible for acting as a fiduciary agent for the bondholders and participates in the disbursement of bond proceeds to fund project capital costs, payment of principal and interest to bondholders, and coordinating bondholder actions.

Question 27

What are bond ratings?

Answer 27

Bond ratings are determined by nationally recognized rating agencies such as S&P, Moody's, and Fitch. They evaluate an issuer's credit strength in a particular financing. The rating speaks to the probability that bond investors will be paid in full and on time by the borrower. Bond ratings determine the levels and interest rates at which bonds may be issued. The higher the bond rating the lower the interest rate will be.

Question 28

What are targeted financing tools?

Answer 28

They are financing tools that target specific geographies or difficult to finance sectors in a community. Most of these tools are forms of special district financing.

Question 29

What are the two types of targeted tools?

Answer 29

1. Tools designed to generate new taxes in a geographic area through improvements to the built environment. 2. Tools that allow business and industry to generate funds through tax assessments. The assessments finance improvements in the geographic area.

Question 30

What is Tax Increment Financing?

Answer 30

Tax increment financing uses the increased property and/or sales taxes generated by a new development to finance costs related to that particular development. These costs may include public infrastructure, land acquisition, relocation, demolition, utilities, debt service, and planning costs. A TIF district is drawn to direct captured benefits to a designated, usually distressed, area. TIF provides local governments with a funding mechanism that does not rely on general revenue or intergovernmental transfers.

Question 31

What is special assessment district financing?

Answer 31

Special assessment district financing typically follows one of two methods: 1. Assembly of business and neighborhood groups into a district to generate funding for projects and programs. 2. Directly targeted tax assessment program organized by the local government.

Question 32

What are business and neighborhood districts?

Answer 32

Business and neighborhood districts are typically run by property owners in the district. The owners impose self-assessed taxes on themselves in order to generate funds for physical improvements or other amenities. Examples: business improvement districts, special improvement districts, community improvement districts, and neighborhood improvement districts. Once the district is authorized the assessed tax is paid to the government through a collection process and the government returns the special assessment funds to the district's management entity, who then uses them to finance improvements.

Question 33

What are government districts?

Answer 33

Government-focused districts provide similar services to business and neighborhood districts but is managed by government entities. They are typically formed in undeveloped or under-developed areas lacking the ability to support commercial or residential property development.

Question 34

What are environmentally targeted financing methods?

Answer 34

- Brownfields redevelopment financing - Sustainable development - Property assessed clean energy financing programs

Question 35

What are tax abatements?

Answer 35

Tax abatements eliminate or reduce a taxpayer's taxable income. Tax abatement programs often feature an exchange between an business's agreement to make a significant investment in a community and the elimination or reduction of taxable income for a period of years.

Question 36

What are the pros and cons of tax abatements?

Answer 36

Pro: enable a business to save money; attracts businesses to relocate; encourages investment in under-served neighborhoods Con: lack of a "but for" test means tax abatements are wasted / not needed; lack of performance monitoring to enforce tax abatement deal terms.

Question 37

What are investment financing tools?

Answer 37

They are financing tools that incentivize individuals and companies to invest in new machinery, technology, and construction.

Question 38

What are tax credits?

Answer 38

Tax credits directly reduce tax liability. They can be used for several purposes in development projects: - to provide an increased internal rate of return for investors - to reduce the interest rates on a particular financing package - to provide a repayment method for investors in place of cash (tax credits can often be sold on the secondary market)

Question 39

How do tax credits work?

Answer 39

Tax credit programs award tax credits in exchange for demonstrated commitment of resources to a project or qualified business activity. Recipients can reduce the amount of tax liability they owe by claiming the tax credit. As a result, tax credits help to encourage private sector investment and public-private partnerships.

Question 40

What are key federal tax credits related to development finance?

Answer 40

- Historic preservation tax incentives: they were established to support preservation and rehabilitation of older buildings and recognized historic buildings. - New Market Tax Credits: were created to generate additional capital for economic development projects in low-income communities. They provide a 39% federal tax credit for qualified equity investments made through investment in community development entities operating in targeted low-income communities. A five percent annual credit can be taken for an initial three years, then a six percent credit can be taken for an additional four years. - Low-income housing tax credits: created to promote construction and rehabilitation of housing for low-income individuals. It enables developers, corporations, or individuals to raise capital for construction, acquisition, and rehabilitation of housing. Each year, states receive an inflation-adjusted, per-person funding allocation for the issuance of tax credits for qualified housing development projects. - Energy production credits: provides a per-kilowatt hour federally adjusted tax credit for a variety of energy producing activities - Energy investment tax credits: available for qualified solar investment for both commercial and residential properties

Question 41

What are venture capital tax credit programs?

Answer 41

They exist to invest in rapidly growing businesses with governmental support. States target formal venture funds and individual investors who are looking for business investment opportunities. The funds invest in a desired portfolio of businesses, and in return, states provide tax credits to the investor.

Question 42

What are opportunity zones?

Answer 42

Opportunity Zones are a federal tax credit program that aims to improve outcomes of distressed neighborhoods and communities across the country. 8,700 low-income census tracts have been identified as Opportunity Zones. Opportunity Zones receive equity investment from Opportunity Funds, which are capitalized by investors who have realized gains on a recent transaction. These investors can defer payment of capital gains taxes by keeping most of their funds in an Opportunity Fund that directly invests in a qualified project in an Opportunity Zone. If the Opportunity Zone experiences gains, those gains are fully exempted.

Question 43

What is the EB-5 Immigrant Investor Program?

Answer 43

EB-5 is a federally authorized visa category. It offers foreign investors the ability to receive a green card in exchange for creating or retaining 10 full-time jobs in the USA and making a minimum capital investment of $1,000,000 (or, $500,000 in a high-unemployment or rural area). Green cards are conditional and require annual demonstration of sufficient business performance.

Question 44

What are 'Access to Capital' Lending Tools?

Answer 44

Small businesses make up 99.9% of all firms in the united states. They need affordable, reliable capital to get started, for their daily operations, and for new investments. They need working capital to get through the day. They need capital to accelerate new product development. Entrepreneurs and micro-enterprises need capital to get started and to commercialize inventions. Access to capital lending tools are programs that provide either general business development financing or financing that targets firms in specific sectors or certain types of business borrowers.

Question 45

What are Revolving Loan Funds (RLFs)?

Answer 45

They are self-replenishing funding pools that provide access to capital for small and medium-sized businesses. As existing loan holders make payments, the payments are recycled to fund new loans. While the majority of RLFs support local businesses, some target specific industrial sectors, types of borrowers, or policy issues. RLFs are typically used for operating capital, acquisition of land and buildings, new construction, facade and building renovation, landscape and property improvements, and machinery and equipment. The capital to establish an RLF usually comes from a mix of public sources and private sources. The funding is usually a grant. To fund an RLF, state and local governments use a combination of tax set-asides, general obligation bonds, funds appropriations from legislatures, annual dues from counties or municipalities, and state lottery funds.

Question 46

What are Mezzanine Funds?

Answer 46

Mezzanine financing occupies a middle tier of risk in economic development finance. It is less risky than equity or venture capital, but riskier than senior bank debt. It is used to finance post-startup small business ventures that do not qualify for lending from from a traditional lending institution. Mezzanine financing usually comes from community development financial institutions, development corporations, insurance companies, mutual and pension funds, and private investors. An advantage of mezzanine financing is that is cheaper than equity financing and does not require the borrower to give up equity. A disadvantage of mezzanine financing is that it requires ceding independence to lender scrutiny; lenders may demand a vote on the board of directors and may hold the borrower accountable if they do not meet growth projections.

Question 47

What are loan guarantees?

Answer 47

Loan guarantees allow risk to be shifted from a private lending institution to a third-party participant -- usually a government entity. This guarantee reduces private lender risk, which encourages the private lenders to make loans and makes capital available for small businesses. The third-party guarantor must be willing and able to repay the borrower's obligations to the lending institution in the event of default or loss.

Question 48

What are linked deposit programs?

Answer 48

Linked deposit programs provide businesses with access to affordable capital by offering loans at reduced interest rates. These programs use "linked" state or local deposits to buy down the interest rate. Once a borrower is approved for a loan, the linked governmental partners will make a deposit with the lender at an amount significant enough to create a lower interest rate on the borrower's loan for a set period of time. The interest rate on the borrower's loan is then usually two to three percent lower than the bank's traditional rate. The lender will pay the linked partner a reduced interest rate on its deposit. In the end, the lender pays less for the deposit than it receives and thus can charge less for the loan it makes.

Question 49

Certified Development Company / 504 Loan Program

Answer 49

The SBA's 504 Loan program provides businesses with funding for the purchase of fixed assets such as land, buildings, and long-term machinery and equipment. Additionally, its proceeds can be used for the purchase of improvements including grading, street improvements, utilities, parking lots, and landscaping. 504 Loans are funded through Certified Development Companies which are non-profit corporations that promote economic development in their communities. A 504 Loan has 3 sources. A bank contributes up to 50% of the project financing. A CDC provides up to 40% of the financing, and the small business contributes at least 10%. The bank and the CDC make separate loans to the qualifying business.

Question 50

What is the SBA 7(a) Loan Program?

Answer 50

The 7(a) Loan Program, the most popular SBA loan program, offers guarantees to private sector lenders who finance small businesses. In return, the SBA provides a guarantee of repayment in case of default. When a lender processes the application, it decides whether or not to make the loan, and if it will require an SBA guarantee. If the lender moves ahead then it must structure the loan according to SBA requirements, an in return, it receives a guarantee from the SBA for a portion of the loan. In the event of payment default, the SBA will reimburse the lender for a portion of the loss, and the borrower is obligated to repay the remaining amount. The 7(a) program allows lenders to offset some of the risk associated with lending to small businesses, while still ensuring accountability in the event of default. The maximum loan amount for the program is $5 million. The maximum guarantee is eighty-five percent for loans up to $150,000 and seventy-five percent for loans greater than $150,000.

Question 51

What is micro-enterprise finance?

Answer 51

Micro-enterprises are the smallest businesses in a community, usually defined as businesses with less than five employees, a capital need of less than $35,000, and an average loan amount of $7,000. These businesses require a tailored financing approach because they are perceived by lenders as having a high level of risk due to their small size and entrepreneurial nature.

Question 52

What is the SBA Microloan Program?

Answer 52

The SBA Microloan program makes funds available to nonprofit, community-based lenders, called intermediaries, and these lenders in turn make loans of up to $50,000 to eligible borrowers. The average loan size for this program is approximately $13,000. Applications are typically submitted to the local intermediary, and credit decisions are made at the local level. Loans may have a maximum term of six years. Interest rates generally range from 8 to 13 percent.

Question 53

What are local micro-lending programs?

Answer 53

Many state and local governments run microlending programs through development finance agencies, or in partnership with community-based lending institutions, community development corporations, etc.

Question 54

What are peer-based micro-lending programs?

Answer 54

Peer-based micro-lending programs involve entrepreneurs and small businesses lending directly to micro-enterprises. Operating as a lending group, they review applications, creditworthiness, and business plans. They monitor loan performance after loan decisions are made. As micro-enterprises grow, they can later join the the micro-lending group, and they can graduate to larger and more established financing sources.

Question 55

What are crowdfunding programs?

Answer 55

Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people. This process usually occurs over the internet. State and local governments formulate guidelines and regulatory frameworks for crowdfunding.

Question 56

What is innovation finance?

Answer 56

Innovation finance focuses on growing economic innovation through technology development, new businesses and industries, and entrepreneurial activity. It includes angel and seed funds, and it is largely managed by the private sector. Public agencies have increasingly provided resources for early stage capital programs.

Question 57

What is seed and venture capital?

Answer 57

Seed capital is initial capital investment into a new business or product line provided by private investors in exchange for a high rate of return on their investment. This capital allows an entrepreneur to launch a new venture without drawing upon traditional lending sources. Venture capital (aka, private equity) is early stage investment in young companies that requires granting the venture capital provider a hands-on management role in the firm. Venture capital firms are generally private partnerships or corporations funded by private and public pension funds, endowment funds, foundations, corporations, individuals, and foreign entities. Venture capital is different from seed capital because venture capital firms typically do not invest in companies until they are somewhat established whereas seed capital may be used to develop a business idea into a company.

Question 58

What is angel investment?

Answer 58

Angel investors provide private financing for emerging companies that are too small to attract venture capital, but too big to rely on family or friends. Typically, the amount of the investment ranges from $50,000 to $1,000,000 or more. Angel investments can be used at critical points in a company's development, enabling it to get past funding hurdles in its early years. Angel investors also provide hands-on technical assistance to the companies they invest in.

Question 59

What is community development venture capital?

Answer 59

Community development venture capital funds use the tools of venture capital to encourage entrepreneurial growth and job creation in distressed communities. CDVC funds use a double-bottom line approach -- they pursue social and financial returns on their investments.

Question 60

What are SBIR and STTR programs?

Answer 60

SBIR (Small Business Innovation Research) and STTR (Small Business Technology Transfer) programs provide competitive grants for small businesses developing high-technology products.

Question 61

What are business incubators?

Answer 61

Business incubators are programs focused on delivering targeted resources and technical assistance to start-up companies. Incubators may be set up to deliver services at a single physical location or they may be set up as virtual networks. Their goal is to help companies gain financial stability and self-sufficiency.