Judy Cromer VP, Business Finance, St. Louis Economic Development Partnership
Our economy is booming, and business owners are looking for ways to take advantage of the opportunities that exist in a growing economy. Business owners have a deep understanding of how to run their business, because they are involved on a steady basis, however understanding different funding mechanisms and how to access capital for growth can sometimes prove difficult, based on this being a periodic need. Many times there are different types of funding sources available in different geographical areas, and in some cases different types of capital can work together to fund an expansion project in what is called a capital stack.
When you’re thinking about business expansion, to determine the best funding source, the first thing to consider is what type of expansion would work best for your company. Should you add on to your existing structure, retool an existing building for increased efficiency, add a building to your current site, or consider the purchase of a new site to locate your growing business. The next things to consider are the cost, and the return on your investment? Will you save money by creating more efficiency, increase production, or both?
There are three basic types of available funds for business expansion; open end lines of credit, closed end term loans, and interim financing. Open end lines of credit are typically provided by banks. The two primary types of an open-end line of credit are a traditional operating line of credit, and a commercial credit card.
These are used to fund operating costs such as supplies, payroll and benefits, professional services, equipment and machine repairs, utilities and energy costs, payroll taxes, insurance, etc. Open end lines of credit can be tied to specific collateral or the collateral can be more generic rather than specific, such as “all office equipment”. Closed end term loans can be provided by a bank loan, a SBA 7a loan, or a SBA 504 loan.
These are used to finance a small portion of operating costs, but they are generally used to fund real estate acquisition and improvements, the purchase of equipment and vehicles, and they are tied to specific collateral. Interim financing is temporary financing provided by banks and is usually in the form of a construction loan used to purchase and improve real estate, or for the expansion or improvement of existing real estate and structures.
These three basic types of financing mechanisms are structured differently. An open end line of credit is a revolving loan, so the amount of credit utilized and the amount of credit available vary. In addition the payment varies each month based on the amount of credit utilized, and the account is eligible for renewal on an ongoing basis. The amount available is based on repayment capacity. Closed end term loans start off with the maximum balance utilized and the term of the loan is fixed. If the loan has a fixed rate, the payment will remain the same during the term of the loan. If the rate is variable/adjustable the payment can vary slightly based on how interest rates move. The loan amount is based on the value of collateral and repayment capacity.
Interim financing has varied terms which are based on the needs of the individual project being financed. Payments can be fixed or vary depending on the project type. Construction loans have payments that increase based on the amount of funds utilized, which increase as construction progresses. Loan amounts for interim financing are based on the value of the collateral and repayment capacity.
In addition to these traditional types of financing, there are other types of funding available, depending on the location and type of business. Industrial Revenue Bonds (IRBs) are often the best source of funds for a manufacturing business, and in most cases, this type of funding qualifies as tax-exempt, which often times translates to a 30% savings in the interest rate.
In addition IRBs can be utilized to cover 100%, and in some cases more, of the project cost. IRBs can be structured as a fixed or variable rate and can have terms of up to 30 years. Typically you would consider an IRB as a funding source for projects costing $2MM and up. IRBs can be combined with other types of funding including bank loans, SBA loans and tax credit financing.
One more additional note, as business owners, you are well aware that sharing ownership is another way to attract capital and you likely have had many conversations about it with friends and family. Taking this a step further, having foreign friends as part owners of your business is an extra way to access capital and raise money as well as benefit from potentially lucrative international distribution networks.
What better way to grow a business than through both domestic and international investors and sales? Foreign investors typically find American companies attractive investments because of our strong work ethic, industrial competency, and quality products. One of the most frequent ways to find foreign investors is by attending trade shows related to your business. Next time you’re visiting a trade show, scope out the foreign companies and explore what interest you can generate in your business.