The illusive economic development dollar...many entrepreneurs have heard about “Company XYZ” receiving hundreds of thousands or even millions of dollars in “free money” from the [insert economic development agency here]. Headlines in the paper that read; “ABC Inc. will create 100 jobs in Anytown, USA with the help of local economic development officials”. These articles are usually accompanied by a photo of the Governor shaking hands with an out-of-state CEO during the ground breaking.
So how did they get that money anyway? And how can I get some to start my business? The short answer is you probably can’t. The reason is that Economic Developers are interested in seeing three things in a project before they pony up any “free” money: A) Job Creation B) Primary Sector (Out of State)Sales and C) Companies with in a target industry. Lets take a look at these one at a time:
o Job Creation – That headline you read is a major reason why the company is getting assistance from the city or state in the first place. The market for quality skilled and professional jobs is very competitive and many cities are willing to pay out the bucks to attract a company to expand or relocate in their area.
o Primary Sector Sales – Primary Sector generally means that the company they are investing in sells a majority of its products out of state. The rule of thumb is 75% of the companies revenues have to come from sources in other states or other countries. When money comes in from out of state it creates new wealth for the local economy. Those dollars are paid to employees who in turn spend money locally helping other businesses grow and prosper. In addition, it adds to the property tax and sales tax base for the local governments.
o Target Industries – There are several industries which lead to the creation of high quality jobs and typically sell products out of state. These industries include Manufacturing, Production, Information Technology, Value Added Agriculture, Tourism, Natural Resources, Energy Sector and because of their job creation component Call Centers or Customer Service Centers are included.
As a general rule of thumb, start-up businesses do not meet the above criteria and will not qualify for economic development financing.
There are some exceptions though. In some rural areas, where larger companies are not vying to relocate there is a shortage of projects to fund. Because of this your project will not be competing against the “Five Star” companies for the same money allowing for a greater chance of obtaining funding.
Economic developers in these areas are willing to invest in start-up companies who will create a few jobs and give their economy a boost. These agencies generally have budgets between $50,000-$100,000 to invest in a year so don’t expect a huge infusion of capital. But for most start-up projects a $10,000 investment can be leveraged to get additional financing and get started.
Economic development money is generally used to fund the gap between what the bank is willing to lend and the amount of equity the owners are willing to provide, hence the term “Gap Financing”. Generally, funding is limited to a maximum of 50% of a project’s total funding need, but in practice funding is typically 20% or less. While there is virtually no limit to the creativeness of how economic development money is spent, it is generally structured in one of four ways:
1. Grants – While this type of investment is not typical, it does happen on occasion. Many times the public perception is that the money is always granted but this is almost never the case.
2. Common Stock Purchases – In this instance the economic development agency purchases ownership in the company and shares in the profits of the company, while their losses are limited to the initial investment made, like a traditional investor. While this is not a common occurrence it happens more frequently then the outright granting of funds.
3. Low Interest Loans – Because economic developers are not banks they can afford to take on a little more risk and receive less in return. This allows developers to lend money at a lower interest rate, receive less collateral as security, offer longer loan terms and give special incentives such as interest free or payment free periods.
4. Preferred Stock – The traditional way economic developers invest in companies. Preferred Stock is a hybrid security. It is like common stock in that it provides for specific ownership rights in a company and it is like debt in that it has interest in the form of a stated return (dividend). Generally, preferred stock investment requires only interest repayment annually for a specified number of years and then large chunks of principle repayment along with interest after that time period expires. The benefit is lower payments during the initial years of operation. Because of the characteristics of preferred stock is often referred to as “deferred debt”.
Economic development agencies come with many different faces and names. Many have set out specific criteria in addition to the ones laid out in this article. For more information contact the economic development office in your area.
