Monday, February 18, 2013
As in the past, I am going to again ignore reality in telling the story of Best Blogs Ever, Inc. (BBE). The legislation and tax rules governing a form of financing called Industrial Revenue Bonds restrict their use to certain industries. BBE might not qualify under those complex rules, but for purposes of this blog, we will assume it could obtain this type of loan. We now return to the story.
Following completion of the merger with Blog Topics, Inc., the business of Best Blogs Ever, Inc. (BBE) started to take off. We went through two more equipment expansions funded by bank loans and have hired additional blog writers and administrative staff. We also acquired another blogging company in a cash for stock merger. We paid for that merger by buying the stock of the company from its shareholders with a combination of cash we had accumulated over the years and a bank loan. We now have a logistical nightmare with employees in three different offices. We still occupy our original offices, which have expanded such that we now occupy the entire building. The BTI bloggers still work in their offices, and we have the newest employees still working in the offices of the company we just purchased. BBE needs enough office space to house all of our employees, servers and equipment in one location.
We now face the question that many successful small businesses must answer, i.e., whether to continue to rent or to buy or build a building. Mary Jo, formerly our financial consultant and now our Chief Financial Officer, presents us with her analysis of the situation. She recommends that we look into buying a facility. Aside from the possibility for appreciation in value, a building also gives us the option to design the space to meet all of our needs now and in the future. If necessary, we can add space onto a building BBE, thereby avoiding the disruption of yet another move to a larger location in the future. We hire an office design firm to lay out new space for us, and we retain the services of a real estate agent to find buildings in our area.
We have suffered with our offices being located on several floors of the building over the last few years. Using the stairs and the elevator to go between departments on different floors has proven to be a large inconvenience and a major waste of time. We know that wherever we go, the office must be on one level. Our space designers present us with a floor plan that groups the various departments in close proximity to each other and provides plenty of space for expansion. Unfortunately, our real estate agent can not find a building to match the design. BBE will have to build its new offices, but there is not much vacant land in Blogtropolis, where we are located. We expand our search into neighboring communities. Our employees begin to grumble about long commutes if we move out of of the City.
Municipalities do not want businesses like ours to move away. This adversely affects a city's tax base and reduces its population if companies and their employees leave. Mary Jo has had several conversations with the Blogtropolis Development Agency about our situation. This Agency is responsible for bringing in new businesses and their employees. They also help existing businesses to grow in order to keep them there. They have offered to help BBE find new facilities in the City, which could solve our space problems and keep our people happy. Based on the design for the new space and the lack of suitable buildings, we will need to construct a building in Blogtropolis if we are going to stay. The estimated cost of such a project is $2,000,000. If we borrow money from a bank to acquire the land and build our new offices, the interest rate would be 8% and the longest loan term would be eight years. At the maturity of the loan, we would have to refinance it at whatever the bank's interest rate might then be. BBE can not afford to pay off that amount of money in only eight years. We would much prefer to have a lower interest rate and a loan term of at least 20 years. Matt, the head of the Blogtropolis Development Agency, offers to help with a loan in the form of an Industrial Revenue Bond (IRB), which is a form of government financing provided by the City to businesses located in Blogtropolis. IRBs are also called industrial development revenue bonds and private activity bonds. A bond is a debt security which is purchased by investors for the interest payments made on the bond. The amount of the bond is repaid in installments during the term of the loan or at maturity.
The basic idea of an IRB is that the city will issue the bond, which pays tax exempt interest. In other words, the holder of the IRB does not have to declare the interest as income. Since the interest is tax exempt, the bond's interest rate can be lower than the rate on a taxable bond and still provide the bondholder with the same net yield. Assume that a bond of $1,000 pays taxable interest at the rate of 10% ($100 per year). If the holder of the bond is in a 20% tax bracket, that means that $20 of the $100 of interest received is paid in taxes, for a net of $80 for the bond holder. If the same $1,000 bond is tax exempt, the interest rate could be set at 8%, and the bond holder receives the $80 tax free. In either case, the bond holder ends up with the same amount, $80. The higher the tax bracket the bond holder is in, the greater the tax savings. The city takes the IRB proceeds received from the sale of the bond and loans that money to the company at the same low interest rate and on the same repayment terms as the IRB. Such bonds can also have longer maturities than bank loans. The money repaid by BBE is remitted to the bond holders.
It sounds like an IRB may be the way to go for BBE. We will continue exploring this idea in the next blog.
Comments are always welcome.