CDFA Spotlight: The Diversity of Revolving Loan Funds - Four Successful Programs

From the Council Of Developement Finance Agencies. Monday, August 11, 2008

Revolving loans funds (RLFs) are a gap financing measure primarily used for development and expansion of small businesses. A RLF is a self-replenishing pool of money, utilizing interest and principal payments on old loans to issue new ones. Because RLFs can take a variety of forms and pursue different goals, they represent an underused development finance tool. When properly established and administered, RLFs can be used to leverage significant private sector investment and be self-sustaining.

This article examines four programs that serve as excellent models of the role a RLF can play in economic development as part of a larger development finance toolkit. They also represent four different approaches, ranging from a regional fund to a county- and city-wide program down to a fund targeting a specific neighborhood in an urban setting.

For each program, a brief background history will be given followed by more specific analysis of components and features of the program, including goals, capitalization, loan standards/characteristics and measurements of success. While the four programs will have characteristics in common, there are also significant differences. RLFs can be tailored to fit the specific needs of the organization running it and the economic needs of the community it serves.

Introduction to RLFs

A RLF provides access to capital that can be used in combination with traditional lending sources for companies and projects that aren't able to obtain capital from conventional sources. Often the RLF fills a gap between the amount a borrower can obtain in the private market and the amount needed to start, sustain or expand a business.

Some RLF programs offer low-interest or below market rate loans. However, below market rates are not necessary for the establishment of a RLF. The RLF is providing access to the additional capital a business can't secure in the private sector regardless of whether they are market rates or below market rates. In either case, RLFs lower the overall risk for private lending institutions and allows expansions and projects to proceed that would not have been possible without covering the financing gap.

Below are some features to consider when establishing or analyzing a RLF program:

Capitalization
Program and loan characteristics
Goals and targeted businesses
Administration
Measurements of success
To learn more about the basics of RLFs check out CDFA's spotlight article covering this topic.

St. Louis County Economic Council, St. Louis Business Development Fund History and Background

The St. Louis Business Development Fund is a public-private partnership and a for-profit corporation. The SLBDF was founded in 1994 with funding from 11 banks. The initial capitalization was $25,000 from each of those banks for a total of $275,000. Today, 24 banks are shareholders in the SLBDF along with three economic development agencies. The three agencies involved are the St. Louis Development Corporation (SLDC), St. Louis County Economic Council and the Economic Development Center of St. Charles County. A board of directors manages the fund, and the SLDC administers the program.

Any company from the region (both Missouri and Illinois) may apply for a loan. Loans are available for two targets areas:

Growing companies in need of growth capital but are at their lending limits with their bank(s).
Leveraged buyout
Program Characteristics

Profitability is a major component of the SLBDF and prefers to refer to their loans as investments to reflect this concept. The profitability emphasis has two results: it encourages additional private sector partners to join as shareholders and increases the sustainability of the fund for years to come.

Features of SLBDF loans include:

Loans range from $50,000 to $500,000.
Term length of five years.
Interest rate is prime plus three percent
Success Fee of 5% to 15% accrued for any year the investment is outstanding.
No prepayment penalty.
Measures of Success:

$11 million in loans granted since 1994.
66 companies have used the SLBDF program
Current portfolio consists of 28 companies with an outstanding balance of $4.7 million.
Fund profitability and sustainability: the fund has seen revenue, net income and assets increase over time.
The SLBDF has grown significantly since its inception 14 years ago. The SLBDF continues to add investors that work in collaboration with the three largest economic development organizations of the region. As the longest established of the four funds examined, it is also important to note that the fund has continued to evolve as the size and scope of the fund has evolved. Marketing plans for the fund have been developed as well as a new due diligence. The fund has also developed line of credit relationships with the owner banks (aggregate lines of credit total $6.85 million).
Summary

Revolving loan funds provide critical financing when credit access is limited, supporting the development and expansion of local businesses and other special initiatives. While a revolving loan fund cannot finance projects on its own, it is an integral part of the small business loan package. Borrowers benefit from flexible and favorable terms, and financial institutions enjoy lower overall risk. The results include new jobs, new businesses and a healthier local economy.

These four programs have succeeded in establishing viable and sustainable RLFs. Each is unique in its setup and administration, but they all excel in promoting new local projects, creating and retaining jobs and leveraging significant private sector investment in the community.