Operating Businesses. Laura Baron. Matt Meeker. Carol Mihalic. Kermit Billups. Amy Tranckino. Kutak Rock LLP. Novogradac & Company LLP

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2 Operating Businesses MODERATOR Matt Meeker Novogradac & Company LLP PANELISTS Carol Mihalic Kutak Rock LLP Kermit Billups Greenline Ventures Laura Baron Strategic Development Solutions Amy Tranckino Sheppard Mullin Richter & Hampton LLP

3 Operating Business definition What is an Operating Business for NMTC purposes? Non-Real Estate Business Any business whose predominant business activity (i.e. activity that generates more than 50 percent of the business gross income) does not include the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate

4 Operating Business definition (cont.) Operating Business Allocation Agreements Innovative Investments Encourages QLICIs made to operating businesses using shortterm or small dollar investments Available only to the first QLICI provider QLICIs can only be considered funding operating business as long as no part of the QLICI was used for Real Estate Activities

5 INITIAL STRUCTURE OVERVIEW - Determine the actual need/financing gap - Offer support and assistance in securing financing - Vetting proposed NMTC funding structure - Gather investees understanding on how this will all work - Understand short and long term plans - Understand growth needs

6 CDE BUSINESS ISSUES - STRUCTURE FOR SUCCESS - Underwriting - Validate Forecast & Key Drivers (Get assistance!) - Incorporate expected needs in legal documents to minimize the need for modifications - Set DSCR/Liquidity Ratios - Underwrite the amount of debt to be taken out ahead of time - Limit distributions to Net Income - Map out approval process - Conduct a QALICB orientation

7 NMTC COMPLIANCE HURDLES FAQ 42. Restrictions on the Use of QLICI Proceeds to Directly or Indirectly Reimburse Expenditures Incurred by a QALICB or Project Sponsor (an entity that owns or Controls the QALICB) and to Directly or Indirectly Fund a QEI Beginning with the CY 2015 round, only documented reasonable expenditures that are directly attributable to the qualified business of the QALICB can be paid or reimbursed from QLICI proceeds to directly or indirectly fund a QEI, provided that these expenditures have either been (i) incurred no more than 24 months prior to the date on which the QLICI transaction closes, or (ii) represent no more than 5 percent of the total QLICIs made by the CDE into the QALICB. Reasonable expenditures: expenditures for a legitimate business purpose that occur during the normal course of operation, and must be similar in amount and scope when compared to expenditures by a similar entity for a similar project under similar circumstances. Such expenditures may be made directly by the Project Sponsor on behalf of the QALICB or be funded through a loan or equity investment made by the Project Sponsor to the QALICB.

8 NMTC COMPLIANCE HURDLES Allocation Agreement Section 3.3(j) The Allocatee shall not use the proceeds of a QEI to make a QLICI in a QALICB where such QLICI proceeds are used, in whole or in part, to repay or refinance expenditures incurred by a debt or equity provider whose capital was used to fund the QEI, or are used to repay or refinance expenditures incurred by any Affiliate of such a debt or equity provider, except where: (i) the QLICI proceeds are used to repay or refinance documented reasonable expenditures of the debt or equity provider (or its Affiliate), that are directly attributable to the qualified business of the QALICB, and such expenditures were incurred no more than 24 months prior to the QLICI closing date; or (ii) no more than 5% of the QLICI proceeds are used to repay or refinance documented reasonable expenditures of the debt or equity provider (or its Affiliate) that are directly attributable to the qualified business of the QALICB. For purposes of this subsection, refinance includes transferring cash or property, directly or indirectly, to the debt or equity provider or an Affiliate of the debt or equity provider.

9 NMTC COMPLIANCE HURDLES FAQ 44. QALICB s Use of QLICI Proceeds to Pay a Debt or Equity Provider to Monetize an Asset Owned or Controlled by the QALICB or an Affiliate of a QALICB, Including But Not Limited To the Accreted Value of an Asset Under the CY 2015 round, a QALICB is not permitted to use QLICI proceeds to pay a debt or equity provider whose capital is used to monetize an asset owned or controlled by the QALICB or an Affiliate of a QALICB if that capital provider directly or indirectly funded a QEI. This provision does not apply to allocation awards made prior to the CY2015 round. Question 44 supplements and is not in conflict with the CY 2015 NOAA or Question 42 of this document.

10 NMTC COMPLIANCE HURDLES FAQ 43. CDFI Fund Monitoring of the Restriction on the Use of QLICI Proceeds to Directly or Indirectly Reimburse Expenditures Incurred by a QALICB or Project Sponsor CDEs must include such covenants in financing agreements with QALICBs as may be necessary to reflect this restriction. The agreements containing such covenants must be available for inspection by the CDFI Fund. Second, the CDE should collect information as may be necessary and maintain documentation to trace the use of QLICI proceeds to use by the QALICB at the time of the initial QLICI is made and at least annually thereafter. Where the QALICB will repay or refinance a debt or equity provider or a party related to a debt or equity provider under the 24-month or five percent exception rules, the CDE should maintain documentation supporting that the reimbursements can be directly traced to actual expenditures. This documentation must be available for inspection by the CDFI Fund. Documentation to support compliance with this restriction must be retained for the period of the QLICI in the QALICB plus three years or the seven-year compliance period plus three years, whichever is shorter.

11 NMTC COMPLIANCE HURDLES FAQ 42: incurred no more than 24 months prior to the QLICI closing date or represents no more than 5% of the QLICI proceeds (documented reasonable expenditures; directly attributable to QALICB s qualified business; paid or reimbursed to directly or indirectly fund a QEI) Allocation Agreement Section 3.3(j): incurred no more than 24 months prior to the QLICI closing date or represent no more than 5% of the QLICI proceeds (documented reasonable expenditures; directly attributable to QALICB s qualified business; used in whole or in part to pay or refinance expenditures incurred by a debt or equity provider whose capital was used to fund a QEI) FAQ 44: cannot use QLICI proceeds to pay debt or equity provider whose capital is used to monetize an asset owned or controlled by a QALICB or an Affiliate thereof if that capital provider directly or indirectly funded a QEI; supplements and is not in conflict with CY 2015 NOAA or FAQ 42 FAQ 43: covenants in financing agreements; collection and maintenance of documentation tracing the use of QLICI proceeds to actual expenditures; documentation must be available for inspection by CDFI Fund

12 Portions of Business Rule CDEs may treat any portion of the trade or business of an investee as a QALICB if that portion could qualify separately as a QALICB had it been separately incorporated: satisfy all other requirements of a QALICB maintain a complete and separate set of books and records; and use the equity investment or loan proceeds from the CDE, intended to constitute a QLICI, solely to fund trade or business activities of the QALICB portion.

13 QALICB Statutory Requirements Active business Qualified business Operated in low income community Gross income requirement At least 50% of total gross income of entity derived from qualified business within any low income community Tangible Property At least 40% of use of tangible property of such entity (owned or leased) is within any low income community Services Performed At least 40% of services performed for such entity by employees of entity are performed in a low income community

14 QALICB Statutory Requirement Collectibles Nonqualified Financial Property

15 POB vs SPE Asset Locations Fixed Assets vs. Mobile Assets Employee Locations Tax Considerations

16 Tax Considerations SPE Economic Substance Doctrine Sometimes At Odds With Third Party Consent Requirements Lease Assignment & Release/No Lease Guarantee From Original Tenant Sublease/ True Lease Analysis Leasehold Deed of Trust True Debt Analysis POB Agreed Upon Procedures Perhaps Unsecured Full Recourse/True Debt Analysis

17 The Messy Truth Operating businesses do not exist in a vacuum Existing constraints drive deal structure Landlord Consents (Creditworthiness of SPE versus Sponsor) Existing Landlord Financing (Subordination Issues) Existing Credit Facilities Blanket Liens Financial Covenants Refinancing Complications

18 Why Invest in Operating Businesses

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25 NMTC in Baltimore Project Types Since 2003, the NMTC has delivered more than $2 billion in financing to 52 Baltimore businesses, community facilities, and service providers. Source: NMTC Coalition

26 Real Estate Operating Business CDE Analysis Greenline Community Ventures Operating Business Operating business often capitalized through sweat equity and family/friends funding and market (bank) debt. Do we believe in the mission, impacts and outcomes related to the business? Quality and character of management team? Has the business exhausted options for additional market rate capital? Industry and Business Strategy Analysis: Do cash flow projections show stable growth or rapid increases in profitability? Is hiring a sales force sufficient to drive sales, especially in international markets? Does company need additional funding for consultants, regulatory approvals? Have they fully determined their need? How are other players in market performing and raising capital? Valuation: Recent equity rounds? What business events have impacted valuation since capital raise? Ability to raise additional funding. Many businesses actually underestimate the need for subsidy.

27 Define the Problem Real Estate Operating Business Since the recession, many banks have scaled back or eliminated small/medium business lending. BANKERS SEE RISK! excessive loan to value (LTV) insufficient owner equity inadequate collateral unstable cash flows lack of management operating experience unproven markets and technology poor industry structure (barriers to entry)

28 Define the Problem Economic development problem: Shortage of venture capital type funding available to support small businesses and emerging technologies. Causes of the economic development problem: Venture capital providers are concentrated regionally and tend to operate with limited geographic scope. Economic development need: Reliable cost effective source of growth capital for emerging technology companies. This capital will allow these businesses to remain in their communities of origin.

29 Operating Businesses MODERATOR Matt Meeker Novogradac & Company LLP PANELISTS Carol Mihalic Kutak Rock LLP Kermit Billups Greenline Ventures Laura Baron Strategic Development Solutions Amy Tranckino Sheppard Mullin Richter & Hampton LLP