Financial Analysis for Economic Development Deals & Projects. May 17, 2012 Mark Barbash WEDA Presentation 1

Transcription

1 Financial Analysis for Economic Development Deals & Projects May 17, 2012 Mark Barbash WEDA Presentation 1

2 Part 1: Steps in the Development Financing Process Part 2: Private Sector Financing Tools Part 3: Public Sector Financing Tools Part 4: Structuring Business Financing Projects Part 5: Structuring Real Estate Development Projects May 17, 2012 Mark Barbash WEDA Presentation 2

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4 Habit 5: Seek First To Understand, Then Seek To Be Understood The Seven Habits Of Highly Effective People By Steven Covey May 17, 2012 Mark Barbash WEDA Presentation 4

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6 Development financing is a logical process that --- if pursued in sequence --- will lead to an informed decision. May 17, 2012 Mark Barbash WEDA Presentation 6

7 1. Understand the Business 2. Understand the Project 3. Understand the Private Financing 4. Understand the Public Financing 5. Understand the Community 6. Identify the Gap and Structure the Financing 7. Close the Deal May 17, 2012 Mark Barbash WEDA Presentation 7

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9 All lenders/investors are nothing more (and nothing less) than money managers with different goals for return on investment based upon where they get their funding. May 17, 2012 Mark Barbash WEDA Presentation 9

10 Start Up Fast Growth Stable Mature Initial Idea In the Garage Is it a Hobby or a Small Business Commerciali zation Prototyping Initial market identified Seeking early adopters Scaling of the initial idea High cost vs. Low Sales Sufficient volume to reduce costs High acceptance of product or service within the market Track record production or service delivery Several generations of products Ongoing investment from profits May 17, 2012 Mark Barbash WEDA Presentation 10

11 Start Up Fast Growth Stable Mature Risk / Reward Curve Period of Greatest Risk to a Lender Mature Business Junk Risk Bonds Sales Growth Curve May 17, 2012 Mark Barbash WEDA Presentation 11

12 Start Up Fast Growth Stable Mature Risk / Reward Curve 30% Venture 6% Max SBA 7% Junk Sales Growth Curve 3% Prime 2.6% Tax Exempt.9% Treasury May 17, 2012 Mark Barbash WEDA Presentation 12

13 Start Up Fast Growth Stable Mature PERSONAL SEED VENTURE ASSET BASED / LEASING BANKS INSURANCE / R.E.I.T.S. BONDS May 17, 2012 Mark Barbash WEDA Presentation 13

14 Start Up Fast Growth Stable Mature Seed Capital Funds & high income Highest Risk, highest rate Informal process Exit to Venture Capital Managed Venture Funds 30% ROI Formal process with high control Exit to public sale in 5 7 yrs Banks/Lease Medium to low risk Very formal process, no control Loans, leases based upon asset life National Markets Banks, REITS, Corp, No Risk, Treas Rate Loans asset life (10 20 yr terms) May 17, 2012 Mark Barbash WEDA Presentation 14

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16 A bank must match its Source of Funds (depositors, the Fed, other Banks) with its Use of Funds (loans). A bank s loan terms must match its source of funds May 17, 2012 Mark Barbash WEDA Presentation 16

17 Source of Funds: Where a bank gets funds? Depositors Pay Interest to Depositors The Fed Pay Interest to the Fed Other Banks Pay Interest to Other Lenders Use of Funds: How a bank uses funds? Reserves Dividends Business Loans Home Loans Transaction Fees, Interest & Penalties May 17, 2012 Mark Barbash WEDA Presentation 17

18 Credit Risk Conservative credits, lending limits, selected industries The Risk that the company s overall growth will not support the financing Collateral Risk 75% L/V, no single purpose assets, addl. Collateral/gtys The Risk that the value of the collateral will pay off the loan in the event of default Rate Risk Higher rates, (P +) variable rate, wider spreads, fees The Risk that the interest earnings on the loan will be less than the cost of the bank s financing Maturity Risk Shorter term, RE: 10 years; M & E: 5 7 years The Risk that changes in the business over time will reduce the value of the collateral or cash flow Cash Flow Risk Conservative lending, high cash flow coverage ratios (1.5) The risk that the business will not generate sufficient cash flow to make loan payments

19 Riskiest financing Flexible Product and concept development Marketing When will first sales come in Prototype development Personal cash Credit Cards Seed Funds Friends and family Partners May 17, 2012 Mark Barbash WEDA Presentation 19

20 Longer term financing Use a term loan rather than line of credit Low down payment financing Fixed rate financing Preserve equity for working capital Assets being financed are collateral Banks Leasing Companies Asset based Lenders Taxable / Tax Exempt Bonds for heavy equipment May 17, 2012 Mark Barbash WEDA Presentation 20

21 Longer term financing Use a term loan rather than line of credit Low down payment financing Fixed rate financing Preserve equity for working capital Assets being financed are collateral Banks Insurance Companies Real Estate Investment Trusts Asset based Lenders Long Term Bonds for Real Estate Taxable / Tax Exempt Bonds May 17, 2012 Mark Barbash WEDA Presentation 21

22 Receivables, inventory, sales Shorter term financing Only borrow what you need Variable rate based on market Permanent working capital needs to cover the operating cycle Banks Line of Credit Asset Based Lenders Factors Receivable Lenders May 17, 2012 Mark Barbash WEDA Presentation 22

23 Short term growth in sales Longer term growth New customers New product development New business venture Equipment or new production Working capital for new sales Additional Equity from current or new owners Reinvestment of profits Term working capital secured by business assets Equipment financing from producers Asset based Lenders May 17, 2012 Mark Barbash WEDA Presentation 23

24 The Rick Perry / John Edwards Rule The Al Capone s Safe Rule The Heidi Fleiss Rule The George Steinbrenner Rule The Herb Cohen Rule The Berlitz Rule The Scouts Rule The Elephant Rule The Don Quixote Rule

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26 Achieve social or economic goals Attract, Create or retain jobs Assist specific groups of citizens or neighborhoods Fill a gap in the business financing package Leverage bank financing Reduce bank risk Finance non bankable businesses Provide incentives for targeted investments

27 Direct Loan Replaces part of bank financing with public financing Long(er) term, fixed rate, Subordinated to bank first mortgage SBA 504, CDBG, WHEDA, SSBCI Loan Guarantee Provides a guarantee of bank loan, keep bank rate and term Improves creditworthiness of borrower or reduces risk SBA 7(a), WHEDA, USDA Loan Guarantee Intermediary Funds provided to a local entity for investment Terms based upon original source and local criteria SBA Microloan, SBA & USDA Intermediary, SBA Community Advantage Tax Credit Tax credit provided to potential investor en exchange for investment Typically uses an intermediary (New Markets Tax Credit, LIHTC, etc.) Investor ROI reduces need for cash flow for repayment up to a point

28 Bonds (Taxable/Tax Exempt) Replaces bank with capital markets financing Larger projects, better credits, repayment > creditworthiness Higher fees (attorney, transaction, credit enhancement) Tax Exempt Bonds Lower rate through tax exemption passed on to borrower Higher fees because of IRS requirements Larger projects, better credits, repayment > creditworthiness General Obligation Bonds Repayment based on full faith and credit of the issuer Typically only for eligible capital uses of the issuer TIF Bonds Repayment based upon tax increment cash flow Initial up front funding typically through GO

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30 Start Up Fast Growth Stable Mature SEED FUNDS Venture / Wis Eq Fund CDBG/EDA RLF SBA 7a / USDA/WHEDA GUARANTEE SBA 504 BONDS May 17, 2012 Mark Barbash WEDA Presentation 30

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32 Remember: Banks want to provide. Short Term Financing Variable Rate Financing High Down Payment Financing Higher Rate Financing Financing that is not perceived as CRA deals Financing that makes a profit Public sector programs help by providing. Long Term Financing Fixed Rate Financing Lower down payment financing to preserve cash for working capital Lower rate financing Reduced Debt Service Needs Increased Borrowing Capacity May 17, 2012 Mark Barbash WEDA Presentation 32

33 Bank Only Public/Private Partnership Bank 75% Bank 50% Equity 25% Public 40% Equity 10% May 17, 2012 Mark Barbash WEDA Presentation 33

34 1. Can the Program Be Used for the Need? 2. Does the Timetable of the Project Meet the Timetable of the Program? 3. Does the Business Meet the Credit Criteria for the Program? 4. Does the Business Meet the Social Criteria for the Program? 5. Does Prevailing Wage Increase the Project Cost? 6. How Much Public Disclosure is Required? 7. Are there Environmental/Historic Preservation Rules? 8. When Can the Business Spend Money?

35 1. Allow the business to tell their story once 2. Don t waste time with a dog 3. Not all projects can fit with public sector programs 4. Let the program people represent their program 5. Don t overpromise what the program can deliver 6. Don t pile on government programs 7. Explain the strings up front 8. Find a cooperative lender 9. Keep written records of your activities 10. Be prepared to do the paperwork 11. If it sounds too good to be true, it probably is

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37 Deal structuring is a four step of process of identifying 1) project cost, 2) available financing the financing; 3) the financing gap and 4) available tools to fill the gap. May 17, 2012 Mark Barbash WEDA Presentation 37

38 1. Is the company financially healthy? 2. What are project costs to be financed? 3. What financing is available and at what rate and term? 4. What is the business debt capacity? 5. What is the bank only structure? 6. Does the business have both equity and cash flow for debt service? 7. What is the financing gap? Equity, cash flow, collateral? 8. What P3 financing is available to fill the gap? 9. What is the P3 structure? Amount, rate, term, debt service 10. Does the business have both equity and sufficient cash flow for debt service? May 17, 2012 Mark Barbash WEDA Presentation 38

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40 How will the project benefit the business? How will the project benefit the community? Financial Feasibility Is the project timetable realistic? Are project costs documented and realistic? May 17, 2012 Mark Barbash WEDA Presentation 40

41 Business Mission Range of management skills P & L Manager in Manufacturing Technology Manager Supply Chain / Cluster / R & D Manage ment Money Original & reinvested equity Adequate working capital Cash management of customers, suppliers & lenders Clear understanding of the market Customized or commodity market Big market vs. Niche Market Market The Project May 17, 2012 Mark Barbash WEDA Presentation 41

42 Financial analysis gives you the questions to ask. It does not provide the answers. May 17, 2012 Mark Barbash WEDA Presentation 42

43 Is the business healthy? Sales Growth: Is the business growing? Earnings Before Tax (EBT): Is the business profitable? Quick Ratio: Does the business have cash to pay the bills? Debt to Equity Ratio: How well has the business managed borrowing? Days Receivable: Is the business collecting from its customers on time? Days Payable: Is the business paying its suppliers on time? Is the project financeable? Existing Cash Flow Coverage: Is the business making current loan payments? Cash: Does the business have sufficient funds to finance project equity? Debt Capacity: How much debt can the company borrow based upon available cash flow? Project Debt Service Coverage: Can the business make debt service payments on both the existing and new financing? May 17, 2012 Mark Barbash WEDA Presentation 43

44 Sales Cost of Goods Sold: Cost of Making the product = Gross Profit Admin Costs: Running the Company = Earnings Before Tax = Profit After Tax: To reinvest in the company May 17, 2012 Mark Barbash WEDA Presentation 44

45 Assets (Own) = Debt & Equity (Owe) Assets become cash w/in 12 months Pay Debts due w/in 12 months Assets become cash after 12 months Pay Debts due after 12 months Current Assets: Assets that become cash within 12 months Customers (Receivables) Inventory (Inventory) Long Term Assets: Assets that become cash after 12 months Land Building Equipment Current Liabilities: Debts that have to be paid within 12 months Suppliers (Payables) Employees (Accruals) LOC & Term Loans Long Term Liabilities: Debts that have to be paid after 12 months Term Loans Equity Equity Investment Accum. profits & Losses May 17, 2012 Mark Barbash WEDA Presentation 45

46 Sales Growth EBT Positive? Quick Ratio Debt to Equity Ratio Days Receivable Question Ratio Is the business (Sales Yr 2 Sales Yr 1) growing? Sales Yr. 1 Is the business EBT + Sales profitable? Does the business have cash to pay the bills? How well has the business managed debt? How long to collect from customers? (Cash + Receivables) Current Liabilities Equity Debt = Debt to Equity Ratio Receivables Sales X 360 Days Payable How long to pay suppliers? Payables Cost of Goods Sold (COGS) X 360 May 17, 2012 Mark Barbash WEDA Presentation 46

47 How is the company financing its operations? Current Ratio: Current Operations Current Assets: Assets that can become cash within 12 months? Current Liabilities: Debt that has to be paid within 12 months? CA CL = Current Ratio Quick Ratio: Long Operations Quick Assets: Current Assets excluding inventory; (Why exclude inventory) Current Liabilities (Cash + Receivables) Current Liabilities = Quick Ratio Debt to Equity Ratio: To what extent does the company rely on debt? Total Liabilities: All debt Equity: Original and accumulated profits (and losses) of the business Total Liabilities Equity = Debt to Equity Ratio May 17, 2012 Mark Barbash WEDA Presentation 47

48 Management of Cash: Operating Cycle Collection of Receivables Is the company collecting from its customers on time? Receivables / Sales X 360 Paying Suppliers Is the company paying it s suppliers on time? Payables / COGS X 360 Management of Inventory Is the company managing its inventory to preserve cash? Inventory / COGS X 360 Operating Cycle How long is cash tied up in the business? D/R + D/I D/P = Operating Cycle (OC) May 17, 2012 Mark Barbash WEDA Presentation 48

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50 Residential Developers Commercial Developers Land Developers Retail Developers Single family or multi family Urban, rural or suburban Production or boutique Primarily office development Speculative developer? Type of properties Site acquisition Site development Aligned with specific developers Shopping malls Life Style Centers Strip Centers Real Estate Investment Trusts May 17, 2012 Mark Barbash WEDA Presentation 50

51 Banks Real Estate Investment Trusts (REIT) Insurance Companies Capital Markets (taxable and tax exempt) Investors Risk Control Investment Banks and Bank Holding Companies Individual and corp; can be public traded Insurance companies investing premiums Corporate, Investment Bankers, Insurance, REIT Medium to Low or No Risk; Prime + Return Low; Own and operating real estate; larger projects Medium to low or no risk; long term capital; No Risk, Treasury Rate Return Very formal process, low control Ownership; equity or mortgage REITs Formal process; little control Highly structured process, no control Loans, Leases based on asset life; Yrs Typically purchase and refinancing Long term loans or investments Bonds, Loans based on asset life; 7 30 years May 17, 2012 Mark Barbash WEDA Presentation 51

52 Construction Financing Short term through construction completion Presumes refinancing or sale of project upon completion Construction draws vs. take out Management of construction is key Highest risk; looking for take out commitment Permanent Financing Refinance project upon reaching stabilization Long term, fixed rate Based upon cash flow that the project produces Insurance companies REITS May 17, 2012 Mark Barbash WEDA Presentation 52

53 How will the project benefit the developer? How will the project benefit the community? Financial Feasibility Is the developer experienced in the market and sector? How stable is the developer and how firm is the financing? May 17, 2012 Mark Barbash WEDA Presentation 53

54 Gross Receipts (total potential revenue) Vacancy Factor (% vac or phase in as $) = Effective Gross Rent (EGR) Operating Expenses Net Operating Income (NOI) Debt Service = Cash Flow for Investor ROI May 17, 2012 Mark Barbash WEDA Presentation 54

55 REVENUE Year 1 Year 2 Year 3 Year 4 Gross Rent Receipts Tenant Contributions Other Income GROSS INCOME Vacancy EFFECTIVE GROSS RENT (EGR) OPERATING EXPENSES Maintenance and Insurance Property Taxes Operating Expenses Management Fees Replacement Reserves TOTAL OP. EXPENSES NET OP. INCOME (NOI) DEBT SERVICE = CASH FLOW (CF) CASH ON CASH ROI % (Cash Flow + Equity) May 17, 2012 Mark Barbash WEDA Presentation 55

56 Are the pro forma assumptions realistic? Net Operating Income: Is the project profitable? Is the value of the property commensurate with the total project cost? Debt Capacity: How much debt will the project support? (NOI/Constant) Cash on Cash ROI: Is the project providing a market return to the developers? (Cash Flow / Cash Equity) Project Debt Service Coverage: Can the project make payments on all financing? (NOI/Cash Flow) May 17, 2012 Mark Barbash WEDA Presentation 56

57 In determining the amount of financing a bank will lend, Cost Value May 17, 2012 Mark Barbash WEDA Presentation 57

58 1. Developers are dreamers and story tellers 2. Most developers never saw a project that didn t fit the market 3. Real estate markets can turn bad very quickly 4. Look for signed leases 5. Watch out for developers fees 6. Who s calling the shots? 7. If it sounds too good to be true, it probably is

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60 Money: Inadequate working capital to finance growth needs Project costs escalate The financial strength of the business deteriorates Market: Defined too broadly Expanding into an unfamiliar or inappropriate business line Management: Inadequate business skills among principals Expanding too fast May 17, 2012 Mark Barbash WEDA Presentation 60

61 Failure on the part of the public sector lender to understand the level of risk it is willing to take The public sector program cannot deliver fast enough The public sector program cannot be flexible enough Unrealistic expectations of how government programs can help Failure to obtain support from every appropriate level necessary for public sector program approval Failure on the part of the public sector lender to take INFORMED risk May 17, 2012 Mark Barbash WEDA Presentation 61

62 Don t just take risk. Take INFORMED Risk May 17, 2012 Mark Barbash WEDA Presentation 62

63 First seek to understand, then seek to be understood Deal structuring is a logical process that will lead to an informed decision. Lenders / investors are money managers with different goals for ROI based upon where they get their funding A bank must match its Source of Funds with its Use of Funds. A bank s loan terms must match its source of funds. Deal Structuring is a process of identifying the financing gap and using available tools to fill the gap. Value Cost Financial Analysis doesn t give you the answers. It gives you the questions to ask. That s the job of the EDP. Don t just take risk. Take INFORMED risk. May 17, 2012 Mark Barbash WEDA Presentation 63

64 Wisconsin Basic Economic Development Course September 10 13, 2012 Pyle Center, UW Madison Madison, WI Economic developers, public officials, and others involved in economic development who want and intensive "basic" overview of economic development concepts, methods, strategies and practices. What will be covered: What is economic development and what is the role of an economic developer. Managing a local economic development organization. Growing from within small business development & entrepreneurship. Marketing & attraction Community & neighborhood development Strategic planning for economic development Workforce Development Business Finance Real estate development & reuse May 17, 2012 Mark Barbash WEDA Presentation 64

65 Thank you. Mark Barbash Economic Development Consulting (614) May 17, 2012 Mark Barbash WEDA Presentation 65