Revolving Loan Funds & Development Finance

Overview

A revolving loan fund (RLF) is a gap financing measure primarily used for development and expansion of small businesses. It is a self-replenishing pool of money, utilizing interest and principal payments on old loans to issue new ones. While the majority of RLFs support local businesses, some target specific areas such as healthcare, minority business development, and environmental cleanup.

Establishing a revolving loan fund provides access to a flexible source of capital that can be used in combination with more conventional sources. Often, the RLF is a bridge between the amount the borrower can obtain on the private market and the amount needed to start or sustain a business. For example, a borrower may obtain 60 to 80 percent of project financing from other sources.

Quality RLFs issue loans at market or otherwise competitive and attractive rates. Many RLF studies have shown that access to capital and flexibility in collateral and terms is more important to borrowers over lower then market interest rates. RLF programs should be built on sound interest rate practices and not perceived as free or easy sources of financing. RLFs must be able to generate enough of an interest rate return to replenish the fund for future loan allocations. With competitive rates and flexible terms, a RLF provides access to new financing sources for the borrower, while lowering overall risk for participating institutional lenders.

Typical uses for RLF loans include:

Operating capital

Acquisition of land and buildings

New construction

Facade and building renovation

Landscape and property improvements

Machinery and equipment

Loan Characteristics

Loan terms vary according to the use of funds. A loan used for working capital, for instance, may range from 3 to 5 years, while loans for equipment are up to 10 years and real estate loans may last 15 to 20 years. It is important that terms are fixed to the useful life of the asset financed.

Loan amounts range from small ($1,000 to $10,000) to mid-sized ($25,000 to $75,000), with larger ($100,000 to $250,000 and up) amounts available when the borrower has secured a substantial sum from private lenders.

Capitalizing a Revolving Loan Fund

Initial funding, or capitalization, of a revolving loan fund usually comes from a combination of public sources, such as the local, state, and federal governments, and private ones like financial institutions and philanthropic organizations. Funding acquired for capitalization is usually the equivalent of a grant – it does not need to be paid back.

Most revolving loan funds have at least one local public source for capitalization combined with other sources. If capitalization is exclusively local, the RLF may have greater flexibility in lending, as state and federal involvement tend to include restrictions that may not fit local business needs.

State and local governments often use one or a combination of the following to capitalize an RLF: tax set-asides, general obligation bonds, direct appropriations from the state legislature, annual dues from participating counties or municipalities, and funds directed from the state lottery.

The federal government is another common source of capitalization. Communities may apply for funding from the United States Department of Agriculture (via the Rural Economic and Community Development Administration), Housing and Urban Development (via Community Development Block Grants), and the Department of Commerce (via the Economic Development Administration).

Standards and Results

While RLFs take on projects with above average risk, borrowers are held to standard financial requirements in loan security. Before a loan is issued, a business or prospective business usually supplies the following documentation:

Business plan

Business experience and management information

Credit history and financial statements

Sufficient collateral to repay bank and RLF funding

Other personal or corporate guarantees on the project

Cash flow projections

As a public investment instrument, revolving loan funds are expected to result in public goods – namely projects contributing to economic growth and community revitalization. Borrowers therefore, must address performance measures established by the loan administrator such as:

Number and type of jobs created or retained

Increase in tax revenue

Private funding relative to public investment

Benefits to low and moderate-income citizens, from business ownership to job opportunities

Examples

Urban Redevelopment Authority of Pittsburgh

The Urban Redevelopment Authority of Pittsburgh operates several Revolving Loan Fund Programs through The Center for Innovation and Entrepreneurship (CIE). These RLFs are used as gap financing products for commercial real estate development and small and medium sized business development. CIE programs work in conjunction with private finance to leverage the capital needed to help businesses grow and expand. CIE RLFs include:

Micro-Enterprise Loan Program

Pittsburgh Business Growth Fund

Pittsburgh Entrepreneur Fund

Business Energy Savings Program

Pittsburgh Enterprise Zone Revolving Loan Fund

Urban Development Fund

New Markets Tax Credit Loan Fund

CIE programs are primarily seeded by Federal Community Development Block Grants or funds from the Pennsylvania Department of Community and Economic Development. RLFs are key to the success of the CIE as they allow for the opportunity to re-lend dollars several times. From 2014-2016 the CIE made 69 loans supporting over $51 million in total project costs and 559 jobs.

Oregon Business Development Fund

The Oregon Business Development Fund (OBDF) is a state level Revolving Loan Fund managed by Business Oregon to provide capital to Oregon based businesses. Funds under this program can be used for land, buildings, equipment, machinery and permanent working capital. Loans are fixed-rate with terms tied to the useful life of the asset financed. All businesses using this program must create or retain jobs and must typically be a traded-sector business in manufacturing, processing or distribution. The program gives preference to rural and small businesses under 100 employees.

The OBDF was originally capitalized by the State of Oregon Lottery Funds and an EDA RLF grant. Subsequent capitalization events have included the Oregon Lottery, General Fund, and SSBCI proceeds. As of July, 2017 the program had more than $35 million in current capitalization and a maximum loan amount of $1 million.

EDA RLF Program

The EDA Revolving Loan Fund Grant Program provides grants to communities to capitalize a Revolving Loan Fund. As part of the Economic Adjustment Assistance Program, EDA regional offices award competitive grants to units of local government, state governments, institutions of higher education, public or private non-profit organizations, approved economic development district organizations, and Indian tribes to establish Revolving Loan Funds (RLFs).

EDA's RLF recipient, in turn, disburses money from the RLF to make loans at interest rates that are at or below market rate to small businesses or businesses that cannot otherwise borrow capital. As the loans are repaid, the grantee uses a portion of interest earned to pay administrative expenses and adds remaining principal and interest repayments to the RLF's capital base to make new loans. A well-managed RLF award actively makes loans to eligible businesses and entities, continues to revolve funds, and does not have a termination date. As of November, 2017 there were 520 EDA funded RLFs making for a total combined capital base of $824 million.

Starting a Revolving Loan Fund

If small businesses in a community have issues accessing conventional financing, public and/or private entities can set up a Revolving Loan Fund. Here are some basic steps for starting an RLF:

Research existing RLF’s and compile samples of application forms, program guidelines, and other materials.
Invite lenders and potential borrowers to participate in the design process.
Establish the purpose of the RLF. This should include a needs assessment.
Set the eligibility requirements for borrowers.
Determine the allowed uses of funds as well as prohibited uses.
Set a minimum and maximum amount for the loans.
Decide if the loans must be matched by existing equity or other sources of funds.
Determine the length of the loan term, which may vary based on the use of the loan. For example, the term for a loan to purchase equipment may be based on the life of the product while a loan for real estate may have a 15-year term.
Establish an application fee, origination fee, and policies regarding closing costs. Define the default and delinquency terms.
Decide if the interest rate will be variable or fixed and whether the rate will vary based on the project.
Develop the loan application form. Create a short pre-application form or checklist to help borrowers determine if they are eligible.
Set up a committee to review loan applications.
Determine the administrative duties and staffing needs associated with the program.
Promote the RLF and capitalize with funds from grants and individual donations.
Provide loans and technical assistance to borrowers.

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 in supporting small businesses. The results include new jobs, new businesses, and a healthier local economy.