A revived business financing program.

Included in the federal budget passed this summer were several initiatives to promote the growth of small and mid-sized manufacturing companies. One of these programs was the permanent renewal of industrial development bonds (IDBs). Through this little-known financing mechanism, qualified manufacturing companies can issue IDBs to obtain tax-exempt, below-market-rate financing to construct or buy new facilities, rehabilitate an existing plant, expand a current site and/or purchase new equipment.

For companies that can take advantage of this program, IDBs are the lowest-cost financing alternative available.

Before the Tax Reform Act of 1986, IDBs were widely used for a variety of commercial activities. The Tax Reform Act limited IDBs to companies involved only in manufacturing. With the narrower focus, many people thought that IDB financing was no longer available.

The lack of awareness has resulted in millions of dollar's worth of IDB funds being left unspent.

IDBs are a type of municipal financing available to private companies for the purchase of land, buildings and new equipment associated with manufacturing activities. Because interest paid to the IDB bondholder is exempt from state and federal taxes, the interest rate paid by the borrower is substantially below rates traditionally available to medium-sized companies.

Although the local municipality's name is associated with the IDB to make it tax-exempt, all responsibility for payment of interest and principal rests with the private company as borrower. Since bondholders can look only to the company and not the municipality for repayment, the IDB must be supported by a letter of credit issued by a financial institution to guarantee the company's obligation. USES FOR IDB FUNDS

Funds are intended to help businesses purchase major assets. IDB borrowers can construct a new facility, purchase a newly constructed facility, acquire and rehabilitate an existing building, expand their current site, purchase new equipment or combine almost any of these uses.

In some cases, IDBs can be used by real estate developers to construct a build-to-suit project, or a company could issue an IDB to purchase a plant through a lease-to-buy option.

Borrowers receive financing at the lowest interest rate available. For example, over the past four years, interest on variable rate IDBs issued through California's Bonds for Industry IDB program, including bond coupon and annual letter-of-credit and administrative fees, have averaged 6 percent annually. Currently the rate totals approximately 4.5 percent to 5.5 percent.

Other benefits include terms of up to 30 years, assumability, and no pre-payment penalties on variable-rate IDBs. In addition, a single bond issue can be used for both construction and permanent financing.

To qualify for an IDB issue, potential borrowers must meet several criteria:

* Financing must be for a manufacturing facility: Manufacturing is broadly defined as value-added processing, product conversion or preparation of a product for market.

* Project cost must be between $500,000 and $10 million. Bond proceeds cannot be used to refinance existing debt.

* Borrower's total capital expenditures cannot exceed $10 million in the municipality where the IDB-financed project is located. This limitation covers expenditures for a period that extends both three years back and three years into the future from the date the IDB funds are issued.

* Individual states will frequently require that the project demonstrate a public benefit. For instance, in California this benefit comes in the form of job creation, job retention or energy conservation.

COMPOSITE IDB PROGRAMS

To make the IDB issuance process easier and more cost effective, several composite IDB programs have been developed in various states. Composite programs assemble all the parties necessary to complete an IDB (financial adviser, bond counsel, trustee and underwriter), help borrowers through the application process, develop standard loan documentation and take multiple borrowers' IDBs to market together to limit up-front fees and get the lowest interest rates. Although borrowers can apply for IDBs outside of composite programs, most borrowers find they can save money and limit complications by going through a composite. The IDB process is more complicated and time-consuming than conventional financing, and the fees associated with an IDB issuance can mount. Nevertheless, the low interest rate makes this the most attractive alternative over the life of the financing.

Union Bank and HB Capital Resources Ltd. structured and managed one-half of the IDBs issued in California since 1989. While their program is limited to IDBs within California, these advisers will help borrowers outside of California identify potential sources of IDBs.

Aaron Gershenberg is a vice president at the Los Angeles office of Union Bank, which is co-founder of California's Bonds for Industry composite IDB program and also serves as a financial adviser to the program.