There is no such thing as free money, but occasionally an honest-to-goodness bargain comes along. Trudy Corp., a $5-million company in Norwalk, Conn., recently stumbled on one when it was offered an intriguing approach to financing a new production facility.
Trudy, a 36-year-old marker of stuffed animals, had been purchased in 1979 by two brothers, Bill and Peter Burnham. At the time, it was a $1-million business with waning fortunes. The new owners thought that they could crank up growth by broadening the company's market thrust, and they proceeded to peddle Trudy's animals (bears, lambs, and their ilk) to mass merchandisers and chain stores.They also began making special-order items for such companies as Merrill Lynch, Pierce, Fenner & Smith Inc. (a stuffed bull) and Burger King Corp. (a stuffed Whopper).
The strategy paid off -- so well, in fact, that the Burnhams realized that the company would soon outgrow its 17,000-square-foot plant. In the summer of 1982, therefore, when Trudy's sales were nearing $3 million a year, the brothers began thinking about a new production facility and, not incidentally, how to pay for it. Naturally, they wanted to line up the lowest cost financing they could find. What came to mind were industrial revenue bonds (IRBs), which are designed to encourage businesses to expand within a particular area and which typically carry long-term interest rates about 10% to 15% lower than the prime rate. The Burnhams approached officials at the Connecticut Development Authority a state agency that authorizes growing businesses to issue tax-exempt IRBs, and explained that they wanted to build a new facility of about 40,000 to 50,000 square feet, at an estimated cost of around $3 million. They also told the officials the kinds of things that development authorities in distressed areas are always glad to hear: With the new plant, the company would eventually be hiring a few dozen new workers and that it would be the first company to move into the Norfolk, Conn., enterprise zone.
A month or so after submitting the formal application, Trudy got the go-ahead from the state to shop around among commercial banks and other potential investors for the best tax exempt borrowing terms. As they made the rounds, it seemed that they would have no trouble finding an investor willing to provide a 20- to 25-year loan to cover the entire plant cost. After all, Trudy was growing and its profits kept getting better.
But the tone of the negotiations changed. Even the most interested bankers began dragging their feet on the details, Peter Burnham recalls. Among other things, they seemed reluctant to lend the full amount. They also jacked up their requests for collateral. The Burnhams were understandably dismayed. Just as they were about to settle for the least disappointing offer in hand, however, they got a letter from a small investment banking firm named MacArthur/Nathan Associates. The firm is based in Madison, Conn., and Springfield, Mass., and John MacArthur, one of its partners, was interested in visiting Trudy.
The Burnhams sat down with the investment banker last February and told him about their troubles. MacArthur listened, and he studied the private company's financial reports. Impressed with the strength of the business, he told the Burnhams that he thought he could pull together an investment proposal with more attractive terms than the commercial banks were offering.
MacArthur's strategy was to take advantage of short-term, tax-exempt interest rates, which, he noted, had lately been about two percentage points lower than those available for long-term IRBs. But he wasn't actually proposing that the company finance its plant with short-term money. He was only recommending a financing vehicle called a "low floater." The low floater is a financing technique which, while pegged to short-term interest rates, functions in much the same way as a 20- or 25-year bond. It is, to be sure, built on tax-exempt instruments with a 30-day maturity -- which is why it qualifies for lower rates. But it is structured to roll over automatically at the end of every period, so that it acts every bit like a long-term bond.
MacArthur warned the Burnhams that there were lots of details they would have to attend to. They would have to secure and pay for a letter of credit from a major bank in order to satisfy the investors' need for protection, and they would have to hire an underwriting firm to sell the deal and remarket it in the secondary market. MacArthur offered to help move things along. But he estimated that -- even with these costly considerations -- the company would see savings of about two points, under market conditions of last winter: 7.5% compared to 9.5% to 9.75% for a more conventional IRB.
The Burnhams asked a host of questions about the potential risks. "The first thing I wanted to know was the peak rate level for low floaters back in 1981," remembers Peter Burnham. He found that when the prime rate surged all the way to 21 1/2%, low floater rates never exceeded 10%. As to whether there could be problems rolling over the 30-day securities, "I was satisfied that there had never been a problem in remarketing, so that was enough for us."
Today the Burnhams have a letter of credit from Citibank. Thomson McKinnon Securities Inc., of New York City, is their underwriter. Trudy's new production facility is due to be completed in January of 1985, at which point a complex transaction, totaling $3.5 million, is scheduled to close. While the initial interest rate hasn't yet been set, Peter Burnham anticipates that the company will wind up paying about 7 1/2% -- or possibly a bit less. Based on that cost of money, "I figure we'll be saving about $100,000 a year in interest charges compared to what we were originally planning to do," he says. "We feel like we're pretty safe, even if rates go up."
Trudy hasn't closed off its options, though. If at any point in the furture long-term rates begin to look more appealing, the company can convert its low floater into a fixed-rate bond. "If long-term fixed rates ever fell to 5% or 6%, we could jump on the bandwagon," Peter Burnham says. Then again, he is not holding his breath waiting for that to happen. Fortunately, he doesn't have to.