Business Finance Basics

Transcription

1 1 Business Finance Basics Equity Financing Debt Financing Finances and Firm Stage Empirical Data on Use of Debt & Equity Examples Finance Instruments & Disaster Recovery

2 2 Equity Financing Definition of equity Governance and financial rights Forms of equity: preferred stock, common stock, partnership interest, project equity Key equity terms Company valuation Voting rights & board representation Registration rights Anti-dilution covenants

3 3 Debt Financing Definition of debt Financial terms: Principal Interest rate Loan term (maturity) Amortization period Non-financial terms Collateral and security Financial covenants Debt service coverage ratio Loan-to-value ratio

4 Debt Examples Figure 2-1. Comparision of Princiapl Balance Over Time for Interest Only and Amortizing Loans $1,000, $900, $800, Interest Only Loan Princip al B alan ce $700, $600, $500, $400, $300, $200, $100, $ Number of Months Partial Amortization Full Amortization

5 Small Firm Capital Sources 5 Capital Source All Small Businesses Small Firms < 20 workers, sales < $1 mm Small Firms > 20 workers, sales > $1 mm Principal Owner Equity 31.33% 44.53% 27.22% Angel Finance 3.59% n.a. n.a. Venture Capital 1.85% n.a. n.a. Other Equity 12.86% n.a. n.a. Total Equity % 47.67% Commercial Banks 18.75% 14.88% 19.94% Finance Companies 4.91% 3.08% 5.47% Other Fin. Institution 3.00% 3.53% 2.83% Trade Credit 15.78% 11.81% 17.01% Principal Owner Debt 4.10% 5.59% 3.63% Other Sources 3.83% 5.11% 3.45% Total Debt 50.37% 44.00% 52.33%

6 Firm Stages 6 Seed Stage 1 to 3 years Very small size Pre-growth Limited finance needs Few assets No revenue Start-up Stage 1 to 5 years Small size Slow to moderate growth More finance needs Some assets Unpredictable earnings Maturity Stage 10 + years Largest size Modest growth Renewal investment needs Sizeable assets; may be outdated Earnings predictable Growth Stage 5 to 10 years Medium size Rapid growth High investment needs Sizeable assets Some earnings predictability

7 Capital Sources by Firm Age 7 Capital Source 0-2 Years 3-4 Years 5-25 Years 25+ Years Principal Owner Equity 19.61% 17.37% 31.94% 35.42% Total Equity 47.90% 39.37% 48.00% Commercial Banks 15.66% 30.84% 17.86% Finance Companies 8.33% 2.51% 5.85% Other Fin. Institution 3.84% 2.36% 2.87% Trade Credit 13.40% 13.42% 17.10% Principal Owner Debt 6.02% 6.19% 3.91% Other Sources 4.85% 5.31% 4.41% Total Debt 52.10% 60.63% 52.00% 56.50% 17.25% 3.28% 3.38% 13.86% 3.68% 2.05% 33.50%

8 8 Empirical Data and Growth Stage Theory High reliance on debt (> 50%) finance at start-up and early stages Heavy use of external institutional debt (40%) at start-up Growth in principle owner equity and total equity after 4 years Owner s personal assets are important to raising external capital

9 Financing Economic Development Class 3: Introduction to Accounting and Financial Statements I. Accounting Principles A. Dual Aspect Concept: A firm s Assets = Equities (Liabilities and Owners' Equity) Business assets must be claimed by someone, either creditors or owners Corollary, every financial transaction effecting a firm must involve two accounts of the firm. If an asset account increases, and assets = equities, then for this requirement to hold, either an equity account must increase or another asset account must decrease. B. Debits and Credits Asset accounts are called debit accounts; equity accounts are called credit accounts. Every financial transaction entails a debit and a credit. An increase in an asset account is a debit and a decrease is a credit. An increase in an equity account is a credit and a decrease is a debit. Income accounts are credit accounts; an increase in an income is a credit. Expense accounts are debit accounts. Increases in income add to the value owners equity, which is a credit account. Expenses reduce the income going to owners, thus are debits. B. Realization Concept and Matching Concept

10 These concepts are used to determine when to recognize income and expenses. Income is recognized and credited to a firm's accounts when goods are shipped or services are rendered. It is not recognized when cash is received. Matching concepts is the rule for how expenses are allocated: costs are recognized as expenses in the period when the revenue associated with those costs are reported. (Not when expense is paid for.) Alternatively, costs not directly related to producing a good or service are matched to the period in which they correspond. Examples: rent, administrative staff, other overhead. D. Accounting records are prepared on an accrual basis not on a cash basis. General Accepted Accounting Principals required accrual-based financial records. Difference between accrual and cash based financial statements Accrual is based on the idea of accurately presenting a firm's "earned income", i.e. the actual economic results of its activities, not the cash result of its activities. When we look at all the costs associated with an income generating activity over a period of time what were the financial results, independent of when the firm received payment for that activity and when it paid for the associated costs. Distinction between revenue (accrual) vs. receipt (cash) Distinction between expense (accrual) vs. expenditure (cash) Example of cash vs. accrual financial statement:

11 Compare September Accrual and Cash Income Statement for following business. A mail order bookstore ships $2,000 worth of books in September. The customers pay upon receipt of the books, which occurs in October. The inventory of books sold in September was purchased for $1200 over the past 3 months (June to August). Overhead costs for the month include rent of $200 and salaries of $500. Cash Statement Accrual Statement Revenue 0 2,000 Cost of Sales 0 (1,200) Rent (200) (200) Salaries (500) (500) Net Income (700) 100 One implication of accrual financial statements is that you can't understand a firm s cash flow, cash utilization and cash needs by the income statement alone--you need to understand both the income statement and balance sheet. Three sets of financial flows effect a firm s operating cash flow: 1. Purchase and production activities convert cash into inventories 2. Sales activities convert inventories into accounts receivables 3. Collection activities convert AR into cash Income statement covers part of 1 and 2; Balance sheet-part of 1 and 3. II. Accounting systems generate financial statements about the firm's financial position and financial operating results. Main financial statements are the Balance Sheet and Income

12 Statement. Example: American Biotechnology Company A. Balance Sheet - represents what is owned by a company (assets) and what is owed (liabilities and equities) --claims on those assets at a specific point is time. It can also be seen as a sources and uses of funds statement. A one-time status report. Major Asset Categories Current Assets -- assets to be used within one year vs. Long term assets - life of over one year 1. Cash 2. Marketable Securities 3. Accounts Receivable - bills for goods and services already rendered or delivered 3. Inventory - goods owned by a company to be used in its business; its includes raw materials, good in progress and completed products Long-term Assets: 4. Investments 5. Fixed Assets - Property, Plant & Equipment shown less depreciation 6. Intangible assets - goodwill, patents licenses, etc. 7. Other assets: e.g., pre-paid expenses

13 Major Liability Categories Current liabilities - expected to be paid off within one year 1. Accounts payable 2. Income taxes payable 3. Accrued expenses payable 4. Deferred revenue, i.e., prepayment for goods or services to be provided in the future 5. Current portion of long tem debt Other Liabilities 7. Long term debt Owner's equity: three parts: (1) stock, shown at "par value"; (2) other paid in capital--owner's direct cash investment over par value; (3) retaining earnings or accumulated surplus or deficit

14 Income Statement - presents earnings activities between two points in time. It summarizes two parts of business earnings - revenues and expenses. It tells us the economic results of the firm's activities during a period of time. A flow report. Income is reported for sales occurring during the period Expenses are reported to match revenue. Expense categories: Cost of goods sold - material and direct labor costs to produce goods or providing services. Can also be listed as Cost of sales. Revenue less COGS = Gross Margin. This is the profit margin before administration, overhead, interest, and taxes. Useful way to measure Gross Margin is as a percentage of sales Gross margin % varies for product sales and R&D Product sales gross margin = (5,013-4,967/5,013) =.009 R&D gross margin=(7,675-2,007)/7.675 =.73 Which business would you rather be in? From Gross Margin, the following expenses are deducted: Research and Development Expenses Selling, general and administrative expenses, i.e., overhead Depreciation and Amortization -- non-cash expenses The result after these expenses is Earnings Before interest and Taxes or Net Income before interest taxes. Sometimes this is referred to as Earnings Before Interest and Taxes (EBIT) Interest and taxes are then deducted to show the final result, or bottom line, net income (or earnings) after taxes

15 III. How to relate financial statement to cash flows Statement of cash flows included in audited statements but many companies, especially small businesses do not produced audited financial statements. Need to be able to generate your own cash flow statement. How to generate your own cash flow statement: First focus on cash flow from operations, before investment and financing activities. Cash Flow From Operations Begin with net income: 1. Add back taxes and interest (alternatively you can begin with income or earnings before taxes and interest) 2. Add back non-cash expenses (depreciation & amortization) 3. Add back sources of cash from balance sheet a. increases in AP, Accrued expenses, other accrued liabilities b. decreases in AR, inventory, prepaid expenses 4. Subtract uses of cash a. decreases in AP, accrued expenses, etc. b. increases in AR, inventory, etc. 5. Subtract taxes: Result is a net cash flow from operations To get a complete cash flow, you would adjust net cash flow from operations by (1)cash flow from investing activities, e.g., investment in plant, equipment, investments (2) cash flow from financing activities: proceeds from borrowing and stock sales, repayment of long term debt, interest payments.

16 16 Real Estate Finance Differences with business finance Real estate development process and financing issues Real estate financial statements Finance instruments & underwriting Funding gaps City Plaza example

17 17 Differences with business finance Scale of investment is large Financing physical, fixed assets Need for long-term financing Use of separate construction and permanent financing Competition and markets are regional and/or local More predictable income & expenses

18 18 Three Phases of Development Predevelopment Planning & design, site control, permitting, preleasing/sales, securing financing Large costs, high risk no revenue=>requires equity, grants, deferred loans Construction & development Site acquisition, final design & contractor selection, construction Limited risk => construction loan and equity Occupancy and management Asset management=> permanent debt take-out Retire debt, realize equity returns

19 Real Estate Financial Statements Development Budget 19 Sources and uses of funds statement Analogous to a balance sheet Acquisition, hard costs, and soft costs Contingencies and reserves Per square foot basis useful for comparisons Sources of funds Debt sources, equity investments, grants

20 Real Estate Financial Statements Operating Pro Forms Revenue, expenses and net cash flow CAM, escalators, and percentage rent Lease terms define revenue key to analyze Vacancy rates Operating expenses IREM, ULI comparable project data to analyze Replacement and operating reserves Cash flow, debt service and net cash flow Supportable debt: PV of [cash flow/dscr] Supportable equity: PV of net cash flow & expected gain on sale 20

21 21 Real Estate Debt Instruments Predevelopment loan Construction loan Real estate mortgage Mini-perm loan Bridge loan

22 Underwriting Real estate Loans 22 Development Team Capacity Experience & ability of development team members Management company deserves special attention Project cash flow risk Initial lease-up risk: will property be occupied at target rent? Tenant credit risk: will tenants pay their rent? Re-leasing/market risk Operating expense risk: are operating costs adequate? Collateral value and appraisals Appraisals set the market value & max. Three ways to value a property: cost, comparable sales, discounted cash flow. Quality of construction Quality of maintenance and replacement funding

23 23 Common Funding Gaps Supply of pre-development and equity financing Weak markets: Market rents do not support development costs New development needed to change market dynamics Lithgow block: income supported 57.5% of development costs; grant/subsidy for 42.5%

24 City Plaza: Supportable Debt and Financing Gap 24 Minimum Annual Cash Flow $144,550 Debt Service Coverage Ratio 1.25 Cash Flow Available for Debt Service $115,640 Supportable Mortgage Loan $1,152,105 Round to $1,152,000 Annual Debt Service $115,629 Total Development Costs $1,490,000 Total Sources (Debt & Grants) $1,302,000 Funding Gap $ 188,00

25 25 City Plaza: Options to Fill Gap Subordinate Loan from cash flow after senior debt Minimum Cash Flow $ 28,921 Assume 1.10 DSCR Cash flow for debt payments $ 26,292 Present value, 10 years, 10% $165,794 Present value, 15 years, 10% $203,887 Use 13 year term and amortization for loan Annual Debt Service: $25,895

26 Capital Availability and Capital Market Imperfections Centrality of addressing market imperfections What the theory of competitive markets says about potential capital market imperfections How the institutional structure/operation of capital markets informs market imperfections and capital supply problems Role of class, gender and race in capital markets Implications for economic development finance Dual practice framework Example: financing home mortgages for lowincome households

27 27 Market Imperfections in Theory Theory: perfect competitive markets allocate capital to the most productive users Perfect markets require: Many suppliers and users of capital Perfect information/insignificant information costs Insignificant transaction costs Costs and benefits are reflected in prices (no externalities) Participants seek to maximize economic returns Imperfections and capital supply gaps occur when these conditions do hot hold Political and policy case for development finance Better productivity and economic growth Social benefits

28 28 Capital Markets in Practice Capital markets: set of institutions that accumulate and channel savings to households, businesses and governments and provide a return to suppliers of capital Institutional structure and operation of capital markets shapes supply gaps Public vs. Private capital markets

29 29 Public Capital Markets Standard investment instruments Extensive public information Liquid investments Direct investor purchase of securities Regulated by states & federal government (SEC) Stock market supplies business equity Bond markets supplies debt to governments, firms and households Money markets supplies short-term debt High transaction costs to access public markets Several $ hundred thousand, >10% of small issues Gatekeepers interests and biases limit access

30 Private Capital Markets 30 Intermediary institution between capital users and suppliers Direct placement and negotiation of financing between capital user and intermediary Depository intermediaries: commercial banks, savings banks, credit unions Non-depository: commercial finance companies, life insurance companies, venture capital funds Geography affects supply High fixed information costs & opacity Regulatory influences on supply Non-rational behavior and investment bias

31 31 Capital Markets: Recent Trends Increasing role of public markets and decreasing assets held/originated by depositories Mortgage banks & brokers, pension funds, mutual funds Bank consolidation and growth in in venture investment has created larger intermediaries and minimum transactions Automation of business lending (credit scoring) Growth of fringe & predatory financial services in low-income and minority neighborhoods Sub-prime mortgages grew tenfold in 1990s

32 Race/class/gender and Capital 32 Availability Long history of disparity in access to capital and exclusionary policies FHA mortgage policies Red-lining of low-income neighborhoods Segregated financial institutions and networks Inequality in income, wealth, & education limits access to informal and formal capital Institutionalized discrimination in financial institutions & products serving communities Nexus of residential & financial segregation Sub-prime loans are 3X more likely in low-income area; 5X more likely in black neighborhoods, independent of income Large racial disparities in lending decisions and pricing remain

33 Economic Development Implications Several common capital supply gaps result from capital markets imperfections: Lack of institutional equity for most small businesses Limited availability of small commercial loans Limited availability of long term debt Disparities in access to capital exist based on geography, personal wealth, race and gender Private capital markets and intermediaries are most critical sources for community economic development Need to understand how market, regulatory and internal factors shape regional capital supply by private financial institutions for community economic development

34 Dual Approach to Development Finance Perfect operations/practices in private sector capital markets Risk sharing tools and policies Bank and financial institution regulation Addressing information and transaction costs Create alternative financial institutions Revolving loan funds Venture capital funds CDFIs Micro-enterprise Funds

35 35 Loan Guarantees Overview of guarantee terms SBA 7(a) program Capital access program Guarantee program policies and challenges Design of emerging technology fund

36 36 Overview and Terms Wholesaling approach: insure losses to get private lenders to make riskier loans. Efficient tool to expand capital availability: fund only expected losses Balance moral hazard with lending incentive Key guarantee terms: Loss covered: principal, interest, collection costs Percent of loss guaranteed Order of loss payment: first, second or pro rata Maximum guarantee amount Guarantee term (time period) Payment timing (direct pay vs. post-collection) Pricing: historic losses, option prices, bond prices

37 37 SBA 7a Program Largest small business finance program guaranteed 88,845 loans valued at $14 billion in FY2005 Guarantees up to $2 million on bank or finance co. loans for working capital and/or fixed assets: 85% guarantee on loans < $150,000 75% for loans > $150,000. Interest rate cap at prime % to prime %. Loan terms up to 10 years (WC) and 25 years (FA) In FY2005, $61.1 billion 7(a) portfolio equaled 5.9% of outstanding commercial & industrial loans by commercial banks. Estimate of 4.7% for all banks

38 SBA 7a Program: Impact on Private Lenders 38 7(a) program allows lenders to provide longer terms loans, lower equity requirements, and serve more start-up, women and minority-owned firms Based on 1996 GAO study: Average 7(a) loan term was 13 years vs. 3.3 years for non-guaranteed loans--51.5% of non-guaranteed loans were lines of credit vs. 2.1% for 7(a) loans. 22.1% of 7(a) borrowers were start-ups versus 0.4% for non-guaranteed loans. 7(a) borrowers were more likely to be minorities (13.5%) than firms receiving non-guaranteed loans (8.2%). These findings are consistent with results in Haynes study of the SBA 7(a) program, and lender survey data. Share of loans to minority and women-owned firms grew to 32% and 38%, respectively, in FY2005

39 SBA 7(a) Program: Innovations and Key Findings 39 Two important innovations over past 20 years: Preferred lender program: delegates decision to lender LowDoc program: simplify process for loans < $100,000 Findings from studies of 7(a) program: Haynes: strong evidence that SBA guarantees expand credit for high-risk borrowers; less evidence of increased lending in concentrated markets. Hunter: guarantees levels affect lenders care overseeing loans and default rates. Using a SBA guarantee to refinance loans increased default probability by 12%. Implications for practitioners: 7(a) program expands credit availability on better terms Work to maximize use of 7(a) program by local lenders Apply lessons of 7(a) program to other guarantee programs: Risk-based fee, no refinancing, incentives for lender care

40 40 Capital Access Program Portfolio-based guarantee Borrower fee (3%-7% of principal) and CAP program match deposited into a dedicated loan loss reserve at participating bank Reserve covers losses on CAP loans made by the member bank, with no additional recourse 20 states had CAP programs in 1999 with 315 participating banks and $1.2 billion in loans Thee states (CA, MI, MA) had 68% of CAP loans Two cities, New York and Akron, have CAP programs

41 41 CAP Program: Best Practices Increase CAP match to target loans to distressed areas and/or under-served firms: CT: 20% match in targeted urban areas IL, IN, PA raise match for minority-owned firms CAP loans seem to serve riskier firms that might not otherwise get credit: higher loss rates (3.9% cumulative), modest loan size (59,000) and high % of start-ups (18% in MA, 15% in IL) Best Practices for CAP program include: Active marketing and enrollment of banks Significant funding of reserves with capacity to expand them over time Use broad eligibility criteria with incentives to target lending to specific groups or areas

42 42 Guarantee Program Policies Targeting policy: compliment 7(a) program, but broad enough to gain lender participation Financing policy: terms and fees match risk and create incentives for lender oversight Maximum 1st-loss guarantee: 75 to 80% Tie fees to risks and their value Security for guarantee: GO pledge (govt.), cash reserve or cash collateral Underwriting standards: reflect targeting & financing policies Approval & monitoring process: maximize lender role use their analysis & reporting or delegate

43 Emerging Technology Fund: Discussion Questions 43 What financing problem does the ETF seek to address? What type of guarantee best fits this problem? For key program design issues: What is known to inform the design? What new information would you want? Are there lessons from the 7(a) and CAP programs that apply to ETF? How attractive is the program for lenders? What might help generate lender participation? What policies/process would foster greater lender care in loan underwriting and oversight?

44 44 Banks and Community Reinvestment Overview of Community Reinvestment Act CRA Advocacy Practice Pittsburgh Community Reinvestment Group Research on CRA impact Bank CDCs New CRA environment Bank of America Case

45 45 CRA History Emerged from civil rights movement 1968 Fair Housing Act prohibited discrimination in the sale and rental of housing Courts ruled that it applies to housing credit Home Mortgage Disclosure Act (HMDA) passed to address lack of enforcement Requires annual disclosure of home mortgage lending by census tract in every metro area for banks and credit unions 1989 law extended HMDA to mortgage banks and required disclosure of mortgage applications HMDA allowed activists to document lending in neighborhoods to demonstrate the need for the Community Reinvestment Act, which congress enacted in 1977

46 46 How CRA Law Works Requires banks to serve the banking and credit needs of their entire service area including LMI households, small farms and small businesses Banks define an assessment area that corresponds to their service area Regulators examine and rate banks on CRA performance which is a public record: Outstanding, High Satisfactory, Low Satisfactory, Needs to Improve, Substantial Noncompliance CRA performance is one criterion for regulators in approving applications for various actions: application for FDIC insurance establishing a new domestic branch New bank charters and changes in charter mergers, consolidations, and acquisitions

47 47 How CRA Law Works CRA reviews changed in 1995 from process- to outcome-based via score for three tests: A lending test - based on home mortgage, small business, small farm and community development lending A service test - retail banking and community development services An investment test - other investments, grants donations, etc. for community development purposes Disclosure of small business and small farm lending Frequency of CRA review based on bank size and past ratings Vast majority of banks receive outstanding or satisfactory ratings Tests do not consider race or denial rates

48 48 CRA Advocacy Practice Community-based coalitions in cities and states advocate for expanded bank lending and services in low-income and minority neighborhoods Coalitions research lending & service patterns, intervene in regulatory hearings, negotiate formal CRA agreements and monitor implementation Banks sign CRA agreements in response to bad publicity over past practices and to forestall opposition to mergers/expansions NCRC reports 428 CRA agreements for $4.2 trillion since 1977 some double counting as new agreements superseded old ones.

49 49 CRA Advocacy Practice Research, monitoring, publicizing information on bank performance Organizing campaigns, pressuring, negotiating to desired CRA agreements Collaboration with banks to implement agreements, offer new products & services and improve community reinvestment activities Marketing & demand side services need to fully utilize expanded financing Bank, coalition and community development partner capacity all important

50 CRA Best Practices and Challenges: Pittsburgh CRG 50 Long-stranding citywide CRA coalition Early successful campaign & CRA agreement with UNB/Integra merger Worked with many other banks and city to expand investment & home mortgages What did PCRG accomplish? Which approaches and practices struck you most effective or innovative? What were the most critical challenges to its impact?

51 51 Impact of CRA on Bank Lending CRA altered bank lending to LMI & minority communities: Banks rediscovered these markets and their profit potential New collaborations between banks, CBOs and local governments expanded commitment and capacity to serve these markets Institutionalizing special CD lending units Bank report that CRA changed their lending Banks with CRA agreements are more active home mortgage lenders to low-income and minority borrowers CRA loans are profitable & perform well Most banks report CRA small business and housing loans are profitable with equal or higher returns than conventional loans Small business CRA loan returns on equity, delinquency and charge-off rates are very close to conventional loans for the vast majority of banks

52 Bank CDCs: When a Bank is not a Bank A federal regulation allows banks to make investments and undertake activities to benefit LMI areas or advance the public welfare that they cannot outside do Flexible and non-bureaucratic vehicle through which banks can undertake unusual or high-risk activities: High risk loans Equity investments in firms, real estate projects, financing entities or organizations Direct real estate development activities Direct consulting and technical assistance activities Providing grants Limits on bank resources committed to Bank CDC: OCC: 5% of bank capital and surplus (can be 10%) Fed: 5% of bank capital and surplus for state banks Mellon bank example

53 53 New CRA Environment Bank consolidation has created superregional and national banks less tied to a single a city or region Banks establish their own CRA plans Set their CRA agenda Pre-exempt negotiation with coalitions Increasing non-bank lending, esp. home mortgages Adverse regulatory and legislative posture New trend toward pre-emption of state laws

54 54 Program Planning & Design FIVE STEP PLANNING FRAMEWORK 1) Define development goals and targets 2) Assess potential demand (demand side analysis) 3) Assess capital market conditions and gaps (supply side analysis) 4) Evaluate implementation needs 5) Choose institutional model and define products and services Apply to term projects

55 Development Goals and Targeting 55 Development outcomes and geographic focus What type of enterprises, projects and investments are central to goals and development strategies? What financing products and development services needed to advance "projects" are under-supplied? How do existing programs and institutions affect the target market? Use of secondary data analysis to set goals and targeting: Identify development needs and opportunities Find industries and type of firms most likely to advance your goals Define the size and location of potential target markets What targeting issues do you face in your projects? Approaches to analyze targeting?

56 56 Assessing Potential Demand Size and characteristics of the target markets number, size, ownership and location of firms. Target market financing needs and demand Demand vs. need: firms capacity to productively use capital and desire to seek external financing Demand side obstacles to financing and potential development services to address them Type and terms of financing required Expected demand for financing and services: number of loans, total annual lending, required amount of capital, level of development services Information sources: Secondary data Surveys Key informant interviews Focus groups Demand side issues for term projects and how to research them

57 57 Capital Supply Side Analysis Identify financial institutions and capital sources serving the community and target markets: Private & public, formal & informal sources Analyze the market conditions, type of financing supplied and activities of these institutions FDIC/FFIEC data, industry studies, bank call reports, and interviews Review actual practices of institutions and experience of targeted customers in securing financing Interviews, surveys, focus groups Synthesize information to determine supply gaps for target markets and the reasons for them Define interventions to address gaps: What financial products and services are needed? Expand private capital supply or create new program/ institutions? Demand side issues for your projects and how to research them

58 Consider Implementation Needs & Resources 58 What type and amount of capital is needed to fill the identified financing gaps Liability structure/capital sources necessary for financing role Amount of capital needed to meet demand and cover operating expenses: use of financial modeling Start-up funding & initial operating subsidies Type and availability of development services needed Capabilities for implementation under options Governance, staff, professional services, office & equipment, regulatory approval Stakeholders and relationships critical for program success? What are key implementation issues for your projects?

59 Institutional Choice and Program Design 59 Choose Appropriate Institutional Model: Focus on existing capital suppliers or create a new institutions Powers, risk-level, and financing needed for defined roles Amount and type of capital sources needed Desired accountability Define Governance Structure Size and composition of board Involvement of different stakeholders Role of private capital & technical assistance providers Loan review or investment committee roles Design Financial Products Debt\equity Use and purpose Pricing, maturity, amortization, security Balance customer, investment and management needs Development services and how will they be delivered Design investment process, underwriting standards, and servicing/monitoring requirements

60 60 Revolving Loan Funds One of the most common development finance models Part of the basic economic development tool kit Fills capital gaps not addressed via guarantees or CRA regulations Externalities, high-risk debt, high info & transaction costs Several thousand exist in the US, mostly run by public agencies or non-profit economic development organizations Primarily funded through with government grants, especially from CDBG, EDA and state governments RLFs make loans to small businesses, largely for job creation goals. Loan repayments are then recycled to make additional loans. Typical RLF supplies medium-term debt at below market interest rates Growth in technical assistance services by RLFS

61 61 RLF Capitalization and Impact Collectively, RLFs report large impacts but most RLFs have capital below $1 million and make 10 to 20 loans per year. A small set of RLFs have large capital bases, high lending volumes and generate more impact. Average RLF loan is small and higher risk than bank loans. For federally funded RLFs, average loan was $52,000 and default rate was 9.2% in mid- 1990s. State surveys show RLFs supplying smaller loans and have lower default rates.

62 62 State RLF Survey: Key Summary Data Measure AR CA IL MN NC OH WA Total Loans Made 1,088 2,827 1,743 2,634 2,060 2,081 1,071 Median # of Loans Median Capital ($000) Share of grants/ equity NA 12 NA ,300 1,300 <500 NA 70% 95% 75% 69% 76% 90% Median loan size 42,500 48,000 37,433 37,500 51,500 NA 30,000 Median loan term 5 yr. 7 yr. 7 yr. 8 yr. 8 yr. NA 3.5 yr,

63 Performance Data: State RLF Profiles 63 Performance Measure CA IL MN NC OH WA Total Jobs Created and Retained Average Cost per Job 14,537 18, ,135 11,091 20,483 9,877 $14,308 $5,148 $6,485 $9,233 $21,188 $5,984 Default Rate 6.9% 7.3% 6.1% 3.5% 1.2% <5%

64 64 RLF LEVERS AND POLICIES Targeting policy- most critical RLF policy: Eligible type of business/projects. Sets potential impact & scale Informed by local ED goals & strategies, capital gaps Financial products and terms: Loan size, interest rates, repayment terms and security; critical value in supplying subordinate and market rate debt Tradeoffs between development and financial goals Capital structure and funding sources: Defines level and type of lending for RLFs Should match targeting and financing strategy Underwriting criteria and risk standards: Formal policies to support sound lending and risk managements Standards for ED impact, business capacity, repayment risk Development services: Build demand, increase impact and reduce financial risks. Core loan packaging, one-on-one advice and referral services Relationship building: Explicit efforts to build referral networks, secure co-investment, expand development services, gain funding and political support,

65 65 Financial-Development Trade Offs Scenario: $ 2 million RLF Base Case: 7% rate, 5 year amortization 2% loss rate Assets and Cumulative Loans after 10 Years Assets: $1.82 million Loans: $4.48 million 9% Interest rate Assets: $2.16 million Loans: $5.2 million 3 Year Amortization Assets: $1.84 million Loans: $6.4 million 4% Loss Rate Assets: $1.54 million Loans: $4 million

66 66 RLF MANAGEMENT CHALLENGES Strategy Challenges Defining a strategy to maximize impact with limited capital. Complement other economic development activities and avoid capital substitution. Managing the trade-offs between economic development and financial objectives: taking risks and incurring losses, repayment terms and revolving loan capital, Operating Challenges Managing professional origination, underwriting and approval process with limited staff and for high-risk borrowers. Providing/securing sufficient technical assistance for client firms. Building strong relationships with multiple partners: business community, lenders, political leaders, economic development agencies, and technical assistance providers. Capitalization Challenges Securing sufficient and appropriate capital to achieve a sustainable scale

67 67 Industrial Site Revolving Loan Fund What is ISLF s targeting strategy? Financing strategy/policies? How well do they align with city ED goals? What are the strengths and weaknesses of these strategies? How well do ISLF lending operations appear to be managed? Do you see any best practices or lessons for other development finance entities from ISLF s experience? What changes or improvements would you recommend?

68 68 Venture Capital Overview of Venture Capital Three Phases of Venture Capital Investing SBICs and SSBICs State Government Initiatives Community Development Venture Capital Key Challenges and Best Practices

69 69 Overview of Venture Capital New capital source developed after WWII to supply equity to high-growth early stage and technology-based businesses that needed large investments before becoming profitable Potential for large economic development impact due to its role in financing new technologies and industries, and growth firms Private partnerships invest funds from financial institutions. pensions, corporations, wealthy individuals, & endowments Some financial institutions and corporations set-up their own funds. 1998: 500+ VC funds had $50 billion & invested $13 billion. With Internet boom, VC exploded to 635 funds that raised and invested over $90 billion in 2000! By 2005, investments dropped to $21.7 billion-67% above 1998 Multiple public and civic efforts to expand and target VC Federal SBIC/SSBIC programs and new market tax credits. 45 state initiatives via publicly managed funds, investment in private funds, or tax incentives to private investors. Some regions and cities have created venture capital funds Recent emergence of community development venture capital

70 70 Raising Investment Capital Need Long-term patient capital and far more capital than RLFs: VC funds typical have year life Capital covers high management costs, lack of cash flow in early years, and follow-on investments. Pension funds are key investor: 40%+ of new annual capital Fueled 240% increase in size of median VC partnership during 1990s Investors use incentives that tie compensation to returns and covenants in partnership agreements to influence managers ED-oriented venture capital funds use multiple capital sources: General obligation bonds (CDFC) Appropriations (Mass Technology Development Corp) Dedicated revenues (Alaska Renewable Resource Corp) Federal loans and grants (SBICs, Murex) Public pension funds: (Michigan, Silicon Valley VF) Local corporations and financial institutions : Tax incentives for private investors (Kansas, CAPCOs) Organizational form and capital sources are inter-related: Limited partnership is best to attract private and pension investors but precludes the reinvestment of gains Quasi-public corporation allows reinvestment of gains and greater accountability for government funding

71 71 Venture Capital Investing VC investing involves extensive pre-investment due diligence, staging of investments, active monitoring of firms (frequent visits, board membership), and syndicating investments among funds Funds screen a large number of firms to make a small number or investments. Only 1 or 2 out of every hundred are funded. Active monitoring favors investing near the VC fund office while syndications allow funds to invest outside their region. Implies the need for both local capacity and strong ties to national VC network. Growth in fund size has shifted private VCs from their historic role financing early stage companies to large transactions and later stage companies. Average VC investment grew in real dollars from $3.2 million in early 1980s to over $11 million in late 1990s. 2005: 6% of companies and 3% of invested dollars were in seed or start-up stage enterprises Investments are highly concentrated geographically (over half in CA, MA, and Texas) and by industry (80% in 4 industries) Herding by VC firms in which they over invest in a few hot industries and ignore others with strong growth prospects

72 72 Exiting Investments Exits convert illiquid investments to cash and realize returns Four ways to exit equity investments: Initial public stock offering (IPO)--the most profitable exit Acquisition of firm by another company Buyback of stock by firm Royalty or other debt-like payments A small number of investments generate super returns and account for the bulk of VC fund profits. A large share (25% to 35%) fail and most investments provide very modest returns Exiting strategies & returns closely linked to IPO market VC investment focus follows industries with strong potential for completing an IPO Role for public purpose VC funds in supporting growth sectors & technologies overlooked by public stock markets and VC industry Difficulty of exiting pure equity investments leads some VCs to use debt instruments with equity kickers Mezzanine investment-debt with warrants or royalties Deferred debt repayment with high interest rates and/or success fees

73 SBA Small Business Investment Company (SBIC) Programs 73 SBIC program created in 1950s to promote private venture capital by licensing SBICs and providing them low-interest debt Program flawed by use of debt to fund equity investment funds and many poorly run SBICs: Only 25% of almost 800 licensed SBICs are still active SSBIC program created in 1972 as tool for inner city economic development based on Black Capitalism SSBICs faced same problems as SBICs and had very small capitalization (many had $2 mm of less) 30% of SSBICs were still active in 1997 Average returns of 1% from 1976 to 1996; 5% from 1986 to 1996 Two types of financially successful SSBICs: Asset-based lenders for taxi medallions, restaurants, grocery stores Equity investors in larger growth-oriented minority and women-owned firms Lessons from SBIC/SSBIC Experience Don t use debt to finance equity investment funds Funds need a large capital base to be viable Private sector management does not guarantee success

74 State Government Venture Capital Initiatives states have promoted venture capital via three approaches: Public venture capital funds Investing state dollars in privately managed funds Tax incentives for private investment in privately managed funds Most states direct capital to privately managed funds Many initiatives are linked to demand side policies for technology commercialization and small business development. Programs build local venture capital capacity and demonstrate a market to attract larger flows of VC dollars Best practices from studies of state experience: State officials should set goals and monitor performance but not make and manage investments VC funds, public or private, need skilled professional managers, compensation to attract them, and sound investing processes. Public funds need to operate outside state civil service system Strong focus on financial returns is key to political & financial viability, and attracting private co-investment Marketing and development services are needed to generate sufficient deal flow How does the Canadian provinces labor-sponsored funds compare to US state approach? Are there lessons for the US?

75 Community Development Venture Capital 75 Emerging private venture capital investing for economic & social goals, e.g., job creation in low-income areas, quality jobs, minority and women ownership: Double bottom line Kentucky Highlands Investment Corp. created to simulate economic development in rural Kentucky, is the earliest CDVC fund. About half of current CDVCs serve rural regions. 68 funds with $870 million in capital in study found average fund < $7 million with just under half equity funds and the balance providing debt Seek lower returns that private VC funds (10 to 15%) Investments have been modest ($200,000 to $300,000), emphasized early stage firms and serve more diverse industries that conventional VC Banks have been the primary type of investor Growing focus on financial returns and trend toward bigger funds and investments in larger companies Social investment standards and practices are informal and need further development Capacity and strategies to exit investments are unproven

76 VC Management Challenges and Best Practices 76 Investment strategy must be linked to capacity to generate high-growth firms Service area and industry targets with scores, if not hundreds, of potential investments Link to demand-side initiatives to cultivate business opportunities and support entrepreneurs Attract entrepreneurs from outside the area Find and support entrepreneurs & firms with high growth potential Commercial use of technology from universities and research labs Support infrastructure of advisors, angels and skilled workforce Building skilled local VC management capacity Understanding of and commitment to ED mission Compensation to attract skilled managers Contracting with local private firms is an option Strong public/community oversight of managers Cultivating credibility and relationships with national VC industry Raise Appropriate Recurring Capital Sources Minimum fund of $5 to $10 million financed with equity Pension funds & financial institutions are key sustained sources Can New Market Tax Credits to expand the investor base?

77 Community Development Financial Institutions (CDFIs) 77 Private financial institutions focused on serving low-income communities Place-based with local accountability Primarily capitalized with debt: interest bearing loans or deposits Dominated by two models Community Development Loan Funds Community Development Credit Unions

78 Community Development Loan Funds (CDLFs) 78 New model using capital from "social investors" to raise funds for community development lending. Several hundred exist nationally; about half have an economic development mission. Locally organized and controlled non-profit organizations Large share of capital (50 to 60%) from loans by individuals, churches, foundations and banks. Access to a larger and more diverse capital allows larger average size than RLFs: almost $10 million Risk profile is between that of banks and RLFs Spread between cost of funds and lending rates covers operating costs. Need more assets to fund operating costs vs. grant-based RLFs average size close to $10 mm

79 79 CDLF Advantages Relatively simple to start-up since no bank charter needed Community control and responsiveness Flexibility in lending policies: no regulatory constraints Access to more funding than RLFs: foundation and government grants Institutional and individual loans Capacity to lend a large share of assets (70-90% vs. 50 to 60% for banks) Source of below-market debt for housing or non-profits by attracting below-market loans and subsidies

80 80 Financing Roles Suited to CDLFs Loan products must fit reliance on debt Interest rates, amortization and loss must meet cash flow obligations to investors Short to medium term debt with moderate risk Predevelopment financing for real estate projects Construction and bridge financing for affordable housing, commercial real estate projects, and non-profit facilities Working capital and equipment financing for small businesses Working capital and equipment financing for non-profit organizations

81 Business vs. Housing Oriented CDLFs 81 Housing CDLFs are 2X larger and utilize more debt capital than business funds Business CDLFs make more loans, smaller and have higher loss rates (7.2% vs. 2%) than housing lenders Business funds rely more on government funding (46% vs. 5%) Medium size business CDLFs ($2.5 to $8 mm) are strong performers with loss rates and high self-sufficiency

82 82 CDLF Challenges & Best Practices Defining target markets and products to match community needs, repay debt and reach scale Trend toward serving expanded markets geographically and by customer Manage lending process to reduce loan losses Sound underwriting standards and due diligence process Expand technical assistance (Cascadia Loan Fund) Fund expanded loss reserve Cultivate a stable and large investor base Core set of lenders with low turnover of loans Outreach and cultivation to expand investors: Boston Community Capital has over 300 sources Financial management of assets and liabilities

83 Community Development Credit Unions 83 A membership organization supplying banking services and loans to members with a common affiliation ( field of membership ) A financial cooperative--a member controlled institution based on one member-one vote governance An insured depository institution Serves low income individuals and communities 964 NCUA-designated credit unions with lowincome memberships; total assets of $15 billion (2003) Credit union model adapted to serve low-income communities via the civil rights movement and war on poverty

84 84 CDCU Characteristics Provide banking, credit and development services (e.g. education, counseling, technical assistance) NCUA Definition: 50%+ of members have income below 80% of US median income or earn 80% of national average wage Average asset size of $16 million; 65% of assets in loans. ROA on.9% Lending focuses on consumer loans. Auto loans account for 43% of loan assets; home mortgages are 20%. Business loans capped at 12.5% of loan portfolio, which can be waived for LICUs. Average loan charge-offs of.71% in 2003

85 Development Roles of CDCUs: Banking Services to the Poor 85 Provide an alternative to predatory and highcost financial service firms Tailor services to unique needs of non-banked consumers Convenient bundling of services Wire transfers and affordable pay day loans Partnerships to expand services and attract more members Financial literacy and asset development Financial education and counseling Credit building products and loans for low-income needs Individual development accounts to promote savings

86 Development Roles of CDCUs: Small Business Lending 86 CDCUs are more active small business lenders than conventional CUs Potential CDCU business credit roles: Personal loans for business purposes Small business loans to independent businesses with more emphasis on character lending Specialized/niche business markets Alternative business types Minority or immigrant-owned enterprises Affiliate entity to supply high-risk debt, conduct training & technical assistance, develop new products & services

87 CDCU Challenges and Best Practice 87 Building a large membership to start and sustain the credit union Define a field of membership with capacity for several thousand members and several million dollars in deposits Sponsor and partnerships to recruit members Creating a service model tailored to banking, credit and development needs of target market. Market research to understand customer needs and obstacles Partnerships & affiliates to expand & fund development services Use partnerships to reach a larger membership, supply diverse financial services, raise capital and lower costs Credit union service organizations to share costs Involve members in setting policies, delivering services and operations to advance the mission and reduce costs Non-member deposits to increase deposit base Cultivate capital sources for specialized lending roles

88 Self-Help and Opportunities Credit Unions 88 Self-Help Credit Union For what purposes was Self-Help Credit Union created? What are its primary lending activities and markets? How have these evolved over time? What are its primary sources of capital? How do these relate to and support its lending activities? What are the most important innovations and best practices from Self-Help s approach to development finance? Opportunities Credit Union What are OCU s primary lending activities, services and markets? How do these compare to Self Help? What is unique about OCU s approach to development lending? What specific products and services have they developed to address the needs of their low-income market? Are there common strategies, lessons or best practices across the two credit unions? What does their experience relate to the economic development role of CDCUs?

89 89 Microenterprise Finance Approach mushroomed in past 15 years with foundation and federal government support Serves start-up and small businesses with one (selfemployment) to five employees Service model combines training and technical assistance with lending Targets groups historically denied access to credit and TA: low-income, minorities & women Provides small loans: usually $500 -$10,000, but may be as high as $25,000 Staff intensive programs due to small transactions and more intensive entrepreneurial assistance Broader goals than traditional ED programs: poverty alleviation and human development Three service models: peer group, individual, training

90 90 Peer Group Lending Model Adapted from successful experience in developing countries: Grameen Bank, ACCION International Borrowers operate in a group context with credit decisions and collections made by the peer group Peer group also serves support and problem solving role Loans are staged with short repayment periods and "graduation" to larger loans as earlier loans are repaid Peer group guarantees the loans of all members. New loans are not extended until the group repays all prior loans Mechanism to serve small, start-up businesses that lack collateral and need very small amounts of capital Can lower costs, reduce losses and expand access for inexperienced entrepreneurs Adds complexity, group process may deter some owners, longer period to gain sizable loan

91 91 Individual Lending Model Provides TA and credit to individual entrepreneurs Loan approval through "traditional" process Primary emphasis on credit with less extensive training and basic skill development Provides larger loan amounts ($5,000 - $25,000) with longer terms (1-5 years) Serves both start-up and existing businesses Simpler model, easier to scale-up, services tailored in business needs More staff intensive, larger capital needs and lacks support mechanism of peer groups

92 92 Training-Led Model Focuses on business knowledge and skills as key factor for business success rather than credit Business plan development as focal point for training Credit is an optional, not defining element, of the program Entrepreneur can seek credit, defer start- up or not establish business Builds foundation in business skills & capacity; no staff and capital needs for lending Can add costs for intensive training and lacks credit incentive to attract & motivate entrepreneurs Adapt and combine models to meet local needs & goals Institute for Social and Economic Development (ISED) combine training programs with helping entrepreneurs access existing private financing Portable Practical Education Program (PPEP) - organizes associations among existing firms to deliver technical assistance and financing through these association

93 Program Characteristics & Performance Programs in 2002: 2/3 provide training, 2/3 supply credit largely via individual lending programs Average program: 175 clients and 41 loans per year Loans average $6,700; Portfolios average $341,000 Clients are largely women(64%) & low-income(58%) Training-led programs serve pre-start-ups with a high share of women and low-income entrepreneurs Credit-led programs serve start-ups and existing businesses; half of clients are women & low-income owners Median loan losses in 2000: 5% for training and 3% for credit-led programs High operating costs: $3,500/ loan; $379,000 per program Cost-recovery rates average 14%--programs are not self-sufficient and require sustained grant funding

94 94 Program Outcomes Studies report mixed outcomes: Some show positive impacts with income gains lifting a large share of participants out of poverty Others show modest job impacts and income gains Most effective program have job impacts on the scale of small RLFS: about 100 per year Businesses are largely self-employment often supplementing labor market income Taub vs. Servon: What is the ED potential of MEPs?

95 MEP Design & Operating Challenges 95 Defining target markets and service area to generate sufficient demand and address underserved groups Choosing the appropriate model and services Trends toward individual lending model and expanded services that assist clients overtime Reaching and involving historically isolated groups Special outreach via enterprise agents, partnerships, and social, community, and business networks Managing the lending and servicing process Formal lending policies and processes Standards and evaluation tools that fit start-up, informal and low-income entrepreneurs Delivering diverse training & TA services Address range of client and specialized business needs; evolve over time as entrepreneurs develop Securing adequate and sustained operating funds Expanding income, raising core grants & diversified sources

96 96 Best Practices Aspen Institute FIELD Project ( Training Pre-training assessment of participant s readiness to start a business Focus training on business plan development Strong emphasis on financial skills and structured real-world assignment Specialized short modules to develop skills, address industry issues and more flexibility Technical Assistance Extended technical assistance after training to help clients establish business and succeed with regular contact over a one to two-year period Coaching and guidance in assessing appropriate assistance Growth-oriented services to help firms access expanded markets. Specialized industry knowledge and relationships and investment in new capacity are critical to help firms gain new markets.

97 Managing Lending and Investing Operations Major Operations of a Finance Program Marketing and identification of projects Review and screening projects Underwriting of request and commitment of funds Servicing and monitoring of loans and investments Principles For An Effective Investment Process Well defined policies and procedures to align decisions with economic development goals and financial objectives Transparent process to facilitate successful applications, provide accountability and build trust Skilled staff devoted to all aspects of the process Creating a relationship of shared goals and mutual benefit Accountability at the policy and transaction level Commitment to continuous improvement 97

98 Marketing and Identification of Projects 98 Pursue marketing objectives Increase awareness and understanding of program Identify lending or investment opportunities Build relationships that help you achieve objectives Obtain information on your market and clients needs Marketing approaches Advertising Targeted mailings Press releases and press coverage One-on-one retail marketing: calling officer approach Referral networks Talks and presentations to selected audiences Best Practices Annual plans with senior staff commitment & resources Engage all staff in marketing Strong referral networks Track information sources for new inquires & customers

99 Initial Review and Screening of Projects 99 Objectives of the screening process Determine if the applicant and project fit economic development goals and type of financing provided Diagnose weaknesses and provide/refer to assistance Assess readiness for financing Provide a clear understanding of what the client needs to do to apply and qualify for financing Best Practices Screening criteria and standards to review requests An application standard --what a firm needs to apply and what must it have accomplished to be seriously reviewed Help firms meet standards and secure financing: Ineligible: refer and introduce to appropriate sources Incomplete information/weakness in project: Define what needs to be done, refer to technical assistance or provide assistance directly Infeasible or poorly conceived project: explain why

100 Underwriting and Commitment of Funds 100 Objective of the underwriting process Assess firm/project feasibility; ability to repay loan/provide return Understand the risks and how to reduce or manage them Decide on financing structure to meet the project s needs and your financial objectives Document decisions, expectations and financing transaction Three Components Underwriting standards Due diligence process Decision making process Best Practices Sound explicit underwriting standards A well-defined and thorough due diligence process Expertise in your target market or industries Proactive management to identify and resolve issues and make decisions. Provide leadership in financial packaging: know the constraints and requirements of other funders to visualize a viable plan that can meet all parties' objectives. Good systems to close loan and transition to servicing.

101 Option A 101 Staff Underwriting Analysis and Investment Proposal Internal Manager or Committee Review Investment Authorized Option B Staff Underwriting Analysis and Investment Proposal Staff Underwriting Analysis and Investment Proposal Option C Internal Manager or Committee Review External or Board Inv. Committee Review Board Review Board Review Investment Authorized Investment Authorized

102 102 Servicing and Monitoring Objectives of loan servicing and monitoring Ensure timely repayment of the loan or investment Protect collateral (tax liens, insurance, security interest) Track the firm's progress in meeting its objectives Identify/respond to problems to help firm and minimize losses Options Underwriting staff handles loan monitoring Separate staff handles loan monitoring Contract to third party Best Practices Clear and comprehensive servicing requirements Regular reporting: financial, ED standards, performance versus projections Strong internal tacking systems Follow-up quickly on non-performance Communicate with borrowers and develop trust Understand the source of problems and seek solutions Portfolio wide risk analysis; action plans to address problems

103 103 Risk Management Policies to Reduce Credit Risk Sound credit standards and policies Careful analysis of applications to address flaws before financing (Phoenix Forge). Provide technical assistance to resolve problems and strengthen firm or project Use loan covenants to provide warnings and leverage Active monitoring to identify potential problems early Obtain sufficient security within constraints of the borrower and your leveraging goals Good legal documentation of financing and security Fund adequate loan loss reserves Diversifying with a Targeted Investment Strategy Limit loan size Co-lend or co-invest with other lenders; sell loan participations. Vary loan types to reduce some risks (e.g. senior and subordinate loans, shorter and longer terms, etc.) Specialize: know your target market well to make good judgments Develop technical assistance capacity in target area

104 Raising and Managing Capital for Development Finance Institutions 104 Strategy & policies to raise and preserve capital to achieve mission and scale Impact of capital structure and sources: Shapes the type of financing that can be supplied Determines lending/investment volume and scale Ability to fund TA and development activities Impact of capital management policies: Source of capital via profits and retained earnings Financing products, terms & losses shapes the ability to raise capital from investors Three aspects of capital management Pricing, loss management, securing capital sources

105 105 Pricing Loans and Investments Set market-rate interest rates/investment returns: preserves capital, provide access to more sources; helps avoid capital substitution. If below market: Floor rate = cost of capital + expected loss rate + operating cost percentage. Reduce risk of loses from fixed rate and long-term loans: Variable rates for short-terms loans and when interest rate risk can be absorbed by borrowers; rate caps can limit borrow risk. Sell or securitize fixed-rate loans Match fund large fixed-rate loans or new programs, via FHLB Community Investment Program, negotiated loan, or development deposits. Risk of losses from prepayment exist. Consider using tools to accelerate loan repayment: Medium term with long-term amortization; Call provisions when borrower or project becomes bankable Interest rate kickers

106 Managing and Funding Loan Losses 106 LA Community Development Bank: loan losses of 40% Sound investment standards, policies and process Base annual loan loss reserve on the greater of expected losses or average losses over an economic cycle to build up reserves in good times and avoid catastrophic losses. Establish mechanisms to fund losses Set interest rates to cover expected losses Charge a loss insurance fee, e.g., Capital Access Program Raise grants to fund loan loss reserves, especially important for small and start-up entities or programs Use of loan guarantees for depository institutions

107 Raising Capital & Expanding Funding Sources 107 Four components of capitalization Secure core grants and equity Cultivate stable debt sources Manage funds for others investors Pursue loan sales and asset securitization Community Reinvestment Fund Seed Corporation Example

108 Diagram of a Loan-backed Securitization 108 Loans transferred to trust Developme nt Finance Institution (DFI) Bankruptcy Remote Trust Established to Hold Loan Assets Trustee receives loan payments and pays out cash flow to investors and DFI. DFI gets subordinate interest in loan cash flow and proceeds from security sale. Investors receive cash flow from loans over time. Asset-Backed Security With Senior Interest in Loan Cash Flows Investors Purchase Security Investors purchase security, providing cash proceeds to DFI.

109 Municipal Finance & Economic Development 109 State & local government taxing powers, debt tools and credit quality can serve economic development purposes: Raise capital for development finance programs Finance infrastructure, public improvements or services needed to attract private development and investment Expand capital availability for manufacturers and development projects in targeted areas Finance non-profit facilities Primary municipal finance tools are: Tax-exempt debt Tax-increment financing Assessment districts

110 110 Municipal and Tax-exempt Debt Major Types of Municipal Debt General Obligation Bonds Revenue Bonds Tax Increment Financing Allowable Uses of Tax Exempt Bonds Under IRS code. General state and local government facilities/uses 501(c)(3) use, i.e., non-profit organizations Industrial development bonds for small manufacturers Waste-water and solid waste treatment facilities; pollution control facilities Multi-family and single family housing bonds for lowincome households Redevelopment bonds to eliminate slums and blight Empowerment Zone Facility Bonds

111 111 Industrial Development Bonds Tax-exempt financing for manufacturing plants A source of long-term fixed rate debt Firms limited to $10 million within 3 years (+ or -) of the date of issue and $40 million over their lifetime Primarily a capital subsidy for firms that are bankable as bonds require a letter or credit or willing buyer Can expand access to capital markets for small firms: Pooling several small loans into one bond (PA, AR) Provide credit enhancement through reserve or insurance fund (MA) Lower transaction costs with private placement, standard legal documents and financing team=> makes small transactions feasible. St. Louis mini-bond program with deals of $500,000 to $2 million

112 112 Structuring Municipal Debt Interest paid semi-annual Typical structure is serial bonds Principal divided into series of bonds with sequential annual maturities Lowers interest cost Match annual maturities to available cash flow Debt service = interest on all bonds & principal of maturing bond

113 113 How much debt can be supported? Year Available Cash Flow Interest Rate ,000, % Principal Amount ,250, % ,500, % ,000, % ,000, % Total 12,750,000

114 114 Calculating Principal Amount Start at last year=>interest paid only on maturing bond Cash flow (CF)=Principal (P)+ Interest (I) Interest = Interest rate (i)*principal Cash flow = P + P*I; CF=(1+i)*P P=Cash flow/(1+i) P 2011 = 3,000,000/(1.05) = 2,857,000 2 nd to last year, interest on P 2011 & P 2010 I =.05(P 2011 & P 2010 ) CF = P (P 2011 & P 2010 ) = 1.05* P *P 2011 P 2010 = (CF -.05* P 2011 )/1.05 P 2010 =(3,000, *2,857,000)/1.05 = 2,721,000 P n = (CF n Interest on future principal)/(1+ i n )

115 115 How much debt can be supported? Year Available Cash Flow Principal Interest ,000,000 1,460, , ,250,000 1,780, , ,500,000 2,117, , ,000,000 2,721, , ,000,000 2,857, ,850 Total 12,750,000 10,935,000 1,812,396

116 116 Tax Increment Financing Set aside new "incremental" tax revenues to raise financing for a project or public improvements. Financing can be on pay as you go basis, debt, or developer financing Base year tax assessments & revenue frozen at year TIF district is established and continue to flow to taxing jurisdictions New or incremental taxes after base year are diverted to TIF district and its governing authority. Increment comes from assessment growth, improvement to existing properties and new development

117 TIF Uses to Support Economic Development 117 Address site and infrastructure obstacles for a project Site assembly and preparation Environmental contamination Public infrastructure Address blight and infrastructure needs that impair development & investment in a large area or district Target investment of tax revenues to an area suffering from neglect and disinvestments Can be a tax base sharing mechanism (e.g., Montgomery County EDGE Program) Spread and abuse of TIF whereby it is used to bypass voter referendum requirements and/or subsidize development that would otherwise occur, diverting revenue from local governments Uncertainty in level and timing of incremental tax revenues is a obstacle to selling bonds and using TIF Orlando TIF Case

118 118 Tax Increment Financing Set aside new "incremental" tax revenues to raise financing for a project or public improvements. Financing can be on pay as you go basis, debt, or developer financing Base year tax assessments & revenue frozen at year TIF district is established and continue to flow to taxing jurisdictions New or incremental taxes after base year are diverted to TIF district and its governing authority. Increment comes from assessment growth, improvement to existing properties and new development

119 Creative Use of TIF Financing: Genesee County Land Bank & TIF District 119 Flint, MI has a large supply of tax foreclosed & abandoned property Reuse required reform of the tax foreclosure process and a way to raise funds to clean-up, assemble and improve abandoned properties Three-part financing strategy A land bank to hold and sell properties and use sales proceeds to reuse purposes A scattered site TIF district to use tax-increment on reused properties to fund other projects County-wide scope to use revenue from stronger suburban market to fund projects in Flint

120 Challenges to TIF-Debt Financing Orlando Case 120 How much can the CRA borrow with the TIF revenue and a 10-year bond? What can be done to increase the debt that can be raised with the TIF revenue? What credit issues and risks do you see for investors? What could be done reduce these risks and strengthen the credit?

121 121 Assessment Financing A fee is assessed on property owners in a geographic area to financed needed infrastructure or services Special district area is set to include the beneficiaries of the infrastructure or services funded. The district collects the assessment and uses it to either pay the cost of services and/or repay debt issued to fund infrastructure. The district may build and maintain the infrastructure that it finances, or it may only be a financing entity. Widely used to finance services, infrastructure and facilities of 34,683 special districts according to 1997 US Census of Governments). California and Illinois were the most active users of special districts, each having over 3,000

122 122 Assessment Financing Difference from Tax Increment Financing A new, added levy is collected instead of using the increase in existing taxes from new development. New development or tax base growth is not required for an assessment district to be a feasible financing tool Economic Development Uses Finance infrastructure for new development in a targeted area. Finance improvements for an existing redevelopment area or to support a specific economic development project. (e.g., a parking garage for a downtown development project) Fund services or activities that benefit property owners and/or businesses in a business district. (Business Improvement District).

123 123 Business Improvement Districts Assessment district used to improve & revitalize commercial districts, usually downtown. Addresses need beyond infrastructure, such as public safety, cleaning services, beautification, promotion and marketing, special events, business recruitment & retention, and transportation. Marketing in the most common BID activity Supplemental security and sanitation are common in large cities Dallas BID funded a trolley to transport people from downtown to a nearby neighborhood retail district. Dayton funded marketing and business recruitment. Cleveland funded security, maintenance, & collective marketing 404 U.S. BIDs in California, New York and Wisconsin accounted for almost half. BIDs expanded in the 1990s, with over half created in that decade

124 124 Business Improvement Districts Organizing aspect of BID is key to get property owners, merchants, others to set shared goals and priorities, commit to work together to address them, and contribute financially to fund activities Process of planning, organizing and gaining BID approval is complex and time consuming can take 1 to 2 years. A capacity- and trust-building process whereby the time and effort invested in building a shared vision and commitment should have long-term benefits BIDs fund staff to organize, coordinate, plan and advocate for the business district and important projects Priorities of property owners and merchants may differ Property owners may emphasize physical improvements Merchants may care more about attracting shoppers Common interests around security, cleanliness. Interests could be represented in separate BIDs (Albany) Business/property owner financial commitment is a way to leverage more government funding. Dayton BID is funded 1/3 by business assessment, 1/3 by the city, 1/3 by the county.

125 Feasibility Study of the New Orleans Digital Media Center Prepared by: MIT and UNO Student Group Date: May 19, 2006 Lisa Brosnan, UNO Shawntel Hines, MIT Quinn Eddins, MIT Tegin Teich, MIT William Massaquoi, MIT

126 Executive Summary Digital Media Center Finance Plan Digital media is any type of information in digital format, including computer-generated text, graphics, and animations, as well as photographs, animation, video, and sound. Digital media is beginning to dominate as the preferred form of media because of its ease of storage and documentation, particularly in the recent decades where computerization of data has grown. Louisiana has made great strides to become competitive in the digital media industry, largely through the creation of tax incentives for film, music, and information technology. Before Hurricane Katrina, the entertainment industry was identified by the Mayor s Office of Economic Development as a promising cluster with a relatively high multiplier and the potential to create a significant number of new jobs and tax revenues. In 2004, the State of Louisiana ranked third in the nation for film and television production revenue, falling behind only California and New York. Louisiana, New Orleans in particular, has a long history with music and a strong music culture, both of which have been responsible for thousands of jobs in the city. While generous tax packages lure out-of-state studios, producers, and other digital media related work in New Orleans, these companies often cite a lack of in-state production facilities and skilled workers as the main drawbacks to working in Louisiana. In order to remain competitive with other states in the digital media industry, Louisiana must offer more than tax incentives, building a skilled labor force and production facilities to retain production expenditures in the state. New Orleans should strive to accomplish these goals at the city level particularly by promoting the development of a strong, locally-driven industry. Unfortunately, Hurricane Katrina was a major setback on the digital media industry in New Orleans, with several cancelled infrastructure projects, feature film projects, and independent films. Musicians and industry personnel were displaced. Skilled workers in the IT industry have found jobs elsewhere. Training for skilled workers has been disrupted due to budget cuts in higher education. Mayor Nagin s Bring New Orleans Back Commission outlined a plan for recovery of the film, music, and technology industries in New Orleans in the wake of Hurricane Katrina, calling on the creation of an attractive business environment and the encouragement of private investment. It calls for the development of the digital media industry as a major source of new jobs and opportunities for local business, including the construction of a digital media campus that would house a fiber optic connection, full animation capacity, and software and project development pipelines, and would be financed by private investment using New Market Tax Credits. In addition, this facility should provide production facilities for entertainment industries, education and professional training, and business incubation. To meet the needs outlined in the Bring New Orleans Back plan, the Mayor s Office of Economic Development has proposed the construction of a 60,000 square foot, $25 million digital media center. In order to maximize the impact of the digital media center on the local economy, the city should avoid duplicating services that are already in sufficient supply. Instead, the proposed digital media center should provide services that are undersupplied or unavailable in existing markets. This report recommends that partnerships with local colleges and universities lead to the construction of a digital media center that provides: education and professional training, 20,000 to 30,000 square feet of production facilities including office space for use by students, incubator clients, and local filmmakers, and 30,000 to 40,000 square feet of business incubator space for

127 ii 127 fledgling, local digital media businesses. As a business incubator, the digital media center would facilitate connections to funding and partnerships, provide on-site classes and seminars to enhance the business owner s working knowledge of business basics, and supply computer servers and a robust technology infrastructure. Unfortunately, digital media incubators face key financing gaps typically involving capital shortages in early-stage financing for construction and equipment purchase, ongoing operational sustainability, and enabling start-ups to be competitive. In addition, owners of fledgling companies usually have to pledge a higher return rate to their investors or lenders to persuade them to assume the higher perceived risk associated with a new project. Several lessons can be learned from existing digital media incubators: there has been no use of large private debt and equity sources except those induced by tax-incentives and that large independent foundations are not as active in supporting the construction of digital media incubators (though they may provide support for other aspects of digital media projects). The three main sources of start-up financing for digital media incubators include bonds, individual or family foundation donations, and federal EDA grants. Four models of initial or expansion financing for digital incubators include gifts and grants from wealthy philanthropists, public/private funding, public funds, and a combination of debt and public funds. Potential funding sources for these models include private equity, partnerships, debt, and grants. A combination of these four sources is recommended to finance the city s proposed digital media center. Specifically, this report recommends the donation of city land for the digital media center and the use of approximately $6 million in equity funding facilitated by state tax incentives and New Market Tax Credits, $1.5 million from EDA Programs, $1.95 million form partnerships, and $2 million in CDBG funding. Recognizing that there are differing visions of the future of the digital media industry in New Orleans, this report argues that a more holistic vision beyond the construction of an additional physical center should be undertaken to ensure a thriving industry capable of sustaining a larger number of local firms. To this aim, two additional recommendations are made: that the city encourage a collaborative visioning effort through the creation of an organization that brings together local businesses, non-profits, and government players with interest in the digital media industry, and the consideration of cultural aspects that can further support the growth of the industry. The idea of using different economic, social, and cultural elements to support a new media industry is demonstrated using Vancouver as a case study. In the event that funding obstacles prove insurmountable, this report offers an alternative proposal to the construction of a digital media center. This alternative plan is a two-pronged approach, including a business incubator without walls for the local digital media industry and a comprehensive training initiative building on the recommendations in the Bring New Orleans Back plan. Idea Village serves as the model for the business incubator without walls, which would provide business services, entrepreneurial and digital media networks, digital media education, access to infrastructure, and a loan fund. Training initiatives have already been started on the state level; this report recommends that the city encourage workforce development by providing job skills and work opportunities to high school students and graduates, address the needs of the existing workforce through continuing education by encouraging local community

128 iii 128 and technical colleges to provide training and certificate programs in skills specific to the digital media industry, and continue other initiatives to better connect the workforce to the needs of industry. Hurricane Katrina severely disrupted the growth of the entertainment industry in New Orleans and stunted the state s plans to be a hub for digital media. The city s plan to construct a digital media center would fulfill several economic development goals, including small business support and job creation. However, the construction of a digital media center will face financing obstacles which can be overcome by combining equity, debt, grants, and partnerships. Both the digital media center and its proposed alternatives will support post-katrina economic development goals helping to restore New Orleans as a strong competitor in the entertainment and digital media industries.

129 Table of Contents Section I: Overview of the Digital Media Industry 1 Section II: Recommended Program for the Proposed Digital Media Center 4 Section III: Financing and Sustainability Plan 12 Section IV: Financial Analysis 19 Section V: Managing and Expanding Visions of the Digital Media Industry 20 Section VI: Alternative Proposal 26 Section VII: Additional Resources 30 Section VIII: References 35

130 I. Overview of the Digital Media Industry Louisiana has made great strides to be competitive in the digital media industry, largely through the creation of tax incentives for film, music, and information technology. The entertainment industry was identified by the Mayor s Office of Economic Development as a promising cluster with a relatively high multiplier and the potential to create a significant number of new jobs and tax revenues. This industry, drawing on New Orleans unique culture, also enjoys a symbiotic relationship with tourism, which is the largest source of revenue for the city. In 2004, the State of Louisiana ranked third in the nation for film and television production revenue, falling behind only California and New York. Louisiana hosted over 40 major film and television productions with total expenditures exceeding $550 million, over 80% of which occurred in the New Orleans area. More than $67 million in payroll was expended on Louisiana residents. Over 1,000 new jobs were created in the state with approximately 600 being permanent, well-paying jobs. The film industry has grown so rapidly in Louisiana over the past few years that many are calling the state, Hollywood South. Studios and producers, lured by a generous tax incentive package, enjoy working in the state. However, these studios often cite the main drawbacks to working in Louisiana as a lack of in state production facilities and a lack of skilled workers. While production studios benefit from the state s film tax credits, those benefits may be lost in travel expenses incurred from bringing crews into the state. Leaders in the industry in Louisiana, though, have indicated that current facilities are not working at capacity and that Hollywood producers would like to see a larger workforce in Louisiana in order to bring labor costs down. Tax incentives for the digital media industry are listed in the Appendix. The tax incentive package for film in Louisiana production has recently been altered. As of January 1st, the State of Louisiana will provide incentives solely for in-state production expenditures. Louisiana offers very competitive tax incentives, but other states are looking to benefit from such strategies. The Illinois State Senate recently passed legislation that would increase tax incentives in that state and also extend benefits to January, Other states with competitive tax incentive packages include New Mexico, Massachusetts, and Florida. Canada does approximately $5 billion in movie production annually. Most studios and producers, though, would rather film in the U.S. when incentives are evenly matched. Louisiana, and New Orleans in particular as the birthplace of Jazz, has a long history with music and strong music culture responsible for thousands of jobs. Festivals contribute to the economy of the city while adding invaluable character and atmosphere. Film scoring, for example, is an industry within digital media with great potential. New Orleans is home to a wealth of musical talent in film scoring who generally must leave the state to earn a living. Budgets for major motion picture scores, usually done in Los Angeles and London, can soar into the hundreds of thousands of dollars. Scores for midsize projects, in the tens of thousands of dollars, are usually recorded in Seattle and Salt Lake City. Standard pay for musicians is $60.00 per hour, and pay is higher for section leaders and conductors. Tax incentives also exist for in-state music investment.

131 Pre-Katrina, business, university and government leaders worked together to pass state legislation that would attract the high-growth digital media industry to Louisiana. Through this legislation, the state positioned itself to become a hub for emerging technology in the fields of video games, educational software, and simulations with a variety of uses from medical to homeland security. The IT industry had directly employed approximately 8,000 people in New Orleans prior to Hurricane Katrina and had a gross impact of approximately $1.2 billion annually. In order to remain competitive with other states in the digital media industry, the state of Louisiana must offer more than tax incentives. Recognizing this, the state is focused on building a skilled labor force and production facilities to retain production expenditures in state. Post-Katrina Recovery of the Industry in New Orleans Hurricane Katrina has had an enormous impact on the film and television industry in New Orleans. Substantial infrastructure projects were cancelled, as were several feature film productions and a host of smaller independent films. A few of these projects were put on hold, but many relocated elsewhere. The local businesses that support incoming production were also greatly impacted by Hurricane Katrina. Local vendors and suppliers were destroyed and key industry personnel were displaced. Many have followed productions to other parts of the state as well as to other parts of the country. Musicians and industry personnel have been displaced, without the ability to support themselves financially in New Orleans. Skilled workers in the IT industry have found jobs elsewhere while the training for skilled workers has been disrupted due to budget cuts in higher education. Government Initiatives to Rebuild the Entertainment Industry Bring New Orleans Back Redevelopment Action Plan Mayor Nagin s Bring New Orleans Back Commission has outlined a plan for recovery of the film, music and technology industries in New Orleans in the wake of Hurricane Katrina, involving thecreation of an attractive business environment and the encouragement of private investment rather than federal funding for digital media. This would be accomplished through existing state legislation and a refocusing of federal legislation to entice various components of the industry to return to New Orleans. For example, in order to enhance existing Louisiana film and television incentives, two existing federal programs would be employed. These include a modification of IRS Section 181 and the New Market Tax Credits. The BNOB plan does not just focus on recovery; it calls for the development of the digital media industry as a major source of new jobs and new opportunities for local business. Specifically, it proposes a digital media campus to house video game companies using the

132 Louisiana Digital Media Act tax credits. It would include: a fiber optic connection to the Internet backbone, fully built animation capacity, software and project development pipelines, and the work space to accommodate 250 to 500 people. The plan also calls for the development of a unified, standardized academic program among the five major universities in New Orleans to educate the workforce required to sustain the industry. The plan requests $100 million of the CDBG dollars already allocated by the federal government to the state to be put toward rebuilding infrastructure and supporting university initiatives. No direct federal funding other than what is already available through GO Zone legislation is required. Louisiana Economic Development Council Plan, Vision 2020 Louisiana s long-term master plan for economic development, Vision 2020, advocates a cluster strategy for developing the state s economy and ensuring its future competitiveness. The cluster strategy focuses on developing linkages between competing and complementary companies, suppliers, and associated institutions and developing critical industry infrastructure in order to recruit out-of-state companies and support the development of local companies. The plan identifies nine high-priority industry clusters including entertainment and information technology. Through partnerships that combine the information technology and entertainment industries, the state government intends to put Louisiana at the forefront of the development of creative and highly lucrative digital media content.

133 II. Recommended Program for the Proposed Digital Media Center In accordance with the recommendations of the Bring New Orleans Back committee and the Louisiana Economic Development Council, the city of New Orleans is considering the construction of a $25 million, 60,000 square foot digital media center. It is expected that the center will facilitate the growth of the entertainment industry in the state and, in the process, create new jobs and new opportunities for local businesses. Digital media centers typically support the development of digital media related industries by providing the following: Production Facilities for Entertainment Industries Providing state-of-the-art facilities and support services for the production of digital media can increase the production of motion pictures, television shows, computer games and web content within a region. An increase in the activity of these industries can in turn create secondary benefits for additional industries, such as real estate, hospitality/tourism and transportation. Education and Professional Training Training a workforce with skills in digital media production can help to attract the production of film, television, computer game and internet content to a region while improving the capacity of the local economy to capture the economic benefits created by these activities. Business Incubation Offering space and services for fledgling digital media companies will promote the creation of indigenous digital media industries. These home-grown industries will be instrumental in enhancing the region s reputation as a prime location for digital media production. If the proposed digital media center is to maximize its impact on the local economy, it should avoid duplicating services that are already available in sufficient supply and focus on providing services that are undersupplied or unavailable in existing markets. Current and future supply and demand for digital media production, training and business incubation facilities must be taken into consideration when determining the type and extent of facilities the center will offer. After careful consideration of the relevant markets we prepared the following recommendations: 1. Provide 20,000 to 30,000 square feet of production facilities for use by students, incubator clients and local filmmakers, but do not target facilities and services toward large-scale film production companies.

134 Rather than training students directly, form partnerships with local colleges and universities. Such partnerships will provide students access to production facilities, give incubator clients access to training, seed capital and university-based entrepreneurial culture, and create the opportunity for technology transfer. 3. Provide 30,000 to 40,000 square feet of well-equipped office space for incubator clients in conjunction with business development services. The following three sections provide an analysis of existing market conditions in support of these recommendations. The Market for Digital Media Production Facilities When examining the market for digital media production facilities, it is important to distinguish between facilities for film production and facilities for digital media production. Production space for digital media may or may not suit all the needs of film production. A digital media center could provide high capacity servers, fiber optic cables, equipment for capturing, editing and screening high definition video, facilities for recording, mixing and mastering high definition audio, and equipment for 3D animation, character design and compositing - all of which a film production may not use - while providing studio space that is too small for the production needs of most feature films. Likewise, studio space for film production may or may not have the facilities and equipment needed to record, create and manipulate images and sound digitally, though it can be expected that large film production complexes will contain facilities for digital media production. The Robert E. Nims Center for Entertainment Arts, Amusements and Multimedia Industries in New Orleans is such a complex. In addition to 79,000 square feet of studio space, the Nims center offers a robust IT infrastructure, HD video and audio equipment, facilities for HD sound production and facilities for digital editing and 3D animation. Thus, while New Orleans does not currently have a full-fledged digital media center, a wide range of digital media production facilities are available. Roger Benisheck, director of the Nims Center, says that the center purchased its HD and digital editing equipment because no other facilities were offering these services in New Orleans but since 2002 there has been an adequate supply of film production related digital media production facilities in the city. The supply of digital media facilities for commercial film production is likely to increase in coming years given current plans to build two large-scale film production facilities in and around New Orleans. Louisiana Entertainment Associates has announced plans for a $250 million movie-making complex in Tangipahoa Parish, about 50 miles northwest of New Orleans. The complex, named Louisiana Cinema City Studios, would include studios, production offices, a film laboratory, shops, restaurants, condominiums, and a golf course. Two other companies, Film Factory LLC and LIFT (Louisiana Institute of Film Technology) LLC, have proposed to collaborate on a 320,000-square-foot film studio and vocational school on a nine-block-long site near the Treme neighborhood in New Orleans. The project, valued at over $100 million, would include several soundstages, post-production facilities, a back lot and outdoor sets, as well as offices, a school, student stages and a three-story garage.

135 These facilities are expected to be full service entertainment production complexes supplying all of the digital media services required for film and television production and post production. Demand for digital media production facilities is more difficult to predict. Film production activity in the region is expected to increase in the future given the growth in film production activity before Hurricane Katrina, concerted efforts on the part of city and state governments to attract film production and the recent announcements of large private investments in production facilities. However, the expected increase in demand for film production facilities on the whole will not necessarily translate into demand for facilities for digital media production. This is because digital media is mostly used in editing and other postproduction activities and, according to Dr. Benisheck, out of state production companies typically prefer to hire companies in their home states for these services. This preference is a product of the strong relationships that have developed over many years between film production companies and postproduction companies near their headquarters in Los Angeles and New York. Moreover, the development of high bandwidth communications technology has reduced filmmakers reliance on postproduction facilities near their shooting locations. They can send audio and video to be enhanced and edited in Los Angeles and receive it back the very same day. Given the facilities for digital media production currently existing in and planned for New Orleans, as well as the uncertain demand for such facilities, we recommend against providing facilities and services targeted at out-of-state film production companies. To do so would replicate services that already exist in adequate supply and divert resources away from other activities, such as providing facilities and services for training and business incubation, that are undersupplied and in great demand. Furthermore, we believe that since the studio space in the proposed center will be small compared to the amount of studio space available in other film production facilities, the center would be at a competitive disadvantage compared to these facilities in attracting business from film production companies. Nevertheless, the digital media center will be well suited to meet the demand for digital media production facilities from students, incubator clients, small production companies and independent filmmakers, so a moderate amount of film production facilities should be provided.

136 The Market for Training in Digital Media Next, consider the market for education and training in digital media related skills. On the supply side there are a number of colleges, universities and other institutions in the city that offer training in entertainment related digital media. The film school at the University of New Orleans has a very good reputation and offers both graduate and undergraduate degrees in film production. Students are drawn to this school for its relatively low tuition and the opportunity to get a hands-on education producing their own films (students in the top 5 film schools generally work on other people s films). UNO is also the home of the Nims center, which UNO faculty and students use extensively. Delgado Community College and South Louisiana Community College (SLCC) also offer training in digital media technologies. In 2002 SLCC introduced its Digital Media Initiative to train students in the use of professional-quality high definition digital cameras and production equipment so that they could take advantage of the jobs created as a result of the tax incentives offered for film and video production. As mentioned above, the $100 million film production facility planned by Film Factory and LIFT will include a vocational school. Developer Malcolm Petal, chief executive officer of Film Factory and LIFT, said the complex could train as many as 750 people a year for jobs in movie production. Demand for training in digital media is more difficult to ascertain than supply. Film production companies have indicated that the paucity of labor with skills appropriate to film production is the most significant factor limiting film production activity in Louisiana. The state has responded by emphasizing training in its plans to attract greater film production to the state. However, as we mentioned in our discussion of the market for digital media production facilities, an increase in film production activity by out-of-state production companies will not necessarily result in a significant increase in the demand for a local workforce trained in the use of digital media technologies. It is likely that production companies will seek professional digital media services from businesses located near their headquarters rather than businesses located in New Orleans. While it is true that an increase in film production activity in New Orleans will increase the demand for local labor, this demand will probably be for unskilled positions, such as caterers and drivers, or skilled production-related position, such as loaders, grips and gaffers, but not positions related to post production that require an expertise in digital media. Given the presence in New Orleans of several universities and colleges that provide training in the use and development of digital media technologies, and given the uncertainty of the demand for a workforce with this training, we recommend against the direct provision of training at the proposed digital media center. Instead, we recommend that the center form partnerships with local colleges and universities in order to augment the training these schools offer their students while expanding the services the center can provide to its incubator clients. Under such a partnership the center would provide students and faculty access to a broader range of digital media production facilities than is available in their own institutions. In turn, the university partner would provide incubator clients with access to a variety of resources including technical expertise, mentoring, and an entrepreneurial culture.

137 Such linkages would promote technology transfer and commercialization activities and provide the digital media center with a renewable source of new incubator clients. The Market for Digital Media Business Incubation Currently New Orleans has no incubation facilities for start up digital media companies. According to Dr. Benisheck, the Nims Center hosted small start-up businesses in its office space at one time, but evicted them because they were not profitable. The demand for a digital media incubator is small at the moment, but could become great in the future given the resources that the state and local governments are putting into digital media training and the planned expansion in the supply of digital media related training facilities. Many students at these new training facilities will want to start their own digital media businesses, and they will be looking for spaces and services to help them do so. A digital media incubator would help foster a grass-roots film and digital media industry that would simultaneously create local demand for digital media services while increasing the region s capacity to attract large-scale film productions by out-of-state firms. The result could be a beneficial cycle in which the expansion of local industries attracts production activity from outside the state, which in turn develops a workforce experienced in film production that allows local industries to expand further and improves the region s overall film production capacity. Given the undersupply of incubation facilities in the region, the significant potential demand for such facilities and the considerable benefits they could bring to the local entertainment industry, we recommend that a digital media business incubator form the centerpiece of the proposed digital media center. Overview of Digital Media Center Facilities and Services According to the National Business Incubator Association (NBIA), business incubators typically have 30,000-40,000 square feet of office space. Since the proposed digital media center will be 60,000 square feet, this would leave 20,000 30,000 square feet for studio and educational space. This section describes the types of facilities and services that should be made available for each of these uses. Production Facilities Fully equipped production studios would be used extensively by incubator tenants and would provide rental options to local digital-media related businesses. The studios should be designed for video and audio production and post-production for education, entertainment, and business. They might include the following equipment: Multiple HD digital cameras Flexible lighting grids Motion Capture System (MCS) with Blue/Green cyclorama studio Studio control room with digital video and audio recording capabilities including Digital video switcher with video effects Multi-channel digital audio recording capabilities Control room large enough for several crew members and clients

138 Storage room adjacent to stage for prop storage Links to robust server network for easy transfer and storage of digital recordings In addition to the production studios, separate editing rooms should be made available for non-linear editing, audio production, digital effect creation, DVD or game authoring, or any other computer-workstation application. Educational Facilities and Services: Classroom space should be available for on-site instruction by community college and university faculty Employee training and student intern programs could be made available for incubator clients Incubator Facilities and Services: Secure offices available to entrepreneurial businesses in a variety of sizes and configurations. Lease rates should include a full complement of business development support services Support programs that assist incubator clients by: Facilitating connections to funding, partnership opportunities, networking opportunities, business expertise and University resources. Providing access to legal consultation and patent specialists Creating a sense of community through physical settings, intellectual stimulation and working in close proximity to like-minded individuals. On-site classes & seminars to enhance the business owner s working knowledge of business basics beyond simply knowing the product Computer servers & robust technology infrastructure A state-of-the-art networking environment with high-bandwidth fiber optic cabling, wireless Ethernet, and abundant connectivity points within the workspace. Front desk and mail services Conference and private meeting rooms Competitive rent

139 Photocopying and faxing equipment Requirements of Admission to the Digital Media Incubator In order to maximize its impact on local digital media industries, the digital media center should seek out and cultivate the most promising startup companies. To accomplish this the center must set up an admissions process during which entrepreneurs have the opportunity to present their business ideas and gain feedback on how best to move forward with the development of their business or the completion of their business plan. During this process potential clients will be evaluated on the basis of the following criteria: 1. A realistic business and marketing plan reflecting the potential to grow the business and become a leading player in their market segment. 2. Reasonable credit history and adequate financial resources to remain in business for at least six months. 3. A strong entrepreneurial management team with experience in the industry and at least one full-time person working in the business. 4. A match between the needs of the incubator client and the resources available within the incubator program and the community. 5. Not in direct competition with other incubator clients. 6. No legal claims or lawsuits pending against the business. 7. The potential for multiple job creation at wages higher than the county average. 8. Plans to locate in surrounding area and stay for at least three years. Expectations for Incubator Clients Once Admitted Grow their business, achieving agreed-upon benchmarks, using appropriate services, and participating in the incubator support programs. Pay their rent Provide regular status reports

140 III. Financing and Sustainability Plan Digital media incubators face key financing gaps that can present challenges in putting together a complete financing package that allows the center to operate with sustainability. These gaps typically involve capital shortages for three activities specific to digital media incubators: early-stage financing for construction and equipment purchase; ongoing operational sustainability; and enabling fledgling start-ups to beat their competitors to market. In addition to these challenges, typical financing for new start-ups may be more difficult to obtain from private equity sources than financing for an ongoing project. Owners or developers of new start-ups almost invariably have to pledge a higher rate of return to their investors or lenders to persuade them to assume the higher perceived risk associated with a new project. Extra underwriting costs also can add significantly to the costs of loan processing and review procedures. In some instances, lenders may require developers to have an additional 2 or 3 interest points on a loan rate or require developers to provide specific percentage of equity in the project to make sure that the developer has sufficient capital at risk in the new venture. Addressing Start-up Financing Concerns As the analysis below will show, successful financing for digital media incubators shows that creative and proactive cities, colleges, and universities can partner with states, federal agencies, private individuals and family foundations to seed the establishment or expansion of a digital media incubator. Because of the great diversity in digital media ownership, no single best approach for financing will suit every project. However, there are a few lessons we can draw on from existing digital media incubators. First, there has been no use of large private debt and equity sources except those induced by tax-incentives. Jill Dominguez, President of the WRJ Group Inc, which developed the Santa Ana digital media incubator suggests that a digital media incubator should not be financed by conventional debt and private equity sources. According to Dominguez, most incubators do not generate enough cash flow to either service a critical level of debt or provide returns for private equity financing Second, research suggests that large independent foundations are not as active in supporting the construction of digital media incubators, although they might provide support for other aspects of a digital media project. The Children s Digital Media Center (CDMC) project, for example, which brings together a five-university research consortium, is funded by a fiveyear $2.45 million grant from the National Science Foundation with additional funding from the Stuart Foundation, the Henry J Kaiser Family Foundation, the Markle Foundation and the Smith Richardson Foundation.

141 Third, there have been three main sources of start-up financing for digital media incubators. These include bonds, individual or family foundation donations and Federal EDA grants. The Nims Center at the University of New Orleans and the Larry and Katrina Dodge School of Film and Media Arts at Chapman University in California were financed largely by individual and family foundations as well as EDA grants. An important point to note is that, where EDA grants have been used, the grant amount has never exceeded $1.6 million. The Santa Ana DMC used predominantly debt financing. Financing Models for Existing Digital Media Incubators Four models of initial or expansion financing for digital incubators have been analyzed: gifts and grants from wealthy philanthropists; public/private funding; public funds; and debt and public funds. These distinctions have been made only to facilitate the analysis of the various financing models. In practice, the lines between these various funding models may not be clearly delineated as they appear here. By suggesting that a digital medial incubator was capitalized from a debt source, for example, does not mean that other funding sources were necessarily disallowed. It merely means that bulk of the funding came from that specific source. Gifts and Grants from Wealthy Philanthropist A number of digital media center projects such as the Johns Hopkins Media Center and the Roberts E. NIMS Center at the University of New Orleans have benefited from very generous lead-gift funding from wealthy philanthropists. Johns Hopkins, for example, credits the generous support of Mrs. Kerrin Fenster and her son Edward Fenster for funding the center. Similarly, in February 2004, Larry and Kristina Dodge gave Chapman University in California a $20 million gift for its School of Film and Television. Chapman subsequently renamed the Film and Television School the Lawrence and Kristina Dodge College of Motion Picture and Media Arts. This gift of $20 million followed a $5 million gift Chapman received in January 2004 from businesswoman and philanthropist Marion Knott of Orange Country. The physical facility was named Marion Knott Studios and now houses the Dodge College. Public and Private Funds Some digital media incubators/centers have combined both public and private funds to start or expand a center. In 1999, the University of New Orleans received a Nims Family Foundation donation of $1.2 million for an endowed chair, which was matched by a Board of Regents contribution of $800,000 to set up the Robert E. Nims Digital Media Center. The Nims Center also received a $1 million construction infrastructure grant from the U.S. Department of Commerce, Economic Development Administration. Public Funds

142 The South Louisiana Community College (SLCC), Digital Media Initiative is an example of a publicly funded financing model. Start-up financing came from the federally funded Temporary Assistance for Needy Families (TANF) program, totaling more than $1 million. The TANF grant was justified on the premise that it would be used to train Louisiana residents for film production jobs. Debt and Public Funds The Santa Ana College Digital Media Center is the quintessential example of the fourth model that combines debt sources and public funds in one package. This project was partially funded by a $1.6 million grant from the U.S. Department of Commerce s Economic Development Administration. The project's total budget was anticipated to be $13.6 million and included $12 million raised from debt financing from the Measure E local bond initiative. Potential Funding Sources Private Equity The supply of initial private investment capital for start-ups in New Orleans is limited. Of the $20.9 billion venture capital deals across the US in 2004, Louisiana captured only $3.2 million. Hotel Bookings Solutions, a former New Orleans based firm, tried unsuccessfully to raise $8 million in investment financing from private equity sources. This failure forced the company to move to Atlanta, where there is a much larger pool of investment funds. These failures are emblematic of the daunting challenges that Louisiana firms face in acquiring an infusion of early stage capital. At the same time, when private firms invest capital, they do so to make a return by minimizing their risk. Therefore, the most successful public projects that attract private funding show an understanding of the perceived risks those investors face. They do so by taking steps to help private investors better manage their risks by meeting certain objectives. Some that are more relevant to this digital media project include but are not limited to the following: Reducing the project s cost of financing This is usually done by subsidizing the interest costs on project loans (for example, with tax-exempt financing or low-interest loans. They also can reduce loan underwriting and documentation costs by taking advantage of loan packaging assistance or technical support that might be available through Community Development Corporations (CDCs) and other local institutions. Offering terms or incentives to ease the Project s financial situation Tools like tax abatements, tax credits, or grace periods can improve the project s cash flow and make the project numbers work. Similarly, training and technical assistance services can offset project costs and reduce the need for cash.

143 Offering assistance or information that provides investor and lender comfort Performance data for the industry or insurance that can help transfer risk may increase the investor s and lender s comfort level with a digital media incubator project. Meeting these objectives, particularly by using tax incentives, may allow this project to tap into private equity sources. Tax incentives help with a project s cash flow by allowing revenue to be used for the project purposes rather than for tax payments. With a digital media project, a direct financial assistance program through tax incentives may help fill capital gaps by financing specific parts of the project or offsetting the extra up-front costs of construction. At the Louisiana state level, the most critical of these incentive programs are those that promote digital media development. Under this arrangement, investors are given 20% credit for investment made during the first and second years after certification; 15% credit for investment made during the third and fourth years of the project; 10% credit for investment made during the fifth and sixth years of the project; and 10-year carry forward on credits with the provision that these credits are transferable. These arrangements expire January 1, At the Federal level, $1 billion in New Market Tax Credit authority is provided from 2005 through This authority is for investment in community development with the goal of fostering recovery and redevelopment in hurricane affected areas. The program exists to create investment into urban and rural low-income areas to help finance community development projects, stimulate economic growth and create jobs. Private-sector investors receive credit against federal income taxes. Partnerships In the face of limited private equity sources, one option for involving the private sector is through partnership agreements with individuals and private companies that have demonstrated interest in the film industry in New Orleans. These sources include corporations, individuals, production companies, and universities. While some of these sources might be competition for the proposed digital media incubator, it may be worthwhile to pursue partnership possibilities with one or more of them. Production companies that are active in the film industry in New Orleans include the Louisiana Institute of Film Technology (LIFT), Film Factory LLC, Lions Gate Entertainment, Louisiana Entertainment Associates and Independent Studios of New Orleans. LIFT and Film Factory LLC have recently acquired New Orleans City Council approval to construct a $100 million movie production studio. The city's Industrial Development Board and the State Bond Commission have given preliminary approval to selling as much as $150 million in bonds to build and equip the studio and vocational school. In addition, Alfredo Leone and Robert Dimilia, partners in the Louisiana Entertainment Associates, have plans to build a $250 million movie-making complex, which they hope to call the Louisiana Cinema City Studios in Tangipahoa Parish, about 50 miles northwest of

144 New Orleans. Before Hurricane Katrina, Threshold Entertainment, producers of Mortal Kombat movies and video games, had interest in building a $150 million film studio and digital theme park in New Orleans. Similarly, a number of corporations have demonstrated interest in the film industry in New Orleans, including Sony and Disney. Disney is currently filming Déjà vu, a $75 million movie, in New Orleans. Last year, Sony shot All the King s Men in New Orleans. Sony is also especially interested in a recording studio and production facilities in New Orleans. Computer companies, such as Microsoft or Apple, who are particularly eager to break into the film and digital media industry might be interested in donating studio equipment, thus lowering the expenditure on such cost items. Partnerships with universities may also provide a key strategic alliance for this project because of their focus on bringing new technologies to the marketplace and developing a new workforce. Undergraduate programs provide the practical creative technical and digital arts skills needed to fuel the industry. Graduate programs allow for cross- fertilization of ideas and create an environment conducive to cutting edge research and innovation. Debt Tax-exempt and Industrial Development Bonds represent another potential financing source. These bonds are typically issued by state, county, or municipal governments whose interest payments to the bondholder are not taxed by the federal government and may or may not be subject to state or local income taxes. More importantly, under the Gulf Opportunity Act of 2005 signed by Congress, the State of Louisiana has been authorized to issue up to $7.9 billion of a special class of private activity bonds called Gulf Opportunity Zone Bonds outside the state volume caps. Either the State or Municipalities can issue these bonds with the proceeds used to pay for acquisition, construction and renovation of non-residential real estate. This authority expires after Dec. 31, Grants Grant funding presents one of the most likely sources of financing for this project. There are several grant programs the state or federal level, with the Community Development Block Grants (CDBG) and the Economic Development Administration Programs showing the most potential. CDBG CDBG grants can be used for infrastructure improvements or, under certain circumstances, lent to private companies for economic development projects, such as job creation for low- and moderate income people. CDBG allocation for Louisiana for 2006 is nearly $10.2 billion. While most of this allocation has been earmarked for housing investment, it may be possible to obtain a CDBG grant for this project, particular because of its flexible nature.

145 Economic Development Administration Programs The Economic Development Administration (EDA) has emerged as one of strongest funding partners for digital media incubators. Three of the EDA programs are particularly suited for investment in digital media incubators: the Public Works Program, the Economic Adjustment Assistance Program and the Local Technical Assistance Program. The Public Works Program empowers distressed communities to revitalize, expand and upgrade their physical infrastructure to attract new industry, encourage business expansion, diversify local economies and generate or retain long-term, private sector jobs and investment. The Economic Adjustment Program assists state and local interests to design and implement strategies to adjust or bring about change to an economy. The program focuses on areas that have experienced or are under threat of serious structural damage to the underlying economic base. The Technical Assistance Program helps fill the knowledge and information gaps that may help leaders in the public and nonprofit sectors to make informed decisions in allocating limited resources in distressed areas. Grants under the Local Technical Assistance Program often support feasibility studies on potential economic development projects, such as industrial parks or business incubators. Proposed Finance Plan The project s analysis shows that the proposed digital media project could be financed using the following model. The model calls for the use of $6,342,792 million in equity funding facilitated by state tax incentives of $2 million and New Market Tax Credits of $4,342,792 million. A further $1.5 million comes from the EDA Public Works and Economic Adjustment Programs. In addition, a $50,000 technical assistance grant is expected from the EDA. CDBG funding for this project is expected to be $2 million given that most of this year s allocation has been earmarked for housing. Partnership sources are expected to net $1.95 million from various sources including those from corporate partners in software and high tech equipment industries. The city is expected to donate the land required for the construction of the incubator.

146 Table 1.Proposed Finance Plan Type of Source Amount Restrictions Financing City of New Orleans Public Land Land Property acquisition Equity State Tax Incentive $2,000,000 Construction New Market Tax Credit $4,342,792 Construction Grant EDA-Public Works $900,000 Construction EDA-Economic Adjustment $600, 000 Soft cost EDA- Planning $50,000 Planning CDBG $2,000,000 Construction Partnerships Individual & Family $1,000,000 Construction Foundations Microsoft $300,000 Software Hewlett Packard $250,000 Equipment Shell $200,000 Construction JP Morgan $200,000 Construction Future sustainability Sustaining a successful incubator requires careful planning and hard work. Many incubators offer little more than a place to set up shop. Such organizations will hardly be able to deliver superior value to start-ups and investors; in fact, many of them are likely to fail. If competition in the film industry in New Orleans grow as it is projected, it would be difficult for incubators that are no more than set up shops to survive. The distinguishing feature of a successful digital media incubator is one that has mechanisms to foster partnerships among successful film-oriented firms. This helps to facilitate the flow of knowledge and talent across companies and to forge marketing and technology relationships between them. With the help of such an incubator, start-ups can network to obtain resources and partner with others quickly, allowing them to establish themselves in the marketplace ahead of competitors. The new economy is a network economy and only those incubators that can exploit networking by providing fledgling and small digital media establishments with preferential access to potential partners and advisers will succeed. This is perhaps the most challenging task for the proposed digital media incubator. Its long term sustainability depends on the extent to which it is able to become a highly networked organization.

147 IV. Financial Analysis Appendix 1 contains a detailed financial analysis for a $25 million, 60,000 square foot digital media center. It is based on the recommendations of the MIT team and a financial model provided by Jill Dominguez, president of the WRJ group, a Community Investment Corporation that specializes in high-tech business incubators serving minority and lowincome communities. Though the MIT team endeavored to use current and accurate inputs to the extent possible, it was necessary to make a number of assumptions regarding construction and equipment costs, rents, absorption, depreciation and capitalization rates and a number of other variables. Therefore the following analysis should be viewed as a sketch of a possible scenario, and as such a springboard for further discussion and analysis. The following two paragraphs explain some of our central assumptions in creating the financial model. Building Dimensions According to our recommendations for the physical program of the Digital Media Center, we have assumed that the site will contain 40,000 square feet of office space and 19,2000 square feet of studio space, which will used by a business incubator, a partnering academic institution, and non-incubator tenants. Of the 40,000 square feet of office space, 30,000 square feet will house the incubator, 5,000 square feet will house classrooms for use by the university or community college, and 5,000 square feet will be rented to non-incubator digital media companies. Though the latter space will be available to rent by the entire community, it is expected that most of the tenants be companies that graduate from the incubator but want to continue to work in the media center because of the quality of the facilities and the synergies with other tenants. The 19,200 square foot studio space will be shared by the office tenants, with the rent obligation divided between the three groups of users in rough proportion to their level of occupancy of the office space. Thus, incubator tenants will rent the equivalent of 10,000 square feet of the studio space while academic and other tenants will rent the equivalent of 4,600 square feet. Project Costs To come up with the project costs for a digital media center at the desired scale we researched comparable projects from around the country and analyzed their construction and equipment costs. After Based on the construction costs for similar projects in California, Massachusetts and Baton Rouge, Louisiana, we decided on direct construction costs of $150 per square foot which, when financing, development and other soft costs are taken into consideration, brings total construction costs, excluding land acquisition, to $10,686,692. Given a similar investigation of equipment costs in comparable projects, we came up with total equipment costs of $1,156,100. If the total costs are expected to be $25 million, this would mean the project could be located on land worth $13 million which, according to our financing recommendations, would be donated to the project by the city. It is the opinion of the MIT team that this is a large amount to spend on land, and it would be more advisable to either increase the size of the facility from 60,000 to 80,000 or 100,000 square feet, or reducing the amount of financial resources sought for the project.

148 V. Managing and Expanding Visions of the Digital Media Industry Combining Visions Interviews revealed differing visions of the digital media industry in New Orleans. Various parties seem to be considering different ways to serve the digital media industry, and expansion plans of existing centers, such as the NIMS Center and L.I.F.T, are under way in the city and surrounding parishes. As they currently exist, these different visions risk duplication of efforts and potentially unproductive competition. To take full advantage of the human, physical, and financial capital invested in the digital media industry in New Orleans, we strongly recommend an organization that will serve as a vehicle for collaboration among the visionaries in the digital media industry. There is some dispute as to who might serve as the best facilitator of such an effort. The city could take the lead in such efforts, organizing a group to strategize about the creation of such a group. However, the city should be prepared to promote equal voice to all parties; civic, for-profit, and non-profit. The needs and ideas of small, local companies should not be subverted to larger voices of more powerful studios that can speak more immediately to the economic interests of the city. Ideally, the results of an equitable conversation would yield a well-rounded discussion where the consideration of a variety of perspectives results in a holistic, creative vision of the future of the industry. An organization structure could be formal or informal, ranging from an industry association to a development corporation. It could be based on sliding scale or no-fee structure, and would hopefully serve as a way to foster and carry out joint projects. Expanding the Vision In an attempt to consider a more holistic vision of the future of the digital media industry, ways to foster the growth of the industry in general are considered below. Such efforts should require less resources and increase demand for services provided by a digital media center. The following are reasons to expand the city s efforts beyond a physical digital media center: General demand for digital media services must be created and sustained. These recommendations are a more comprehensive approach to increasing demand for digital media services in New Orleans through a stronger local industry. The character of the city will be additionally enhanced by developing a digital media culture. The development of a more engaging digital media culture should stimulate additional spending and may spillover into other industries such as tourism.

149 Supporting small-scale, local digital media companies requires more than the provision of physical space. While small, local digital media companies will benefit from access to equipment, offices, and studios, physical space may not always the strongest need. Small production companies often spend more time shooting on location, and may benefit more from efforts to create a thriving market for their services. Fostering Digital Media Culture The following list outlines various components that work together to foster digital media culture more widely, with the goal of building a thriving industry capable of sustaining a larger number of local firms. This list is not necessarily comprehensive, but it does outline a holistic and regional approach to a building a city s film industry and creating a network of services, events, and venues to support the growth of digital media. While some of these categories, such as community programming, can be applied to all digital media, a narrower focus on film culture is often taken. Similar logic can be applied to other aspects of digital media. Websites for the organizations referred to in this section can be found in the Additional Resources section. 1. Festivals/Contests A variety of festivals and contests appealing to different creative elements engages people of all ages in the film culture of the city. For more information on the value of film festivals for local films and for their comparison with the benefits of small cinemas, which we address below, see Paul Harril s article, cited in the sources for this section. Unfortunately, the success of film festivals and contests is mixed. Strong marketing can help ensure the success of a festival or contest. New Orleans already has some film festivals, and the city should consider how best to support and expand these efforts. Music festivals are already also very popular in New Orleans, and should continue to be supported. Additional events combining music and film can create linkages between the two pieces of digital media. In addition, some less conventional festivals involving other aspects of digital media should be promoted. 2. Cinemas/Exhibitions Public spaces are needed for residents to enjoy the fruits of local contributions to digital media, and the film industry in particular, enabling enthusiasts to fully engage in the industry. Cinemas are one such venue, but unfortunately, they require additional construction capital. A non-profit movie theater in Vancouver cited a development budget of $5 million, much lower than the capital budget for the digital media center. These projects could be spearheaded by non-profit and for-profit establishments with

150 support from the city. The city could sell abandoned land or unused buildings at low costs or connect non-profits to funds associated with such development. As in the case of the UBC Film Society s Norm Theatre, a small cinema can partner with a school in showing local and independent films, international films, obscure or creative, cutting edge films. Unfortunately, some small, independent theaters have had trouble staying afloat without foundation or city support. If this strategy is unsuccessful, small theaters and film festivals could be products of local art or cultural institutions. For example, Boston s Museum of Fine Arts has a film series, which features contemporary international cinema, restored classics, American independent films (including films by local artists), films showing for the first time in Boston, and retrospectives by international film artists. The Program also hosts a number of film festivals throughout the year, plus special screenings and films relating to special exhibitions. Visiting artists frequently attend screenings and discuss their work with the audience ( In addition, small digital media galleries can be promoted and supported to provide exhibition space and local events. The 119 Gallery in Lowell, Massachusetts is an example of a successful non-profit digital media gallery that has various events engaging local and non-local artists and digital media enthusiasts. In fact, the gallery has been successful in attracting Boston residents despite its location at a 30-minute drive from the larger city. 3. Online Networks Examples of virtual resources include general cultural publications geared towards specific audiences (such as Gambit Weekly and Where Y'at in New Orleans), weblogs and other news sources, and resources specific to film or other digital media needs, such as NewEnglandFilm.com. Content can include news, job postings, event listings, forums for discussion, and listings of local films. According to an article by Judy Malloy on Center for Digital Democracy, online presence is critical for emerging and experimental artists and alternative art spaces. The artists could be provided free online space through a served devoted to digital media. Lafilm.org is an excellent resource for the state, but a gap may exist for the city level. The city could implement a survey to determine what resources exist in New Orleans, and a city-specific site could be created from this information. 4. University Culture Schools with film programs generate local film culture. A strong, engaged student body creates more demand for independent theaters, more enthusiasm for local contests, and more film culture in general. Students bring fresh ideas and inexpensive talent to the film industry. In addition, universities can serve as valuable partners in many digital media

151 projects. Cuts in digital media programs at local universities would detract from the larger industry in New Orleans, and if schools are considering such cuts, they can be offered incentives to continue to put resources into these programs. 5. Community Programs Non-profit community programs connect low-income youth and adults to digital media with the goal of skill and confidence building and the utilization of digital media as an artistic means of expression. For example, United Teen Equality Center (UTEC) in Lowell, Massachusetts has multiple programs connecting teens to digital media as career development. One such program, called The Open School, provides GED preparation and multimedia training skills for out-of-school youth. Students receive certificates for completing work skills training in computer repair, video production, or sound recording, and are then offered paid internships creating a youth-run multimedia business to provide services for local non-profits and small businesses. The city can provide moral support for these types of programs, encouraging community involvement and potentially supporting nonprofits in fundraising. 6. For-profit Industry The for-profit industry encompasses a wide range of efforts. As the digital media center plan recognizes, resources must be invested in the fostering of local for-profit businesses to increase New Orleans capacity to provide local digital media services. Even small, local production companies can have a larger effect on the digital media industry. Chris Cagle writes, Television and advertising have a tangible spillover into the economy of film production. They give employment to filmmakers, editors, DPs, writers, sound specialists and they give business to a number of support industries, such as film developing and set construction (2006). 7. Non-profit Digital Media Centers The Nims Center is an example of a non-profit media center that provides a significant amount of studio space and is expanding to meet existing demand. It tends to serve larger out-of-state production companies that come to New Orleans to take advantage of state tax incentives. However, the Nims Center is also hosting a small, local production firm that experienced losses during Katrina, provides internships for local students, and supported a UNO student effort to create a full-length, animated film called LUBU. Rather than competing with this existing non-profit media center, the city should focus on integrating its efforts with the existing infrastructure provided by the Nims Center. Example/Best Practices: Vancouver This case study focuses more specifically on the film industry as a way to illustrate a broad approach to creating film culture. According to various websites, Vancouver is the third

152 largest film production center in the world. Its tax incentives and local characteristics including climate, varied topography, and generic appearance have enabled rapid industry growth. A wide range of services and facilities exist to serve production companies. The following are examples of how Vancouver meets the recommendations listed above. 1. Festivals/Contests Vancouver has a wide range of festivals that appeal to a variety of audiences, and seems to market the festivals successfully. A few examples of the many successful film festivals in Vancouver are: International Film Festival Reel to Real: Celebration of moving images for youth Chilliwack Documentary Film Festival Vancouver Queer Film & Video Festival 2. Cinemas/Exhibitions The Vancouver International Film Center Vancity Theater is a non-profit independent film house. The following quote is taken from this $5 million, 14,000 square foot facility s vision: The Vancouver International Film Centre and Vancity Theatre is an exciting new centre of excellence for Vancouver's film lovers, both for filmmakers and for cinephiles. It marries the art of film with emerging new technologies and allows the Greater Vancouver International Film Festival Society to broaden its public, cultural and educational mandate ( The UBC Film Society cinema is associated with the University of British Columbia. This cinema has a theater called the Norm, which has hosted speaking engagements from local notables David Suzuki and Mike Harcourt, hosted film festivals and regular screenings, and is used for various conferences and lectures ( 3. Online Networks The following are just a few examples of online resources providing news, networking, job opportunities, and production services: Hollywood North FilmNet ReelWest Hollywood North FilmNet BCFilm.com 4. University Culture Vancouver Productions lists many acting and film schools in Vancouver. For example: Pacific Audio Visual Institute is a career school for Audio Engineering, Broadcast, Sound Production, Film & Music Business, Digital Filmmaking, Game Design, and

153 the Entertainment Industry. It has a full-service music recording studio and film studio complex. VanArts (Vancouver Institute of Media Arts) offers one and two-year diploma and six-month certificate programs in 2D Animation, 3D Animation, Game Art & Design, and Visual Effects. 5. For-profit Industry As the third largest film industry in the world, Vancouver has a well developed for-profit industry. The following is a list of established physical studios in Vancouver: Vancouver Film Studios Lions Gate Studios/Northshore The Bridge Studios Fastcat Studios A-Frame Studios Boundary Road Studios Another important component of a successful for-profit industry is the existence of local post-production services. Because modern technology overcomes geographic limitation in post-production work, it may be unreasonable for small New Orleans firms to compete with established production companies in Hollywood. However, the construction of some viable post-production services would capture more out-of-state money spent on films. Rainmaker Entertainment in Vancouver is an example of a post-production and visual effects facility.

154 VI. Alternative Proposal What has been presented thus far represents a holistic approach to achieving economic development goals through the digital media industry, including the construction of a digital media center with a small business incubator, the creation of a collaborative organization to expand the vision of the industry, and a strategy to stimulate local digital media culture. However, there are funding challenges in constructing and operating a physical digital media center. In case these challenges prove to be deterrents, we suggest a two-pronged approach which can be substituted for the construction of a physical center: 1. A Business Incubator Without Walls for the local digital media industry 2. Comprehensive training to produce a workforce capable of supporting large-scale productions to harness more out-of-state money spent on film production in New Orleans. The justification for recommending an alternative approach is three-fold: The alternative proposal may be less risky in light of doubtful viability of non-profit media centers. Brian Newman s article, The End of an Era?, expresses concern over the failing of numerous nonprofit centers, citing signs of a general downturn, including a number of closings and withdrawal of foundation support. Less capital investment is required to support a business incubator without walls and comprehensive training program. Capital for projects like a digital media center may be difficult to find funding for post- Katrina due to the allocation of funds to more basic rebuilding needs. In addition, workforce development funds may be more easily allocated to direct training programs. A physical center is less adaptable over time. Digital media centers have been criticized for failing to adapt to changing filmmaker needs. Infrastructure should respond to changes in demand, tax incentives, and the economic needs of the city. Our alternative recommendations surpass the limitations of a physical space. Business Incubator without Walls Idea Village serves as a model of a business incubator without walls. Its strategy may be applied to digital media companies, with some adjustments. The proposed business incubator without walls for the digital media industry should support local start-ups and young, growing firms in the digital media industry. It should connect those in the industry to each other, to equipment, to financing, and to business assistance. The repertoire of services

155 should include the following: 1. Business Services A graduate with digital media expertise may not have the business skills necessary to start and run a successful small business. Incubatees should have access to business courses, either through existing courses at colleges or universities or training programs through organizations like Idea Village. 2. Entrepreneurial/Professional Networks Two key networks must be created and nurtured: Digital media industry firms and professionals Business professionals who can provide mentoring and low cost business services These two networks will require extensive cultivation. A partnership with Idea Village could provide the business network. The digital media network must be developed by someone knowledgeable in the industry. It should provide access to local studios, incoming production companies, software and other digital media networks, and mentors for growing businesses. 3. Digital Media Education The development of competitive, cutting edge digital media companies requires continual access to training in new technologies. Partnerships with universities or community colleges could provide this educational link. 4. Access to Infrastructure Existing infrastructure at Tulane, UNO, and the NIMS Center should be enough to support small business needs. Standardization can be achieved through negotiation of consistent reduced pricing and rules of use. 5. Loan Fund While perhaps not initially feasible, one goal of the business incubator without walls should be to secure financing for a small loan fund providing emergency assistance to small companies. Over time, the incubator without walls should aim to expand this fund so that it can provide equipment and other capital grants. The problem of finding the right kinds of entrepreneurs to join the business incubator without walls remains. An extensive screening program must be established, and financing should accommodate these efforts. The Idea Village provided a rough operating budget for comparison with the cost of the physical center. The operating budget is only slightly less than the operating budget for the

156 digital media center, however, it avoids the large capital costs of construction and equipment purchase. Instead, a large percentage of the cost of this strategy is in the investment in extensive mentoring of small businesses. Entrepreneurs in Residence are experienced, high level entrepreneurs who manage a portfolio of clients, providing intensive, one-on-one guidance in business start-up and growth. Table 2. Idea Village Current Operating Budget Operating Expenses Amt/yr #/yr Year 1 % of total Staffing $ 380, % Entrepreneur in Residence $ 80, $ 400, % Fellowships $ 40, $ 200, % Student Internships 10/yr (ea. 250 hrs@$20) $ 5, $ 50, % Marketing (includes events and public relations) $ 50, % Occupancy Costs $ 36, % Equipment (Computers, etc.) $ 15, % Professional fees (accounting & legal) $ 5, % General & Administrative $ 50, % Total Idea Village $ 1,186, % Training To revive New Orleans s film industry and attract the digital media industry to the city, a major focus must be placed on developing a workforce that can support and thrive off these industries. Prior to Katrina, the film, television, and music industries brought millions of dollars to New Orleans. However, as New Orleans strove to compete with New York and Los Angeles for productions in these industries, it became apparent that the key to survival would be through work force development. A major production issue that left New Orleans at a disadvantage was that production companies had to import technical crews, which made the cost of producing media in New Orleans prohibitive. Prior to the storm, economic development officials encouraged unions to have on-the-job training programs that would give its members transferable skills, such as carpentry, electricians, and other types of technical skills. In 2005, Louisiana Governor Kathleen Babineaux Blanco proposed a three pronged strategy to boost economic development, which we recommend being adopted by the Mayor s Office to boost economic development in post-katrina New Orleans: 1. Expanding opportunities for high school students In 2004, less than 10% of Louisiana s graduating seniors entered two-year postgraduate programs. Louisiana s High School Redesign Commission has been developing programs that will provide skills training in high school and allowing students to complete community and technical college courses prior to graduation, helping these

157 students become an integral part of New Orleans s digital media and entertainment workforce. 2. Addressing the needs of the existing workforce through continuing education 65% of the workforce needs training beyond high school in either community or technical colleges, therefore, officials have called on state community colleges to sponsor classes that would teach related skills such as set production, lighting, and other technical jobs. To date, TANF-2 was provided for the development of a Grip, Lighting and AVID training programs at Lafayette, Baton Rouge and Jefferson Community/ Technical Colleges. South Louisiana Community College has developed course offerings which utilize state of the art equipment and applications such as Shake 3.0 Visual Effects and Compositing, Digital Design Pro Tools HD and Final Cut Pro 4. In addition, SLCC offers courses in Final Cut Pro Editing, HD Cinematography/ Shake Compositing, Live Sound Engineering, HD Audio Production, and Film/ Video Production. Finally, Baton Rouge Community College offers an Entertainment Technologies Concentration as part of its General Studies Associate Degree, which targets specific types of production such as film, theater, photography, television, game design and graphic design, while also providing classes in two and three dimensional design, computer art, and film production. 3. Better connecting future workforce development directly to the needs of the industry In order to bring large studios and production companies back to the city after the storm, as well as provide incentives for the digital media industry to consider New Orleans a viable site for production, there must a workforce available to support these industries. The biggest complaint of industry and production personnel is the lack of skilled workers available to support the workforce needs of the film and media industries. By focusing on training workers in transferable skills that will not only be particularly useful to these industries, but to building a skilled labor force overall, the Mayor s Office will be able to fulfill part of its economic development goals through job creation.

158 VI. Additional Resources State Incentives As of Jan. 1, 2006, the State of Louisiana will provide incentives solely for in-state production expenditures. Investor Tax Credit: Flat 25% based upon investments $300,000 and up. Employment Tax Credit: 10% credit of aggregate Louisiana payroll. Infrastructure Tax Credit: 15% of investment for the construction of new production facilities. Digital Interactive Media Production Tax Credit Program (SB 341): Provides tax credits totaling 10-15% depending on the amount of investment with no more than $5 million in credits granted each year. Sound Recording Credits: 10% of total music budget for the project when total Louisiana music expenditures exceed $30, % of total music budget for the project when total Louisiana music expenditures exceed $100,000. Major Players Public State State of Louisiana Department of Recreation, Culture & Tourism. Alex Schott: Governor s Office of Film and Television Development. Mark Smith: Chief Officer for Entertainment Industry Development. City Mayor s Office of Economic Development: Joan Judycki, , jjudychi@tulane.edu New Orleans Film Commission: Stephanie Dupuy, Director, Scott Aiges: Director of Music Business Development before Katrina. University University of New Orleans The film school at UNO has a very good reputation and offers both graduate and undergraduate degrees. Students are drawn to this school for its relatively low tuition and the opportunity to get a hands-on education producing their own films. (Students in the top 5 film schools generally work on other people s films.) Interns at UNO have recently worked on major feature films such as, Runaway Jury, Ray, and Glory Road. UNO was named #1 film school for independent filmmakers by Think Quest USA. This is particularly important as it would be independent filmmakers and recent graduates who would primarily be interested in a film business incubator.

159 Robert E. Nims Center for Entertainment Arts, Amusements and Multimedia Industries: Dr. Roger Benischek, Director. Delgado Community College Delgado is known primarily as a trade school and is the likely source for training in many industry jobs. South Louisiana Community College, Center for Digital Media, Marcus Brown, Director. This center was begun in 2002 for the purpose of training students in the HD technology so that they may take advantage of the jobs that would be created as a result of the tax incentives offered for film and video production. Private Production Companies The Louisiana Institute of Film Technology (L.I.F.T.): Production service company, production finance company, equipment lessor, and educational provider. L.I.F.T. provides manufacturer-certified training in production and post-production equipment. It is also a full-service production company creating feature films, television, and music videos for major distributors, record labels, and manufacturers. Productions filmed in Louisiana include Waiting and Factory Girl. L.I.F.T. provides debt, equity, and rebates of as much as 20% of a project s budget in return for assignment of the Louisiana State tax credits generated by production. L.I.F.T. Corporate Office: 365 Canal Street, Suite 3170, New Orleans, LA 70130/ / Lionsgate Entertainment: Production company, Crash. Has a very strong commitment to New Orleans. Recently donated $100,000 to the Louisiana Cultural Economy Fund to train movie industry workers. Has plans for two pictures to be shot in Louisiana in the near future, PDR and Punisher 2. Had made Monster s Ball in New Orleans area before the movie industry tax incentive program was created in Wayne Levin, General Corporate Counsel and Executive Vice President of Corporate Operations. Joel C. High, Senior Vice President of Music and Soundtracks. Mr. High is very committed to New Orleans. In January 2006, he collaborated with a 33-piece orchestra on the first recording of a major motion picture orchestral film score in New Orleans. This was the score for New Orleans native, Tyler Perry s feature film comedy, Madea s Family Reunion. Louisiana Entertainment Associates: Partners, Alfredo Leone and Robert Dimilia. Separately involved with the production of more than 35 films. Leone has extensive experience in the foreign film market and is poised to lure overseas film companies to Louisiana. They have concrete plans for a $250 million movie-making complex called,

160 Louisiana Cinema City Studios in Tangipahoa Parish, about 50 miles northwest of New Orleans. This would include studios, production offices, a film laboratory, shops, restaurants, condominiums, and a golf course. They see this as a 3-year project. First year plans include 250,000 square feet of sound and broadcast stage space. Sound stages would be 18-38,000 square feet with the ability to combine multiple stages. Grid heights would be adjustable to 40 feet. They have equity in place and are working to secure the debt component, likely through a bond sale. They have not yet formally applied for any state investment. I see this as an important company to watch as it may prove to be a serious competitor. Because of the sheer size and comprehensiveness of this project, the New Orleans project may look for ways to complement as well as compete with this company. Independent Studios of New Orleans. Locally owned and operated in New Orleans Ninth Ward for 35 years. Independent Studios recently announced that it would undergo a $1 million renovation and host job training and workforce development programs for students and apprentice workers. Threshold Entertainment: Producers of Mortal Kombat movies and video games. Before Katrina was interested in building a $150 million film studio and digital theme park in New Orleans. This would provide space for studios and training. Plans were put on hold after the storm. Celtic Group L-L-C: Has plans for a small, 30,000 square foot, studio in Baton Rouge. Disney: Currently filming feature, Déjà vu in New Orleans. This is a $75 million movie that could bring as much as $30 million into the local economy. The producer is Jerry Bruckheimer and the director is Tony Scott. It stars Denzel Washington, Jim Caviezel and Val Kilmer. Disney also filmed Glory Road in New Orleans last year. This is the first production to film in New Orleans after Katrina. It is hoped to send a positive message to Hollywood that New Orleans is now open for business. Sony: Production company, All the King s Men, shot in New Orleans last year. Sony has an affinity for New Orleans and is interested in sound recording and digital production. Piety Street Studio: Music recording studio located in the Bywater section of New Orleans. Worked with Joel C. High on orchestral film score. Individuals & Other Entities Tom Dey: Director, Failure to Launch, filmed in New Orleans, Tom Dey lives in Los Angeles and New York, but has a great affinity for New Orleans because of the rich experience of life to be gained while working here. Of the New Orleans crew: Where they didn t have the depth of experience, they were passionate and eager to learn. Dey would like to direct an adaptation of Walker Percy s The Moviegoer in New Orleans. Terry Bradshaw: Actor and former professional football player, Failure to Launch. As a Shreveport native, Bradshaw has close ties to the state.

161 Lee MacKenzie, Talent Agent, Fameagency, Metairie, LA. Terence Blanchard: Local jazz trumpeter. Best known as Spike Lee s main composer. Has scored many films, but generally records in London and Los Angeles. Jay Weigel: Contemporary Arts Center, Director. Before joining CAC in 1996, Weigel, a composer, wrote music for television, documentaries, and films. Louisiana Philharmonic Orchestra Producers Guild of America David Torkanowsky: New Orleans film score composer, PBS drama Elysian Fields and USA series The Big Easy. Association of Film Commissioners International: A good source of information on economic impacts and other factors concerning the decentralization of the film industry. Organization/Website References Digital Media Culture Organization Website Cinemas/Exhibitions UBC Film Society Museum of Fine Arts Gallery Online Networks New England Film LAFilm.org Gambit Weekly Where Y'at Hollywood North FilmNet ReelWest BCFilm.com University Culture VanArts Vancouver Productions Pacific Audio Visual Institute Community Programs United Teen Equality Center

162 For-profit Industry Vancouver Film Studios Lions Gate Studios/Northshore The Bridge Studios Fastcat Studios A-Frame Studios Boundary Road Studios Rainmaker Entertainment Non-profit Digital Media Centers The Nims Center Studios Vancouver International Film Center Vancity Theater

163 VIII. References Association of Film Commissioners International. The Business of Film Commissions. Retrieved March 4, 2006, from the World Wide Web: Breznican, A. (2006). Déjà vu Starts Production in New Orleans. Retrieved March 14, 2006, from the World Wide Web: Bring New Orleans Back. (2006). BNOB Commission: Economic Redevelopment Plan. Retrieved April 23, 2006 from the World Wide Web: Cagle, Chris (2006). Local Film Boosterism, Film Culture. 1 Mar. From the World Wide Web: Eggler, Bruce. (2006, May 3). Movie studio, school rolling. The Times-Picayune. Retrieved May 7, 2006, from the World Wide Web: Harrill, Paul (2006). Fresh and Local: Some thoughts on regional film distribution. February 27. From the World Wide Web: Hollywood North FilmNet. British Columbia Film Industry Facts. Retrieved April 28, 2006 from the World Wide Web: Louisiana Entertainment Associates, LLC. (2003). Plans for First Louisiana Film Studio Announced. Retrieved March 6, 2006, from the World Wide Web: Malloy, Judy (2004). The Arts on the Internet: Art, Advocacy, News, Information. Nov. From the World Wide Web: Muttalib, B. (2006, February 9). Louisiana Opts for Local Film Incentives. Variety. Retrieved March 6, 2006, from the World Wide Web: National Business Incubator Association. Retrieved May 11, 2006, from the World Wide Web: Newman, Brian (2006). The end of an era? 15 Feb. From the World Wide Web: Patrick, R. (2006, February 3). Film Studio, Once Proposed Here, Could be Built in Louisiana. Staten Island Advance. Retrieved March 6, 2006, from the World Wide Web: Randolph, N. (2006, February 1). Producers Plan Mega-Studio. The Advocate. Retrieved March 6, 2006, from the World Wide Web:

164 Ratny, R. (2006). Governor Proposes Bold Film Incentives to Make the State a Competitive Player. Retrieved March 16, 2006, from the World Wide Web: Ratny, R. (2006). New Incentives Give Illinois a Fighting Chance to Win Hollywood Film Dollars. Retrieved April 24, 2006, from the World Wide Web: Sneed, E. (2005, August 1). Lt. Gov. Landrieu: Creative Industries Emerging as Major Economic Development Engine for Louisiana. Retrieved March 5, 2006, from the World Wide Web: Spera, K. (2006, January 8). New Orleans Scores. The Times-Picayune. Retrieved March 5, 2006, from the World Wide Web: State of Louisiana. (2006). Vision Retrieved March 15, 2006 from the World Wide Web: Thomas, G. (2006, March 10). Donation to Train Film Workers. The Times-Picayune, pp. C1. Torkanowsky, R. New Orleans Composers Feature Bayou Sounds in TV and Film Scores. Retrieved March 5, 2006, from the World Wide Web: Vancouver Travel. The Movie Industry. Vancouver Travel. Retrieved April 26, 2006 from the World Wide Web:

165 Small Business Incubator Report New Orleans, Louisiana Report prepared for: New Orleans Mayor s Office of Economic Development Don Hutchinson, Director Ashleigh Gilbert, Chief of Staff Joan Judycki, Project Manager Prepared by: Massachusetts Institute of Technology (MIT), Department of Urban Studies and Planning, & University of New Orleans (UNO). Ari Goldstein, MIT Brittanya Murillo, MIT Miguel Rodriguez, MIT Billy Phillips, UNO Kimberly Pratt, UNO May 19 th, 2006

166 CONTENTS I. Executive Summary 3 II. Introduction 6 III. Project goals 7 IV. Target businesses 8 V. Partnerships 12 VI. Business Needs 14 VII. Services 15 VIII. Management 16 IX. Development and Operating Budgets 20 X. Sources of Capital 23 XI. Next Steps 25 XII. Appendices 26 MIT/UNO Business Incubator Report 2

167 I. EXECUTIVE SUMMARY Mission Statement and Services The New Orleans Business Incubator Center (NOBIC) will address critical business retention needs with the long-term goal of facilitating new jobs, public revenue, and economic development opportunities for New Orleans. The incubator will offer quality office space for nearly thirty emerging businesses while providing them with entrepreneurial training and services including management assistance, business counseling, writing business plans, financial analysis, professional referral networks, and a supportive environment to network with other small businesses. All services and office support infrastructure is included in the competitive market rate rents. Partnerships In the post-katrina economy, New Orleans has a critical need for new business development and business retention. In an effort to fill an unmet need in New Orleans, the Mayor s Office of Economic Development has spearheaded the creation of NOBIC. Additionally, NOBIC will act as a catalyst to coalesce three service providers within the New Orleans area, including UNO and Loyola SBDCs, and Good Work Network. These partnerships will yield not only anchor tenants for the project, but also a more robust and functional referral and service delivery system. NOBIC will serve to foster entrepreneurial business growth in New Orleans by bringing together a service delivery system and providing continued business support through a continuum of care approach. The incubator will also partner with graduate students at Tulane and UNO in the business, law, and planning programs to gain credit hours while bolstering their professional skills and helping in the rebuilding effort. Facilities NOBIC will have the capacity for 29 businesses. The incubator will feature about 25,000 square feet of flexible office space with access to one conference room, three meeting rooms and a computer lab. Each office will have: T1 lines for high speed internet access, state-of-the-art data, fiber, and video wireless capabilities, fax and phone lines, Web and hosting capabilities, Business support services- including basic legal, marketing, and accounting assistance, General office support- including shared office equipment, conference rooms, and tech support, and Free business workshops, seminars, receptions and mentoring. Feasibility and Demand The existing small business service network is fragmented and unable to meet business demand; this is especially critical in a post-katrina business environment. Moreover, interviews with the two SBDCS, Good Work Network, NewCorp, and Idea Village strongly suggested that a small business incubator would fill a need, currently missing in New Orleans continuum of care for entrepreneurs. Indeed, there is no small business incubator in New Orleans and the existing service providers expressed a strong interest in consolidating their services and physically MIT/UNO Business Incubator Report 3

168 integrating with the incubator. In addition to this testimonial analysis of demand, data from the 2003 US Census indicates that key sectors for small business incubator growth include professional, scientific and technical services, real estate and lending, information, admin and support services, and the construction industry. With a total of 2,321 businesses with fewer than ten employees in the above sectors in 2003, an estimated displacement rate of 60 percent, and a loss rate of 20 percent, there are over 1,000 potential businesses that would likely benefit and create demand for the incubator. Client Acquisition Model NOBIC s acquisition model will center on the following resources and activities: Advertising and media, including various local newspapers and business trade publications Referrals from partners and existing clients Networking events whereby staff participate in local economic development events Community outreach programs, direct mailings, and presentations at chambers of commerce, business district associations, local neighborhood council and city council meetings Advertising on websites including those of the Mayor s office, governor s office, and partner organizations Evaluation Methods The incubator will realize it s goals of fostering economic development by establishing clear goals for each incubatee client as well as prioritizing turnover for each firm when ready, to maximize the total impact of the incubator and its services. Managed by a top quality executive director, an office manager and a support staff and directed by a board of directors representing key players in the small business development world from the public, non-profit, and private sectors, the incubator will establish clear admissions, management, and graduation policies. Entrepreneurs will face admissions criteria based on their potential and their current business savvy, but NOBIC will specifically target those businesses that would benefit most from the incubator experience rather than those with only high growth potential. Accordingly, graduation will involve the following criteria: Each incubatee will jointly prepare specific quarterly benchmarks for the upcoming fiscal year. Benchmarking provides the entrepreneur with a continuous business improvement tool that evaluates performance and competitive advantage at each stage of the company s growth. Businesses revenue growth, including financial transactions in the form of loans, lines of credit and equity financing will be bolstered and monitored. Financial matches and partnerships that lead to growth or procurement activity will be supported and monitored. Job creation potential, for full-time and part-time positions, will be a key component of admissions and graduation policy. MIT/UNO Business Incubator Report 4

169 Sources and Uses With the recommended size of 30,000 gross square feet, the incubator will likely purchase an existing building or engage in a sublease structure with clients. However, development is also an option and is estimated at $5 million, with sources of funds coming from special allocations of City CDBG, State LED, and federal EDA monies being supplemented with New Market Tax Credits and private foundation funding. Annual operating costs are estimated at $252,000 of which $157,000 will be raised in rental revenue with the gap filled by external services and operating grants. Next Steps The Mayor s Office of Economic Development will use this report to build partnerships and garner funds for the project. Specific next steps include establishing memoranda of understanding with the other business service providers, applying for funding from the state, federal government, new market tax credit recipient bodies and local and national foundations. This should be followed by establishing the board of directors, hiring the executive director, marketing, and designing specific admissions, management, and graduation policies once operational. MIT/UNO Business Incubator Report 5

170 II. INTRODUCTION The New Orleans Mayor s Office of Economic Development (OED), the municipal agency charged with fostering and creating a vibrant economy for the City, solicited the help of graduate students from the Massachusetts Institute of Technology (MIT) and the University of New Orleans (UNO) to design and analyze the feasibility of a small business incubator to aid in the economic recovery of New Orleans. Prior to Katrina, OED undertook many tasks, including connecting people and businesses to opportunities by building and leveraging partnerships at home and abroad, workforce training, retaining and attracting businesses, providing support for equal business opportunities, and managing and marketing the City s assets and resources. While continuing to do much of this work, Katrina has forced OED to draw on resources throughout the nation, such as MIT, to help design and implement a successful economic recovery for the city. The incubator project addresses the City of New Orleans need to identify appropriate financing and partnerships for local initiatives that support small and emerging businesses in the post-katrina environment. Indeed, business incubators lend themselves well to this function. They provide leased office space, shared administrative services, and business counseling for small and emerging businesses. The National Business Incubator Association (NBIA) states that 87 percent of all firms who graduate from incubators remain in business, thus significantly reducing typical business failure rates. NBIA research also indicates that for every $1 of estimated public investment in incubators, graduates of incubators generate approximately $30 in local tax revenue alone. Moreover, the NBIA reports that 84 percent of incubator graduates remain in close proximity to the incubator, thus yielding continued returns to the community. In the post-katrina economy, New Orleans has a critical need for new business development and business retention. A business incubator could be utilized to temporarily address critical business retention needs with the long-term goal of facilitating new business development. At the request of OED, the MIT/UNO team has studied the design and feasibility of a small business incubator, to not only help the economy of New Orleans recover, but also to grow and prosper. Hence, this report focuses on how best to design a small business incubator, MIT/UNO Business Incubator Report 6

171 in terms of targeting, services, partnerships, management, and operational policies, as well as development and operations financing. III. PROJECT GOALS The project goals of OED are currently broad in scope; to stimulate economic development benefits for the city in terms of jobs and tax revenues. These will be refined as the project moves forward and defines its place within New Orleans small businesses support activities and other economic development strategies. However, clear, rigorous and achievable goals are key for the incubator to make progress and judge success. The first set of goals will be tied to milestones as the project gets off the ground. Once operational, the incubator will have to establish goals and policies vis-à-vis admissions, management, and graduation. These goals should include the following, in approximate order: 1. Obtain funding from EDA for a feasibility and market study. 2. Establish MOUs with SBDCs and other service providers. 3. Begin applications for CDBG and LED funding. 4. Begin conversations with local CDEs regarding New Market Tax Credits. 5. Launch non-profit entity with key board members. 6. Hire an executive director. 7. Purchase or lease the building. 8. Set operational goals and policies. a. Business outcomes New businesses, success rates, tax revenues, and spillover effects. b. Employment outcomes Number and type of jobs created. c. Management outcomes Graduation rates and milestones. d. Group outcomes Goals for specific demographics or subpopulations (e.g. women and minority entrepreneurs). e. Place-based outcomes Economic development goals for particular neighborhoods, due to incubator graduates, targeted services, or the incubator itself. MIT/UNO Business Incubator Report 7

172 IV. TARGET BUSINESSES Prior to Katrina, small businesses of 50 employees or less, accounted for over 18,000 establishments and 250,000 jobs, more than 40 percent of the New Orleans job market. 1 However, the hurricane devastated both local businesses and the customer base, driving out an estimated 60 percent of the city s small business. 2 As such, a small business incubator is the perfect tool to help retain the 40 percent that were not displaced, but still struggling, while also attracting back a variety of new entrepreneurial businesses. While this report doesn t offer any recommendations regarding a specific industry focus, it does highlight potential business targets. Indeed, while highly targeted incubators have their benefits, 47 percent of incubators nation wide are mixed use. A. Assessing Demand: New Orleans Industry While this report does not take the place of a full feasibility study, it appears that there would be a strong demand for a small business incubator in New Orleans. The demand analysis methodology focused on interviews with key players in the New Orleans small business arena (see Appendix 2 for a list of interviewees), supplemented with secondary data analysis. As outlined by the Bring New Orleans Back Commission s (BNOBC) economic development committee, New Orleans has a comparative economic advantage in ten industry sectors, given the structure of the city s pre-katrina economy. 1. Hospitality 6. Film and Television 2. Bio-Med (Healthcare and Bio-Sciences) 7. Music 3. Maritime 8. Manufacturing 4. Oil and Gas 9. Food Processing 5. Aerospace and Military 10. Information Technology Each of these broad sectors that were vital to New Orleans before Katrina are comprised of horizontal and vertical networks of businesses, many of which would be ideal candidates for a small business incubator. Hurricane Katrina undoubtedly changed the nature of residents and 1 BNOBC Economic Redevelopment Plan and 2003 US Census 2 BNOBC Economic Redevelopment Plan, 7 MIT/UNO Business Incubator Report 8

173 businesses in New Orleans, yet these sectors and the historical business patterns represent the most likely future for the city. A review of the business pattern data from the US Census in 2003, the most recent year available, highlights the type and volume of small business that existed before the storm. The industry types below represent only those with a large percentage of small-scale firms who are non-retail based and thus potential types of firms that would benefit from a small business incubator. Industry Type Establishments with Total Fewer than 10 Employees Establishments Professional, Scientific, and Technical Service 1,269 1,560 Real Estate, Rental, and Leasing Information Admin, Support, Waste Management, and Remediation Services Construction Total 2,321 3,030 Source: 2003 US Census The category of professional, scientific, and technical services is mostly dominated by lawyers and legal services, however out of the 1,269 total firms with fewer than ten employees in 2003, there were also many consultants, architects, engineers, graphic designers, marketing, and design based firms. Many of these would be ideal incubator clients. The real estate grouping doesn t contain small businesses that are normally thought of for an incubator, however most real estate agents and brokers represent firms with fewer than ten employees, have low startup costs, and will be a key sector in the rebuilding process. The information sector, consisting mostly of telecommunications, publishing, video production, data processing, and internet, radio and television based companies, also represents a clear group of businesses that could benefit from a small business incubator. The administration, support, waste management and remediation services category is a broad category, but contains small businesses focused on everything from offering services to buildings and dwellers to travel arrangements, reservation services, office administration, landscaping, travel agencies, tour operators, and security guard companies. Many of these represent viable small business incubator targets. While construction represented only 374 firms in 2003, 73 percent of which were establishments with fewer than ten employees, this number will boom within the next few years. The construction industry, in terms of contractors, plumbers, electricians, painters, carpenters, and other specialty trades, is surely a broad businesses category that to be should be targeted for MIT/UNO Business Incubator Report 9

174 incubator clients. General contractors will need back office space, as will the other small tradesperson type businesses and other vertically linked firms that feed into the construction industry. In fact, one option would be to focus the incubator exclusively on the construction industry. In this scenario the incubator would not only provide services that help builders and developers with land-use, zoning, utility and advocacy work, but also connect them to complementary firms (developers with architects with contractors with carpenters with painters, etc.). The William Factory Incubator in Tacoma, Washington employed this type of approach. Overall, with 60 percent of the businesses displaced by Katrina and 2,321 broadly eligible incubatee-type businesses before the storm and assuming a 20 percent loss rate, there are still over 1,000 potential small businesses that could benefit from the incubator (2,321 * 60% * 80%). Additionally, conversations with Loyola and UNO SBDC administrators and Idea Village staff indicate that they have been unable to meet the total demand for entrepreneurial services. B. Assessing Supply: Existing Business Support Services There are currently five existing organizations working to meet the needs of emerging and existing businesses in New Orleans. None of these organizations provide physical incubation space, but they each offer important services that businesses should able to access through a physical business incubator. Good Work Network, Phyllis Cassidy As a non-profit formed to help low-income entrepreneurs gain knowledge and capital to develop their micro-enterprises, Good Work Network provides counseling and bookkeeping services to clients with little business sophistication. NewCorp Business Assistance Center, Vaughn Fauria NewCorp specializes in minority and women-owned business development through technical assistance, financial literacy training, business plan development, computer literacy for business software, marketing support and management counseling. Additionally, NewCorp can provide access to capital as a participant in the SBA Micro Loan Program, Chase/SBA Community Express Program, SBA 7A Loan packaging, and through the community development financial institutions. Loyola Small Business Development Center, Carmen Sunda This SBDC provides counseling, technical assistance and training for owners, operators, and managers of existing or proposed small businesses in the Greater New Orleans area. Specific assistance includes business planning, loan packaging, website development, logo design, marketing, finding sources of funding, and accounting and legal issues. MIT/UNO Business Incubator Report 10

175 University of New Orleans Small Business Development Center, Alice Kennedy The UNO SBDC provides information, one-to-one business counseling, seminars and workshops to individuals starting a business or whose business has technical assistance needs. Idea Village, Tim Williamson With a mission to encourage a culture of innovation and to provide the focused tools and resources necessary to accelerate the development of high-growth entrepreneurial ventures based in New Orleans, the Idea Village assists high-growth businesses by providing in-depth business consultation, including setting operational goals, advising and consulting on strategic business matters, connecting entrepreneurs to business mentors, and by facilitating access to professional services and capital resources. Unlike most cities of similar size, New Orleans does not have a facility that houses and nurtures entrepreneurs. While the earliest incubators focused on technology companies and other high-growth potential entrepreneurs, in more recent years, incubators have been used for manufacturing and mixed-uses. There are also a number of specialized small business incubation proposals being studied or already underway in New Orleans. These include projects such as an arts incubator, a digital media center for film production, a food processing incubator, a research and technology park innovation center and a business recovery incubator for businesses attempting to re-establish themselves in the post-katrina economy. The city does have an arts incubator, but it is targeted specifically to artists and isn t fully operational. Additionally, the Louisiana Technology Council received funding from the state to operate a recovery center, which some have misidentified as an incubator. Operated by Lee Pryor, this facility offers office space, but few services. Indeed, Pryor believed that a fully functional incubator sponsored by the city would be of great use to emerging businesses. This sentiment was echoed in interviews with the directors of the other small business service providers listed above, who believe that there is a strong need for a physical incubator that serves small businesses in need of a particular set of services, including office space. Thus, there is not only the demand, but a lack of existing organizations to fill the gap. Moreover, as discussed below, the existing small business service providers are more interested in partnering to offer better and more coordinated services than in competing for clients or funding. MIT/UNO Business Incubator Report 11

176 V. PARTNERSHIPS This proposal includes a physical incubator along with the business services identified above. It should be noted that a number of organizational leaders, including Diana Simak with the Louisiana Business Incubation Association, emphasized that effective support services are critically important to the success of a physical business incubator. Without services and policies, the incubator risks becoming a simple real estate project. To build service capacity and foster collaboration between the existing service providers, the incubator should provide space for these organizations. Indeed, the Loyola SBDC, UNO SBDC, and Good Work Network, all expressed a strong interest in physically locating in the incubator to further streamline referral and service delivery systems, identify any duplications or gaps in services, and allow for mobilization to secure funding over time. This proposal builds on the work done for the Entrepreneurial Network of New Orleans (ENNO) project started by the Mayor s Office of Economic Development and cut short by the dramatic staffing cuts that followed Hurricane Katrina. This effort to map existing business services aimed to accurately and comprehensively identify services provided by the many organizations serving small businesses in New Orleans. ENNO was to be an alliance of entrepreneurial support organizations committed to building a community of empowered entrepreneurs. In addition to OED, the Network involved Catholic Charities, Good Work Network, the New Orleans Housing Authority, Labor Solutions Inc., Newcorp, the Regional Loan Corporation, the Capital Access Project, the Idea Village, and the UNO and Loyola University SBDCs. While the status of some of these organizations is unknown, the potential for formal collaboration between the SBDCs, Good Work Network, the Idea Village, and the incubator is salient and important. Currently, these organizations provide different services for different business targets. Indeed, differently-sized businesses have different needs and come to these organizations with varying levels of business skill and preparedness. The following represents the client aims of each organization. Idea Village- serves higher capacity businesses UNO, Loyola SBDCs- serve middle range capacity Good Work- serves lower capacity businesses MIT/UNO Business Incubator Report 12

177 A diversified economy needs to be able to support a range of business sizes but it is clear these businesses have very different needs. Programs likely to attract and support skilled business owners who operate high-growth businesses will have less relevance for microenterprise entrepreneurs. Fortunately, the existing organizations have evolved with a clear understanding of these dynamics. While most provide a range of services and there is certainly overlap, each organization has a specialized area of interest tailored to meet the needs of their clients. One example of how different organizational specialties complement each other is the way in which technical services are provided. The small business development centers each provide group training and individual instruction. The UNO SDBC is known to excel at offering high quality workshops and seminars and the Loyola SDBC has a reputation for being especially effective with its one-on-one counseling. Both these organizations work with owners who have established a basic level of skill skills that may have been developed through the training and counseling provided by the Good Work Network. The Good Work Network works with the micro-entrepreneurs who may also have a greater need for the direct provision of back-office services such as simple accounting and cash flow projections that can be quickly produced by trained staff. Considering that many of these entrepreneurs are one-person shows, including contractors, craftsmen, artists and home care workers, it may make more sense to provide a collective of back-office services than to teach each of them how to use accounting software for the purpose of maintaining their own accounting books. This collective approach to relatively simple technical services would help these very small business owners to focus on their product while saving money. A. Continuum of Care Model The graphic below illustrates a continuum of care for entrepreneurs. The SBDCs on the left will lend their support to the incubator by sharing their services and by referring applicants to the incubator. As mentioned previously, there has also been interest expressed by all three SBDCs to be housed at the incubator, making this service delivery more centralized. Both the university and professional networks will work similarly to the SBDCs by lending support and offering referrals. Such support may include a partnership with graduate students at Tulane and UNO in the business, law, and planning programs to gain credit while bolstering their MIT/UNO Business Incubator Report 13

178 professional skills and helping in the rebuilding effort. These graduate students could help with reviewing businesses in the admissions process which is sure to be a time consuming task if left to the incubator manager alone. Additionally, they can assist clients with developing their business plans and enable businesses to stay abreast of technical innovations. Professional networks would help the incuabtee to build their professional capacity. Such an arrangement might include an agreement with identified accountants and attorneys available to provide their services to incubatees at a reduced rate or free of charge. By building their client base and allowing the incubatees to receive pre-screened, high quality, and low cost services, this arrangement is mutually beneficial. Lastly, upon graduation, businesses could either operate in the real world without additional support services, or potentially access higher-level services provided through the Idea Village. This continuum of care is represented below. VI. BUSINESS NEEDS In addition to assessing the demand for a small business incubator and leveraging partnerships for referral and service delivery, it is important to examine the specific needs of the MIT/UNO Business Incubator Report 14

179 target businesses. While needs will vary from one business to the next, general needs include the following: A structured environment in which to work Reasonable rent Shared services, including Office equipment, computers and faxes Meeting space Receptionist services Technical assistance, including Registering and licensing Writing a business plan Marketing Accounting Legal services Management mentoring Financing VII. SERVICES Based on the business needs and partnerships described above, the incubator should be able to offer the following services: Quality office space in an appropriate location with affordable and flexible leases Access to high quality facilities and technology services, including conference space, telephone, voic , printing, copying, faxing, and broadband. Management assistance and small business counseling. Assistance in developing business plans and skills as well as marketing and growth strategies. Financial analysis services to access debt and equity sources of capital. Entrepreneurial education and training. Referral to professional and advisor resources, such as lawyers and accountants. Access to a network of university, community, and business professionals. Linkage to the National Business Incubation Association. MIT/UNO Business Incubator Report 15

180 VIII. MANAGEMENT All interviewed parties and the literature agree that the incubator should be managed and operated by an independent non-profit entity. While this entity must recruit an expert manager, its board of directors should be comprised of key stakeholders from each sector. It is especially important to include the director or a liaison thereof of OED, the existing service providers, as well as key players in the local lending industry. Thus, the board would have representatives from the public, non-profit, and private sectors. A. Marketing Marketing is vital to attract a surplus of companies, only a small percentage of which will be the perfect fit for the incubator, but also to accomplish broader strategic goals. It can expand other organizations understanding of the incubator to lay the foundation for future partnerships. incubator manager and staff should view marketing and relationship building as part of their responsibilities. Marketing plans require both wholesale and retail strategies. Wholesale marketing, through mailings, media, and advertising is cost effective in reaching a large audience and generating broad community awareness. Retail marketing on the other hand, can better target specific businesses. Referrals can also be reciprocated with recognition as well as reverse referrals in some cases, as incubatee businesses mature. As such, marketing strategies include: Advertising and media, including various local newspapers and business trade publications Targeted mailings Press coverage Presentations Networking events whereby staff participate in local economic development events Community outreach programs, direct mailings, and presentations at chambers of commerce, business district associations, local neighborhood council and city council meetings Referral networks Lenders Technical assistance entities and service provider partners The MIT/UNO Business Incubator Report 16

181 Business and trade associations Civic and community organizations B. Admissions and Acquisition Model Client screening is vital to the success of the incubator. A well-structured screening and admissions process can help ensure promising clients, productive inter-client synergies, and successful graduates. Generally, the process begins with an application and is followed by an interview. The idea is to attract entrepreneurs who have the drive and skills to bring an idea to fruition, while thinking about relationships and linkages between the companies. While the admissions policies should ultimately be determined by economic development goals of the incubator, the targeting strategies and applicant pool also represent influential factors to be considered. Firstly, it s important to identify those businesses that will benefit most from the finance and management services that will be provided. However, admitting businesses on the basis of their success and growth potential needs to be balanced with community and city-wide economic development goals in terms of what sectors and types of jobs should be promoted. Once interest has been generated in the program, an application must be created that solicits information to assess the company s suitability for the incubator. An application should include the history of their company, current revenue, number of employees, type of business, space requirements, information on the company s owners and managers, business plan or description of the company s planned activities and product, and if available, a current financial statement and projections. The purpose of these policies is to determine the capacity and experience of the company so that an appropriate suite of services can address the needs of the potential incubatee. The applicant will be designated as either an emerging business or as an established business. Based on this designation, the business will be assessed for admission to the incubator based on the following criteria. Emerging Business Company s focus Job creation potential Established Business Company s focus Job creation potential MIT/UNO Business Incubator Report 17

182 Financial resources Background checks & credit histories Estimated benefit from incubator services Financial resources Background checks & credit histories Estimated benefit from incubator services Managerial capacity Cash flow projections Emerging businesses are less likely to have an extensive management team or a refined cash accounting system and should not be held to the same standards for the purposes of admissions. These would be activities that the incubator would assist the company to develop to move into the established business category. Indeed, focusing half of the spaces in the incubator for emerging businesses with the other half focused on more medium-capacity, yet still nascent entrepreneurs would yield benefits of diversification as well as more inter-client deal-making and information sharing. Nevertheless, if any applicant isn t quite right for the incubator, they can be directed elsewhere within the established network of small business service providers. Perhaps they need to go back to one of the SBDCs to get help before reapplying. The admissions process should involve the staff of the incubator as well as the board of directors. The staff will assess the goodness of fit of one business with the rest of the incubatee cohort. Generally, synergies should be maximized, while companies that would compete with existing incubatees should not be admitted. The board of directors, who will represent a range of business sectors, will have first-hand knowledge of the potential for business success within specific sectors. This insight, especially when the board has experience that matches that of the applicant, will strengthen the quality of the selected set of clients. While the focus of this incubator is clearly not solely on firms with the most growth potential, strict admissions criteria can help to create a positive reputation for the incubator and create competition for the limited space available. Graduation When a company is admitted to the incubator and at each lease renewal, the incubator director and client will set specific business objectives. These objectives will be used in conjunction with other criteria to determine when clients are ready for graduation. Other important considers are 1) whether the business is financially stable and 2) whether they still MIT/UNO Business Incubator Report 18

183 need the services of the incubator. The former, financial stability, will be assessed with the following metrics: Each incubatee will jointly prepare specific quarterly benchmarks for the upcoming fiscal year. Benchmarking provides the entrepreneur with a continuous business improvement tool that evaluates performance and competitive advantage at each stage of the company s growth. Businesses revenue growth, including financial transactions in the form of loans, lines of credit and equity financing will be bolstered and monitored. Financial matches and partnerships that lead to growth or procurement activity will be supported and monitored. Job creation potential, for full-time and part-time positions, will be a key component of admissions and graduation policy. Length of time at the incubator will vary, but should be less than three years. While most business incubators permit clients to remain for three to five years, many are focused on high-tech companies trying for an IPO and don t want to force graduation for fear of losing temporary rent. Since high demand for the incubator space is expected, graduation should be focused more on policy and less on the comfort of having a stable tenant. The goal should be to graduate businesses that are able to succeed in the private market, having used the service to develop their operating capacity. It is also important that the service of the incubator be made available to new incubatees and that it not be a permanent home for particular clients. IX. DEVELOPMENT & OPERATIONS Deciding where and how the business incubator will be located is important as location will facilitate customers, business supply, and delivery access for the businesses located within the incubator. Based on general feedback from interviews and conversations with people familiar with New Orleans, the Bywater and Upper Warehouse districts represent ideal incubator locations. A substantive and in-depth analysis will help to inform whether these districts offer the best, strategic location with appropriate pricing, existing commercial building stock and MIT/UNO Business Incubator Report 19

184 parking options. Additionally, these initial considerations will ultimately be determined by a holding decision, which is guided by a real estate and financial feasibility analysis. The central question to be considered here is whether the incubator will seek to lease, buy or construct a new building. A leasing option may provide the most financially feasible opportunity as the incubator launches its operations. This will add flexibility as the incubator stabilizes and adjusts to actual local business demand in a post-katrina environment. Moreover, as partnerships with local universities and services providers formalize, it will be important to explore possible needs and sitting opportunities with them. It is expected that as the incubator operations and budget structure matures, it will consider buying an existing building or possibly constructing its own facilities. Each of these options come with their own strengths, and depending on the incubator s growth and management capacity, one may provide greater advantages than the other. A development analysis is provided below which is based on a new construction approach. Based on this analysis, new construction is estimated at about $4.9 million, or $166 per square foot. This assumes market rents for Class B office space of $10 psf. In gathering and corroborating our information with local real estate personnel, we found that there is very little in New Orleans Parish that could accommodate 30,000 square feet of office space. In addition, real estate in the New Orleans is currently undergoing significant flux and an accurate per-squarefoot rate is hard to pin-point. A. Development Costs No specific building has been disclosed as the target of purchase for the incubator, as doing so would create speculative appreciation. However, general characteristics and costs can be estimated. The City does not have any buildings in its existing inventory and would likely acquire a 30,000 40,000 SF building in the Upper Warehouse or Bywater Districts. The following tables explain the potential space allocation within an assumed building of 30,000 square feet. Other assumptions were also made, such as the average space per incubatee of 500 sf and the breakdown of common space. In particular, the values below assume 3,800 sf for the service providers, yet if they need more then the total space available for clients could shrink. The current total incubatee capacity is 29 clients, but this could be reduced if needed. MIT/UNO Business Incubator Report 20

185 Space Allocation Office/Flex Space Total SF Total Usable Common Space Management Space Service Providers Incubatee Space Incubatees Avg Space Reqd Avg Employees Avg Space/Business Number of Incubatees SF 30,000 80% 24,000 20% 4,800 4% 1,000 16% 3,800 60% 14, sf/employee Common Space Conference Ctr (1 rm, 75 capacity) Meeting Rooms (3 rm, 20 capacity) Computer Lab Kitchen /Special Use Total Common Space SF 1,875 1, ,800 With the assumed 30,000 square foot building described above, typical development costs would be approximately as follows: Anticipated Development Costs (30,000 Sq Ft)* Land Acquisition Hard Costs Soft Costs Contractor Overhead/Profit Architectural Fees Total Development Costs Amount $2,000,000 $2,258,500 Per SF $66.67 $75.28 $564,625 $18.82 $173,574 $5.79 $4,996,699 $ *Source: RSmeans QuickCost Estimator, Mid-level Development Estimate B. Operating Cost Annual operating costs would be roughly the following for both the development and building purchase options. For the master lease with subleases to the incubatees system, operating costs would include rent which would be approximately $240,000. However, this would also substantially change the funding scheme and depend more heavily on operational grants from CDBG and foundation sources. MIT/UNO Business Incubator Report 21

186 Operating Expenses Budget % of Total Salaries and Benefits $155,400 62% 1 F/T Exec $72,000-1 F/T Proj. $32,500-1 F/T Office $25, % $25,900 - Telephone $6,000 2% Office Expenses and Maint $7,500 3% Supplies $8,000 3% Travel Expenses $4,000 2% Advertising $4,500 2% Miscellaneous $4,000 2% Office Equipment $2,000 1% Occupancy Costs $21,600 9% Printing $1,500 1% Postage & Messenger $1,000 0% Contingency (5% of Total Operating Expenses) $10,775 4% TOTAL OPERATING EXPENSES $252, % X. SOURCES As mentioned above, sources would change from a capital to operational structure if the purchase or develop options are not pursued. This would eliminate the NMTCs and change the types of CDBG, state, federal and foundational funds. While the development option is presented below, operational subsidies and grants from these sources are also probable. A. Development Sources Sources of Capital City of New Orleans CDBG - Special Allocation $ 996,699 Louisiana Economic Development $ 1,000,000 Federal EDA $ 1,000,000 New Market Tax Credits - Special Allocation $ 1,000,000 Foundations $ 1,000,000 Total $ 4,996,699 As of April 2006, the State was planning to use $350 million of their special CDBG allocation for economic development as per the following breakdown. While these categories, MIT/UNO Business Incubator Report 22

187 funding amounts and their eligibility criteria are still in flux, the City of New Orleans should easily be able to garner $1,000,000 for development cost subsidy. Another option would be to use HUD-108 guarantees to borrow against future CDBG allocations. State CDBG Monies for Economic Development Category Amount (in millions) Bridge Loans $ 100 Long-term Recovery Loans $ 90 Risk Pool for Limited-Equity Borrowers $ 20 Technical Assistance $ 40 Workforce Training $ 40 Marketing $ 30 Higher Education $ 30 Total $ 350 Foundation funding can come from a variety of sources. The large-scale foundations such as Sorros and Rockefeller are giving through the Greater New Orleans Foundation while others like Ford are still looking for investment opportunities and sectors. Besides the well known and large-scale national foundations, the following groups could be tapped for the incubator project and have been known to fund economic development in the past. They include: Bush-Clinton Katrina Fund, Baptist Comty Ministries, Entergy Foundation, Rosa Mary Foundation, Ella West Freeman Foundation, and the Foundation for the Mid South. Additionally, United Nonprofits and the Louisiana Association of Nonprofit Organizations (LANO) would likely support the formation and needs of the incubator nonprofit. The total pool of available funds from these foundations is over $45 million. With total development costs at approximately $5 million, the New Market Tax Credits could raise approximately $1 million. Under the leverage model investors agree to place their funds in a separate legal entity for that entity s equity contribution to eligible. Current law provides a new markets tax credit for a qualified investment in a qualified community development entity equal to five percent in the year of investment and the following two years and equal to six percent for the following four years. CDEs are any domestic corporation or partnership whose primary mission is serving or providing investment capital for low-income communities that is certified by the Secretary as being a qualified CDE. The maximum amount of qualified investments is capped at $2 billion per year for calendar year 2005 and at $3.5 billion per year for calendar years 2006 and However, the Gulf Opportunity Zone has been MIT/UNO Business Incubator Report 23

188 allocated an additional $300 million of NMTCs for 2005 and 2006, and an additional $400 million for The general rule of thumb among NMTC practitioners is that under the leverage model, 20 percent of the eligible costs can be considered grant equity. There must be a nominal return per IRS law, but it can be as low as one percent. Of course, the investors realize their return from the tax credits directly as well as passive losses through depreciation. To access the NMTCs, the City should identify the local qualified community development entities (CDEs) who are legally entitled to apply for credits and receive them for disbursal. B. Operating Sources Operating Income Rental Service Providers $ 8 $ 27,360 10% vacancy Incubatees $ 10 $129,600 10% vacancy total $156,960 Other External Conf Space Use $ 2 $ 9,600 External Services 7% $ 10,987 5% of Rental Revenue total $ 20,587 Grants $ 74,628 Total $252,175 With market rate rents conservatively estimated at $10 psf with the service providers paying $8 psf, the total rental income is projected at $156,960 including a 10 percent vacancy rate. However, depending on the current rental and financial situation of the two SBDCs and Good Work Network, their rent could be increased to market rate as well. Additionally, rates will rise with the market and adjust at each lease renewal accordingly. Other income sources include the provision of external services to non-incubatee entrepreneurs and the use of the incubator s conference space by external organizations. Lastly, grant sources from either public or foundation sources would fill the gap. MIT/UNO Business Incubator Report 24

189 XI. NEXT STEPS The Mayor s Office of Economic Development should use this report to build partnerships and garn funds for the incubator. Specific next steps include establishing memoranda of understanding with the other business service providers, applying for funding from the state, federal government, new market tax credit recipient bodies and local and national foundations. This should be followed by establishing the board of directors, hiring the executive director, marketing, and designing specific admissions, management, and graduation policies once operational. The small business incubator will play a vital role in the economic revitalization of New Orleans. With roughly ten firms graduating per year, the City can expect job growth from the incubator alone of at least 20 employees and a subsequent gain in local tax revenue. Moreover, the incubator will also help it to stay competitive with other cites throughout the United States. Indeed, as cities across the US have seen the power of incubators to develop resident businesses, the number of total incubators has boomed and now totals over three hundred. By nurturing fledgling firms into healthy and thriving small businesses, the City of New Orleans will create an economically amenable environment for entrepreneurs while yielding numerous fiscal and social benefits to the City. MIT/UNO Business Incubator Report 25

190 XII. APPENDICES Appendix 1. Interviews o Mayor s Office of Economic Development Don Hutchinson, Ashleigh Gilbert, & Joan Judycki o Idea Village Tim Williamson o Louisiana Technology Center Lee Pryor o Louisiana Grants Office o Louisiana Recovery Authority o Tulane, AB Freeman School of Business John Elstrott o Loyola SBDC Carmen Sunda o UNO SBDC Alice Kennedy o Good Work Network Phyllis Cassidy o Louisiana Business Technology Center Roy Keller and Bryan Greenwood Appendix 2. Sample Business Education Seminar Series LTC/LED Recovery Center Seminar Series by Lee Pryor à à à à à à à à à à Business plans and successful strategies for growth Sources and ideas for raising cash Practical accounting and cash flow practices Sales and marketing techniques Technology transfer and copyright issues Finding, hiring, and motivating employees Proven best management practices Advances in communication technologies Proper use of the latest in information technology Website optimization MIT/UNO Business Incubator Report 26

191 Appendix 3. NBIA's 1998 State of the Business Incubation Industry Findings MIT/UNO Business Incubator Report 27