Farming Field

A Deep Dive into Recourse Financing

Here we answer clients' most common questions and look at an example of a successful company.

How Much Can We Borrow?

 
You can often borrow more than you may realize. We work with banks that understand the solid waste industry’s most important characteristic—that these companies are more like utilities than any other type of company. Whether your competitive market share in your service area is stable at 30-50%; or you have a contractual monopoly through a “franchise” agreement with a municipality in California or a few other areas; or in Washington State have a “G Certificate” providing a monopoly actually regulated as a utility, it is much more likely that your company has been and will continue to be successful than is the case in other industries to whom the banks typically lend.

Management, Management

 
Good bankers have often said that the most important three things about a potential borrower are, “management, management, and management.”  The reason for that is obvious—a well run company that faces crises or new challenges is much more likely to survive if the management is proactive and responsible. But as a practical matter, all banks start there, there are a lot more factors in play:

Leverage and its Limits

 
How do banks figure out what they can lend you? They look to two primary financial metrics which measure how much debt you have as compared to your “EBITDA” (earnings before taxes, interest, depreciation and amortization costs and charges). That ratio is called a “leverage covenant”. The second is that same annual EBITDA less taxes and distributions to the owners, divided by principal and interest payments due in that year. That is the “Fixed Charge” coverage ratio. Integrated solid waste management companies can get away with more “leverage.”
 

Typical & Atypical Ratios: Banking by the Book

 
These companies are “capital intensive” and are naturally going to have a higher “Leverage” ratio than most other types of companies. Only banks that understand the industry would agree with that. By talking to us, you can be sure you are speaking with an experienced bank. Otherwise you will be at the mercy of what we call, “banking by the book” which means the banker takes no time to learn your business and instead just sets the “financial covenants” including the leverage ratio and as if all industry and non-industry companies were the same. The federal regulators have said that anything over 3.0:1 is a “highly leveraged company”. We routinely get much higher limits than that, as long as there is a good reason for the new equipment purchases or facility development. In over 25 years, we’ve never seen any client who didn’t have a very good reason.
 

Leverage and Real Life – How High Can You Go?

 
So what does all that really mean to you? See below for some fairly typical numbers for a small solid waste company.
“Last Year” is where we start. First, you can see that this profitable company is over the “preferred” Funded Debt to EBITDA ratio—at least according to most banks and bankers. However, in our world with our clients, that is not at all extreme. But is that all they can borrow? No! This company has a growth plan but needs to spend another $18 million on a new material recovery facility, anaerobic digestion project, or even just to buy trucks for a bunch of new customers.
 
We find them an experienced bank to do that and they borrow the whole amount required in “Year 1”. That increases “Leverage” to almost 7:1. Few banks will do that, but it is not unusual for our banks that understand that during construction or other asset purchase, that additional EBITDA is on the way through new revenues, lower expenses, or in most cases, both. So, in effect we get the bank to ignore leverage during construction.
 
Instead, what we look for is shown here. In “Year 2”, revenue from the new assets jumps to $46 million and while expenses go up, so does EBITDA, and the leverage goes down to the “4s”.
 
In year 3 the new assets are fully performing, revenue jumps by another $3 million, and we are now in the mid “3s” on leverage. The absolute numbers are not important, the trend is! (At least with the right bank.)