Choosing the appropriate financing alternatives as your company expands ensures that your business operations run smoothly and growth capital flexibility is maximized.
By Steve Arentsen
The $85 billion North American municipal solid waste and recycling industry is a capital- and equipment-intensive sector. This demands that companies make crucial decisions about how to fund ongoing capital expenditures and growth. Traditionally, companies operating with 50 or fewer frontline collection vehicles (generally, less than/equal to $20MM in annual revenue) have appropriately funded fleet and equipment purchases using traditional equipment leases and/or term loans. Leasing alternatives generally offer fixed-rate financing of specific equipment with up to seven-year repayment schedules.Alternatively, equipment term loans are commonly structured as floating rate obligations and may include a designated interest only draw period, after which any outstanding loan balances are converted to a fully-amortizing term loan. Similarly, operators in this size range commonly fund facility and infrastructure investments using traditional real estate secured mortgage financing.
Although these financing alternatives are time-tested and have proven effective, as a municipal solid waste company’s operation increases beyond $20MM to $25MM in annual revenue, its financing options begin to broaden and become more flexible, particularly when an industry-knowledgeable lender is engaged. This happens because industry-knowledgeable lenders typically offer financing structures that acknowledge the value of the company’s predictable, recurring cash flow that results from a granular, contracted customer base in what is a basic, essential service business. The possibility of a cash flow lending structure is further enhanced if a company’s collection operations are integrated with permitted waste transfer/processing and/or disposal facilities, given the incremental margin capture and expense control that vertical integration in the solid waste industry provides.
Evolving to a Cash Flow Lending Structure
Based on scale and company specifics (business mix, local market share, permitted waste processing/disposal facility integration, profit margins, etc.), a popular industry-appropriate lending structure involves refinancing some or all existing equipment-specific secured financing with a general purpose revolving credit facility with a three to five year maturity. Revolving credit facilities set an agreed-to-borrow limit that can be paid down and re-borrowed based on a company’s operating cash flow.
Revolving credit facilities are interest only with repayment of outstanding principal due at maturity. Borrowing proceeds under this structure are available to fund working capital, capital expenditures, acquisitions and other growth initiatives. A revolving credit facility of this kind is often initially paired with a consolidation term loan, under which, some or all of the company’s existing debt is refinanced on a single amortization schedule, simplifying ongoing loan administration.
As opposed to a leasing or similar asset-based financing structure, under which specific assets are financed and maintenance of monthly principle and interest payments are the primary requirements to maintain compliance with the financing agreement, a cash flow structure with a large revolving credit facility component, requires more limited principle payments in exchange for the borrower agreeing to maintain an acceptable financial profile, governed by ongoing maintenance of agreed upon financial covenant levels. Typically, the primary financial covenants included under a cash flow lending structure are:
• Cash Flow Leverage—Measures cash flow adequacy to fund ongoing unfinanced capex and other cash outflows and is typically defined as Total Funded Debt divided by trailing 12-month EBITDA (earnings before interest taxes, depreciation and amortization).
• Debt Service Coverage—Measures the company’s ability to service required debt payments and is typically defined as EBITDA, less taxes, distributions and unfinanced capex divided by required principle and interest payments during the measurement period (otherwise known as Fixed Charge Coverage). Financial covenants are set at levels intended to allow for ongoing refinance/renewal of the revolver at maturity.
Cash flow lending structures can greatly simplify a company’s typical equipment financing cycle. For instance, under an equipment lease or term loan financing structure, individual assets are financed with the resulting debt amortized as required from ongoing operating cash flow generated by the business. Given operating cash flow is used to service scheduled monthly principal and interest payments, new truck purchases require entering into, and documenting, a new equipment loan or lease for each material capital outlay.
By contrast, under a cash flow revolver structure, trucks and equipment are purchased with draw-downs from the revolver, but given that they are not placed on an amortization schedule, operating cash flow can be used to pay down the revolver, thereby, refreshing availability for additional, incremental truck and equipment funding at a later date without documenting a new loan, so long as compliance with the agreed upon financial covenants can be maintained. Another benefit of a cash flow structure is its scalability. As the company and its cash flow grows, the financing commitment of the bank can scale accordingly, assuming agreed to financial covenant ratios are maintained. Consequently, borrower loan administration and origination activities can be greatly reduced, freeing up management to focus on business operations versus financing activities.
Find a Lender Who Knows Your Business
Clearly one size does not fit all when it comes to financing ongoing operations and growth initiatives within the solid waste industry. That is why, in addition to understanding financing options, it is equally important to work with a lender who has waste industry expertise that allows companies to structure credit facilities in a way that recognizes and leverages the reliability of cash flow that companies of scale generate. That type of lender can become a trusted advisor that not only provides financing, but also helps business owners navigate through crucial growth stages. | WA
Steve Arentsen is a Senior Relationship Manager covering the Waste and Recycling industry for Wells Fargo Bank. Based in Chicago, IL Steve has more than 25-years of industry lending experience and covers 18 states throughout the Mid-West and Western regions of the U.S., as well as the Canadian market for Wells Fargo. Steve can be reached at [email protected].