How do you finance buying an excavation or site-work company?

Iron and earnings: the two halves of the credit

Most service businesses sell for goodwill: the buyer pays for earnings, and a lender has little to repossess. An excavation company is different. Excavators, dozers, loaders, compactors, dump trucks and lowboys can make up a large part of the purchase price, and they hold value in a way goodwill does not.

That makes the financing easier in one way and harder in another. Easier, because the fleet is collateral a lender can value on an appraisal, which supports more debt and a smaller goodwill balance. Harder, because equipment wears out, and the earnings a lender counts are what is left after the fleet is kept up. A company that looks highly profitable because its owner has not bought a machine in years is less profitable than its statements say, and its equipment is worth less than the seller thinks.

The buyers at this size are strategic contractors adding capacity or a region, private equity platforms building civil and infrastructure services groups, independent sponsors and management teams. A company this size has usually outgrown SBA financing, whose 7(a) loans go up to $5 million.

Lenders value the fleet on its appraisal, not on what the seller paid or what the depreciation schedule shows.

Who the customers are and how the work is won

Lenders are most comfortable with a spread: public and utility work for stability, builder and commercial work for volume, and no single customer controlling the book. A company that earns most of its revenue from one developer or one general contractor raises the questions in customer concentration in an acquisition, however long the relationship.

The fleet: appraisal, age and the replacement lenders deduct

Expect the lender to order an equipment appraisal, usually at orderly liquidation value, what the machines would bring in a managed sale, and sometimes fair market value as well; see equipment appraisals. The appraiser looks at make, model, year, hours, condition and maintenance records. A seller who kept service logs and replaced undercarriages on schedule supports a better appraisal. The appraisal also shapes the purchase price allocation: the stronger it is, the less of the price must be carried as goodwill.

On the earnings side, lenders deduct the capital spending needed to keep the fleet working, whether or not the seller spent it. A simple case: EBITDA of 1,500, a replacement allowance of 300 for machines and trucks, and annual debt service of 960 give coverage of 1.25x, the level conventional bank lenders commonly look for. Measured on EBITDA alone, the same deal would look far stronger than it is. Lenders usually test this with a fixed charge coverage covenant; see maintenance capex and fixed charge coverage ratio.

Existing equipment loans and leases are paid off at closing or kept inside limits the senior lender sets, and the buyer needs a clean list of which machines carry liens. See paying off seller debt at closing.

Backlog, bids and bonding

For companies that bid work, lenders look at signed backlog, the work-in-progress schedule and how estimated margins on past jobs compared with actual results. A company that consistently finishes jobs below its bid margin has an estimating problem that will follow the new owner, and the estimators who bid the work are key people the lender will ask about.

Bonding is the constraint many buyers discover late. Public work and many commercial jobs require payment and performance bonds, and the surety that bonded the seller underwrote the seller. A change of ownership means the surety underwrites again: the new owners' experience, the company's balance sheet after the acquisition debt, and the new indemnity. An acquisition that loads the balance sheet with debt can shrink the bonding line, and a smaller line means less public work. Buyers who depend on bonded work should talk to a surety before the letter of intent and shape the structure around the answer.

Seasons, people and the yard

Site work stops when the ground freezes, slows in wet months and runs flat out in dry ones. In colder states the company may earn most of its year in a few seasons and carry payroll, insurance and equipment payments through the winter. Lenders read the business by the month, and the revolver has to be sized for the trough and for bid-work receivables that are paid slowly with retainage held back. Asset-based lenders typically advance 80% to 90% of eligible receivables, but retainage and receivables more than 90 days past invoice are typically excluded. See working capital at close; a deal that closes just before winter needs more cash than one that closes at the start of the season.

• Operators and foremen. Experienced operators and foremen who run jobs without the owner make the fleet productive. Lenders ask who they are, how long they have stayed and whether they are staying. Union or open-shop status affects labor cost and which jobs the company can bid.
• Drivers and trucks. Dump trucks and lowboys bring commercial driver licensing, motor carrier compliance and inspection records.
• Safety record. Trenching and heavy equipment are high-risk work. Injury history drives insurance cost, and on many commercial and public jobs a poor record disqualifies a bidder. Lenders ask for loss runs.
• Licensing. Some states license site-work or underground utility contractors, and the license may sit with the founder.
• The yard. Equipment needs a yard with room, access and zoning. If the seller owns it, the buyer buys it or signs a lease long enough to cover the debt. Fuel storage, washing and fill material create environmental exposure, and lenders taking the real estate commonly require an environmental assessment.

Structuring the purchase

Where an ABL lender and a cash-flow lender both lend, they split the collateral under an intercreditor agreement; see ABL and term loan split liens. Coordinating equipment loans with a senior lender is covered in equipment loans with senior debt. Many buyers keep the founder on through the first seasons, often with rollover equity, to introduce them to builders, general contractors and the surety.

What goes in the file

An asset-based facility starts from an AR aging by customer with days outstanding, an AP aging, the balance sheet, the P&L, a year-to-date P&L, and the debt schedule with the notes and liens on each financed machine, often with bank statements and two to three years of tax returns. The acquisition adds the target's latest full year of figures for every company being bought, never an older year, and the letter of intent. For an excavation company, add a fleet list with make, model, year, serial number, hours and liens, and any recent appraisal; equipment capital spending for each of the last several years; revenue by customer and type of work; the WIP schedule, signed backlog and retainage; the bonding line; and insurance loss runs, truck compliance records and the yard details.

Senior bankers run every Midas Partners engagement. Once the documents are in, Midas Partners builds the financing model, lender presentation, blind teaser and underwriting memo in a day, with the replacement allowance built into coverage the way a lender will measure it; by hand the same package takes at least a week. Of the 1,800+ lenders in the book, 235 write asset-based loans and lines and 1,148 write term and private credit. See the package.