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How to Discuss Capital Project Financing with Your Lender

Jason Johnson
Educational Opportunities: 
Renewable Energy, AgriBusiness

As the ethanol industry has matured and paid off significant amounts of debt in the past few years, it is becoming more commonplace for plant managers and board of directors to consider re-scoping their vision and determine whether or not it might be a good time to expand, enhance or upgrade their facilities. Project discussions range from efficiency projects, new or additional building projects for the ability of increased capacity and new technology projects to allow processing of alternative, value-added products extracted from corn. Some older plants simply need to make investments back into the plant to continue to be competitive in the market.

As plants consider these projects, it is generally very helpful to think through how lenders evaluate the project from a lending point of view. The answer is not all that different from how the management team and board of directors evaluate the project. It starts with a projection on estimated Return on Investment (ROI.)  What are the costs? What are the potential returns and how might additional gallons affect the local corn basis? Unlike the investor, the lender generally only has downside risk to the stated interest rate on the loan and no upside in the form of greater returns an investor has, thus the lender’s tolerance for risk is generally not as great as equity investors.

Weighing Risks and Benefits
When discussing a renewable energy capital infrastructure project with a lender, be prepared to discuss the short- and long-term benefits and risks of the project. Prepare a three to five year projection with the key assumptions used in preparing the projection. Also consider stress testing those assumptions as the lender definitely will be doing so as they evaluate the project. Given those scenarios, what is the ROI of the project and how does it make the plant more competitive in the long run? 

The goal of most projects is to either drive down costs to make plants more competitive from a cost of production standpoint or try to capture higher margin revenue products. Thus, understanding what the plant’s performance drivers are and how the facility ranks from a performance curve standpoint are important. Typically, this is evaluated as an EBITDA per gallon metric. History has shown that the most efficient gallons will have less volatility to earnings during down cycles.

If you’re considering a new technology with new market opportunities, expect some pushback on an expenditure that has the serial number “001” on it. While we have seen great successes, such as corn oil extraction, not all projects have had that type of universal success. Nor are all projects “one size fits all.” There may be geographical differences that make some renewable energy projects successful or unsuccessful. Cellulosic production is also still an evolving path. Often times, it’s better to be patient and ride out the infancy phase of new technology, so any initial bugs can be corrected and data on effectiveness can be accumulated.

Impact on Working Capital
As with all commodity related industries, the project’s impact on the business’s working capital will be a key discussion point, especially in an expansion where more working capital maybe required. Working capital in the $.15 to $.20 per gallon is largely considered a minimum healthy level. Higher working capital levels however, can be a strong mitigator to additional risk a capital investment project may bring. Expect your lender to have covenants around this financial metric. Striking the right balance between investments in assets, maintaining a strong working capital position and distributions back to investors are the biggest challenges we see as projects are discussed.

Management Strength
While the historic and projected financials of the plant are central to a lender’s credit decision, equally important is the strength of a management team. This is evaluated by the business’s historic performance, particularly during challenging times. Strong economic periods can hide management deficiencies, however, performance during challenging times highlights strong management teams. Strong management cannot control all adverse factors, but can help position the facility to better manage through them. 

Debt Levels and Gallons
An ethanol plant’s debt level is usually combination of all the factors previously outlined: historic and projected cash flows, working capital, and strength of management. This is typically defined in terms of debt per gallon and can range from the $.50 to $.65 debt per gallon, depending on the project. As it relates to expansion, there is always the discussion on whether the industry needs more gallons. This is no different from many other commodity based businesses and is a function of supply and demand. If a business is going to expand it must justify how it survives in an oversupplied market. This correlates exactly back to being an efficient producer with working capital to absorb some acceptable losses and a strong management team that can adapt to changes to the market.

Having a good relationship with your lender helps establish management’s credibility and generally creates a more open dialogue as capital projects are discussed. Lenders do not like surprises, so keep them informed and let them know what the business sees as potential risks and why the business is comfortable with the risk. Cultivating this relationship on an on-going basis will position you for a more productive, honest and beneficial discussion when the time comes for capital project financing.
For more insights from Jason and other Compeer experts, check out, where you’ll find grain and livestock industry news, legislative happenings, and financial preparedness guidance.
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