MAU 18 | Environmental Due Diligence

 

Get to know what environmental due diligence for commercial lenders and site remediation for businesses are as Domenic Rinaldi and his guest, Tim Allen, discuss what to do when business owners or buyers have real estate attached to their proposed transactions. Tim conducts Business Development for A3 Environmental LLC. Today, he talks about the discovery process or Phase 1 of the environmental due diligence and when they are needed, as well as Phase 2, the black and white answers to the REC, and Phase 3, the remediation of the problem underground. He also touches on the tolerances that different lenders or banks have when it comes to RECs.

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Tim Allen: Environmental Due Diligence

If you’re a business owner or buyer and there is real estate attached to your proposed transaction, you will want to read this episode. I am joined by Tim Allen who heads up business development with A3 Environmental, a full-service woman-owned company that provides environmental testing. I loved one of the quotes I came across by the founder who also happens to be Tim’s wife, Alisa Allen, “I give peace of mind to banks, business buyers and sellers and commercial lenders that their investments are safe from environmental risks.” Having sold many businesses where environmental testing was required, I have seen the value of a company like A3 can bring to a transaction. Tim, in his own right, is incredibly accomplished, having started an education software company out of college, which he sold. He runs a SaaS platform that helps in the labeling of over 33 million books in public libraries. That’s two of Tim’s many pursuits and accomplishments. Tim, welcome to this episode. I can’t believe it, 33 million books. That’s crazy.

Thanks. It is a lot. It’s shocking to me. It was a lot of work, but we got there.

I’m excited to get into A3 and talk about what you guys do. Why don’t we start there? Talk about what A3 offers and what types of environmental issues you’re testing for.

In environmental due diligence, which is probably mainly what your M&A community would be interested in, what we do is we evaluate the risk associated with a piece of property from an environmental standpoint to the lender and to the buyer. When they purchase the property, they don’t find out that they’ve got $100,000 worth of leaking underground storage tanks or something along those lines. There’s a review process and people know it as a phase one. It’s the first step of that discovery process and there are phases beyond that. What it involves is a database search for the federal, state, county and municipal databases. For anybody who ever had leaking underground storage tanks, used chemicals on-site, transported chemicals, generated chemicals or anything that would be a hazard to the soil, the air or the water supply that would be underneath the building. Their surrounding neighbors who might’ve polluted onto the property that you’re looking to purchase.

Tim, when is a phase one report required? What are you doing after it’s been ordered?

They’re required when a property is changing hands. They’re demanded by the lending institution. We have a surprising number of clients that come to us with all-cash transactions, which means that they’re tapping some line of credit somewhere. The smart ones know enough to get the due diligence done. Plenty of times, they’ll do all cash transactions and then find out six months later when they want to refi into a conventional mortgage, there’s a problem with the property and the banks won’t lend any money on it. They have to fix it before they’ll be able to get a loan against the property.

A bank doesn’t require a phase one on every type of property. Give me examples of where a phase one is required, then how long does the process take from start to finish.

Banks will set their own internal guidelines that are usually based on dollar amount if you’re borrowing over $500,000. In a lot of cases, maybe it’s $1 million. Sometimes it has to do with the type of property, if it’s industrial, automotive or chemical plating facilities, they’ll require it. Plating facilities are horrible. The process is quick. Usually, we have them done in ten business days. That’s two weeks because there’s always a due diligence period once you’ve signed a contract that you have to get your stuff done inside. We’re an industry that’s designed to go as fast as possible as soon as we’re commissioned.

What’s the expertise that’s required to undertake a phase one report? How do you know if you’re going out to get a company like yours that they’re going to be able to do the job they were hired to do?

The expertise that we have, all our employees are either environmental science majors or geologist majors. Three of our senior people are professional geologists. They’re registered with the State of Illinois and surrounding states for that matter. Every state is a little bit different so you have to register in each of the states. There are senior quality assurance people. Alisa, Dave and Morgan have got several years’ worth of experience. The junior people will do the first pass and then they’ll hand it to the senior people who will do the final review and then we turn them in.

MAU 18 | Environmental Due Diligence

Environmental Due Diligence: Environmental due diligence is evaluating the risk associated with a piece of property from an environmental standpoint to the lender and the buyer.

 

Are there specific certifications that cover this industry?

Yes, there is a certain certification for environmental professionals. Engineering firms can do them. They don’t like to but it’s a subset specialty.

You go through phase one, it sounds like it’s extensive. You’re doing a lot of research, pulling a lot of different facts from different places to put this report together. What are the various outcomes? I’m sure it’s good or not good, but are there shades of good or not good? I’m sure there are more technical terms than good or not good.

The term you’re looking for is a REC, which is a pun. It stands for Recognized Environmental Concern. The way the process works is we go through all our databases, do an onsite survey, search around the inside of the property, the outside of the property for anything that could be a hazard either past, present or future to the property. They write everything that they’ve learned up into a report that’s 300 to 500 pages. If they found something, they try and talk it away. Let’s suppose they find a stain on the ground, initially they’ll say, “That’s a recognized environmental concern. Is there some reason why it’s not a recognized environmental concern?” The report will be filled with these things like, “We found these barrels, but these barrels were properly disposed of. The barrels were there but the barrels were empty and there was no sign that they used them.”

At the end of the day, we’ve got RECs and then responses to those RECs until you reach the point where you’ve got a REC that you can’t respond to. At that moment, you’ve got what they call a REC on your phase one. It’s a black mark on it. Sometimes that means that you have to go to phase two, which is some sort of analytical testing that can tell with science that the problem is a problem or it is not a problem. Phase two gives you a black and white answer about the thing that you found and whether or not it is impacting the property or impacting the property in a way that is going to cause some sort of financial liability to the property itself.

You do phase one and potentially it’s all clear. You give the report to the bank and then the parties are clear to close, at least from an environmental perspective. If there’s a REC on the report, does it automatically result in phase two? How’s the decision-making process at that point in time between the bank, the borrower and the landowner?

A lot of times people think that we put a black mark on something and then it’s done. They can’t lend on it. That’s not true. What we do is we open people’s eyes and then the bank and their risk department determine what the next step is and how far they want to take that. Gas stations, I would say 85% to 90% of them have what would be Recognized Environmental Concerns. There’s an entire industry designed to finance gas stations. Those types of banks that will lend on gas stations have a different risk tolerance than somebody who does restaurants and then you show up to them and you say, “Finance my gas station.” A lot of where we go after phase one with a REC depends on the type of lender that you have and the risk tolerances that they have.

There are no national guidelines around this. Every bank can make those decisions themselves.

There is one set of national guidelines about that and that’s for small business lending, which I’m certain your clients and your followers do a lot of. The federal guidelines that drive the SBA drive specific cut and determinant factors for what you have to do when something appears at a high level, dry cleaners, anything automotive and many things involving industry of sorts. If your property is zoned industrial, you’re going to be at least concerned. The SBA is going to be concerned about those things. They are far stricter than a private lender would be. There are automatic phase twos depending on how old some of those facilities are dry cleaners specifically. I don’t know if you’ve ever done an M&A for dry cleaners. I’m certain it happens. They are scary to get involved with, especially when they’re old.

That’s not an industry that we typically play in. We might’ve been involved in 1 or 2 large plant deals, but dry cleaning is not a sector for us. When you get to these guidelines from the SBA, do you find that the banks adopt them because it’s easy for the banks to do that or will they still have their own guidelines even though the SBA stuff is out there?

The smart ones know enough to get the due diligence done, but plenty of times they'll do all cash transactions. Share on X

It varies from bank to bank and their risk tolerance and when the last time they got burned was, quite honestly. They do get burned like they make bad loans because somebody wasn’t creditworthy. They make bad loans because they got bad environmental advice.

Who in the bank is making that decision? Do they have their own environmental technical people? I doubt it. Is it an underwriter that’s making that decision? How does that decision get made at the bank level?

The standards are set by the senior risk officer. In practice, they call them closers that the loan production people hand off a project to a project manager whose job is to close the loan or bring it all the way to the end. The guidelines are set by the risk of people in a bank.

Let’s take this to the next step. Let’s say the report comes back and the bank or the borrower is uncomfortable with the phase one report and there’s a REC or two on them. What happens in phase two? I’m sure there are lots of scenarios, but at a high level, what’s the process there? How long does it take? What are the potential outcomes?

There are many different types of phase twos that are specked custom, the prices are all over the board depending on what contaminants we’re looking for. It might be heavy metals, petroleum products, other chemicals such as dry cleaning fluid and all of those are different scenarios. By and large, what happens is somebody shows up with a drill rig. By somebody, I mean us. We show up with a drill rig and we drill holes in the ground. We sample the soil and then we go all the way down to the groundwater and we sample the groundwater.

We do this in a pattern around where we think that there’ll be a problem and we take those samples and we send them into a certified lab that gives us back certified results about what’s in the soil. We take that, we turn it into another report and the reports got risk factors of how bad whatever we’re looking for is compared to the state regs for the state that you’re in. The regulations from the environmental protection agency, in our case the State of Illinois, how do they stack up against the thresholds that they’ve put together for us? That tells you how much of an issue this is for whatever you’re doing.

Now that we have black and white analytics on that, you’re done with your phase two part and now it’s onto phase three. What do we do about what we’ve learned? Sometimes when we punch holes in the ground, we learn that whatever our fear was is unfounded, which is good. It’s an expensive way of finding out that you don’t need to do further work. Other times when we punch holes in the ground, we find out that the results for whatever is underground are bad and you have to move on to phase three, which is a remediation of the problem that’s underground.

Is all ground testing, like soil and water? Is there ever air testing that comes into play or is there any testing that might happen on the structure of the building itself?

There is absolutely air testing and that’s the most recent addition to the environmental phase one. They have what they call vapor intrusion. If you’ve spilled a lot of something in the soil and then somebody covers that with a building but it’s still in the soil, it leaks through the concrete. People don’t realize but concrete is porous. The vapor comes in through the concrete and then you’ve got workers in there working eight hours a day inhaling it and that’s a serious problem. Part of the phase two process is for situations like what I described to run air quality tests for some chemical that’s in the soil that might be of an unknown concentration that could be impacting health and human safety inside that building.

There are different levels of that too, depending on the use of the building. Is it a daycare? Is it industrial? Whatever the building’s current use is, we have to check air quality. There’s also lead-based paint and there are asbestos and mold. Those three things are out of scope for your standard phase one. If you want them, you have to ask for them. Banks typically don’t ask for them as part of what they need to lend on, but it’s good to know, especially if your building is older. If the building older than 1978, you definitely have lead paint. There’s a high probability that you have asbestos and mold is everywhere, but it all depends on how moist things got. Those are different sectors of the environmental field.

MAU 18 | Environmental Due Diligence

Environmental Due Diligence: The types of banks that will lend on gas stations have a different risk tolerance than banks that generally does restaurants.

 

In those cases, the buyer is going to have to request from the bank separately or do it themselves separately for the lead and asbestos. Is that correct?

That is correct. Depending on the use of the building, asbestos is everywhere, lead-based paint and mold are everywhere. You have to have a decent reason to be concerned about those things. If you don’t touch them and you don’t disturb them, you don’t sand lead-based paint, you don’t disturb asbestos, it can be fine right where it’s at. It’s when you’re tearing down walls and moving things around as part of your build-out or tearing down the building in its entirety, then that’s a problem.

Tim, let’s talk about cost. We’re going to work our way back here. When you get to remediation, it could be anything, depending on the severity. We were involved with one before. It was a small number. It wound up being $7,500. It was a plating business and it was a small cleanup. I imagine they could go into the tens and hundreds of thousands and it’s hard to know until you get into the project. For phase two and phase one, what is the cost to people related to those phases?

With phase one, you’re looking at roughly $1,900. It depends on the type of facility, the size of the facility and location a lot of times because there are travel times, but let’s call it $1,900. For phase two, it could be anything, depending on the size and the chemicals that you’re looking for and things like that. However, the majority of the phase twos that we do or see range between $4,000 and $11,000. That seems to be a general zone for pricing on that. Phase three is the actual remediation part of it all. It depends on what you found and how you can best get rid of whatever problem there is, which I know sounds like you’re digging holes and it’s expensive.

A lot of times, it can be as simple as you found contamination and that’s exactly where you’re going to put a parking lot. You’ve got what’s called an engineered barrier. You put down a parking lot that you were going to have to put down anyway and you tell the state, “You will always have a parking lot there.” The state sends you what’s called an NFR letter, No Further Remediation, then you’re done. They don’t have to be crazy painful. You did a $7,500 plating facility. I’ve seen a $250,000 plating facility remediation.

It depends on the size of the operation and how extensive the contamination might’ve been. I saw on the website somewhere when I was doing a little bit of research on the company, the work you guys do is fabulous. I saw something around an innocent landowner defense and I was fascinated by that. Could you talk a little bit about that?

Phase one is an eye-opening product. In the M&A world, when they’re going to purchase a place, they’re doing due diligence. They’re checking on the financials and the customer base and all the due diligence you do when you go to purchase a business. The phase one has got a component of that. It’s the due diligence to see that whatever you’re purchasing is clean. Once you’ve done it and you’ve done it with a registered company like us, you get what I like to call a firewall between yourself and previous uses. There’s an insurance component to it as well. We have errors and omissions insurance. We got $4 million worth of errors and omissions insurance.

Essentially, if the environmental protection agency comes to you and says, “You have a problem,” you hold up your phase one and say, “I did my due diligence. I checked this out. My environmental company said I was fine. I am off the hook when it comes to cleaning this problem. It’s not me, it’s the previous owners.” If you don’t do a phase one, you purchase the liability that comes with the property along with the building. Think of it as another thing you bought. When you bought it, you bought the liability. When you get a phase one, right before you close on the property, you’ve stopped the purchase of that component of it, the liability that goes along with the particular piece of property.

That’s an outstanding piece of information and a key takeaway for the M&A Unplugged community. You may even wind up with a situation where the bank doesn’t require a phase one and you might look at this and say, “For $1,000 or $2,000, if in the peace of mind that it could give you, maybe you do it.” You’ve cut that liability off.

The thing is, everyone who is in commercial real estate, they get a five-year amortized arm. It’s a balloon payment after five years because the commercial mortgages work that way. They want you to come back to the bank to refinance and get another five years, it might be a 25-year amortization, but it’s a five-year balloon payment. You could be changing banks as recently or as soon as five years. You might stay with the same bank, but you might find a different bank for the second time you would finance and their question is going to be, “Do you have a phase one?”

We're an industry that's basically designed to hop and go as fast as possible as soon as we're commissioned. Share on X

You’re on the conveyor belt, if you plan on owning the building for a long time and having a mortgage over 25 years. If you want to change banks, they’re always going to come back to, “Do you have phase one?” That first bank might not need it, but the second bank will. If you do it at that point, at the time you’re getting your second mortgage and you find out there’s a problem, then they won’t lend to you. Now you’ve got an ending mortgage, one that’s coming to maturity and you don’t have the ability to start the next one and you don’t have the money to pay the building off in its entirety. There’s a real risk there in the transition.

It’s common sense to get yourself the insurance policy. Do it. For $1,000 or $2000, you might’ve saved yourselves tens of thousands or hundreds of thousands potentially. You had explained to me before when we first started talking about a scenario that you got involved with, where a phase one had been done, a report came back and there was a REC. Your firm got hired, if I understand this right, by the seller. You were able to come into the equation, and I don’t want to use the word disqualified, but refute some of the findings in that report and make the record go away or at least have the bank’s concern go away. I’m probably getting some of the facts incorrect here. Can you describe what that scenario was?

It was a mergers and acquisitions scenario. It was interesting too. Since then, we’ve launched a product that we call Defensive Environmental Consulting. It’s the defense attorney’s side of environmental consulting and then the buyer’s side would have the prosecuting side. We’re the defense. We took a cold call off of our advertisements on the internet and it was a gentleman who initially didn’t want to tell me his name. He didn’t want to tell me anything about him. He was upset and he was trying to sell an automotive facility, like a Meineke muffler shop type situation. It was up in Minnesota as a matter of fact and he was unfortunately near bankruptcy at the time. He needed to sell this property to be made whole again.

The buying side that was purchasing it from him was a real estate investment trust. They went to their environmental company and that environmental company came in and sniffed around, then turned in a phase one that said that they had all sorts of recognized environmental concerns. Automotive have concerns. There was no such thing outside of the SBA, the Small Business Administration, there is no such thing as an automatic phase two. It doesn’t work that way. When he called us, he said, “Is there an automatic phase two because they’re trying to charge me $11,000 for this phase two and if I do that, I’m bankrupt. I might as well toss the keys back to the bank and walk away.” I said, “Show me what you got. Send phase one that they sent to you back to us and I’ll see what we can do.” They send it to us and our team read it down from top to bottom. They said, “This is not right. The environmental company that the buyer’s side had is wrong.” They’re wrong on several different points.

We scheduled a conference call and we hopped on that conference call and we talked through what the concerns were for that other environmental company along with the buyer and the seller. We were all on the phone. We hit them point by point and said, “This isn’t right.” At the end of the day, they agreed with us that those things aren’t right. There’s some psychology that goes on in this and you have to understand. Buyers use all the reports, they use the appraisal, they use the environmental reports and they use the property condition assessment. That’s another due diligence report. They use those reports to drive down the costs of things they want to buy. It’s a negotiation. You’re going to find every problem you possibly can and you’re going to stick it to the seller and then you’re going to try and lean on them to get the best possible deal that you can.

If you don’t have somebody who’s in your corner, it’s a bad place to be in. You can’t speak the language and you’ve got a professional telling you, “You’ve got a problem.” The interesting thing is, everyone always knows when they’re being, I want to say BS. They know deep down inside, but they don’t have the scientific background to back it up and we do. We’ve got the state regulations, we’ve got it all. That’s one reason why environmental companies come back with bad science for negotiation. They’ll come back with bad science because there’s a lot of liability in what we do. It’s easier to say, “You’ve got a problem with this and we’re going to have to punch some holes in the ground.”

They’re not doing it for you. They’re doing it to protect themselves long-term with the liability. You wind up having transactions where they’re punching holes in the ground when they never needed to, just so that the environmental company that did the work can point to it if they ever wind up in court and say, “We did it all.” They’re coming in clean. Honestly, they do it for fraudulent reasons. If you’re the environmental company that finds a problem, chances are you’re the environmental company that’s going to do the work. Instead of making $1,900 on phase one, you’ve made $1,900 on phase one and $11,000 on phase two because nobody else around knows any better. We started doing, extensively, defensive environmental consulting. Honestly, the most fun thing we do is to go head to head with other environmental companies and use actual science and the regulations to say, “That’s not the case.”

I’d like to be in the middle of one of those conversations. It sounds like a great outcome. You helped the owner of that business get out and not have to maybe claim bankruptcy or liquidate. That’s a fantastic job. Tim, if you could please give the M&M Unplugged podcast community, all your contact information and do you work nationally? Maybe talk about the scope of where you work. It’s great information you shared. It was awesome.

The company is A3 Environmental. We are environmental consultants. We work nationally. We have ten people in Northern Illinois outside of Chicago and we have another fifteen in metro districts across the United States. We’ll do phase one, phase two work anywhere that we need to. Nineteen years in business and woman-owned.

How would people get in touch with you if they needed to?

MAU 18 | Environmental Due Diligence

Environmental Due Diligence: Buyers will use all the reports, not just the environmental report.

 

Direct to my phone is (630) 935-4363 and my email is simple [email protected].

Tim, thank you again. It was a pleasure having you.

No problem. Thank you, Domenic.

M&A Unplugged community, to quickly recap a few things that Tim brought up, if you’re buying a property it’s important to make sure that if your property even comes close to needing a phase one on the real estate, go ahead and order it, it’s a tremendous insurance policy. For sellers, we didn’t touch much on this, but I will tell you there’s probably a real value to maybe even doing a phase one before you put your business and property on the market, so you know ahead of time if there are going to be issues that pop up. If there are things that are found in phase one, something called a REC, Recognized Environmental Concern, you know it’s going to go to phase two where they’re drilling and boring and doing air quality and researching. Hopefully, there’s nothing there because if you have to get to phase three, remediation, you’re going to be in for some dollars potentially.

It’s some great information. I appreciate having Tim here. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you again on the next episode of the show. Until then, please remember that scaling, acquiring, or selling a business takes time, preparation and the proper knowledge.

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About Tim Allen

MAU 18 | Environmental Due Diligence

Tim Allen conducts Business Development for A3 Environmental LLC. A3 Environmental does Environmental due diligence for commercial lenders and site remediation for businesses.

A3 Environmental, LLC does Environmental due diligence for commercial lenders and site remediation for businesses. We have 15 years of industry experience in Northern Illinois and around the country. We do Phase I’s and Phase II’s as well as property condition assessments.

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