Most subcontractors need capital to cover the costs of a new project before the first invoices get paid. The high costs of mobilizing on a job — plus the reality of waiting 30 – 60 days or more for your first payment, all the while meeting weekly payroll and regular business expenses — would be hard on any business. Add in the 10% of each payment being withheld for retainage, and there’s a lot that can go wrong. Which is why so many subcontractors look for alternative funding solutions, like merchant cash advances (MCAs) or invoice factoring.
MCAs are a notoriously risky venture for a subcontractor, but what about invoice factoring? The answer is less straightforward. Invoice factoring can work for subcontractors, but it also poses risks of its own.
What is Invoice Factoring?
Business invoice factoring is not a loan; it is an advance of receivables. Here’s how it works:
- You submit an invoice to your General Contractor.
- The invoice factoring company will verify the invoice with your General Contractor and get their approval and acceptance of the invoice amount and that it is in fact owed to you.
- Once approved, the factoring company will advance you a percentage of that approved invoice, usually between 70% and 80%.
- When the factoring company receives payment from your general contractor, it will repay the amount they advanced to you, plus their fees (typically 1% – 5% of the total invoice amount).
- Any remaining balance will be sent to you.
Invoice Factoring and Construction Subcontractors
You know how tough it is to get a loan from the bank, so despite its challenges, factoring can be a good way to get the cash you need to make payroll and cover your expenses. Especially if you are working on multiple projects, a good relationship with a factoring company can really help your business overcome a cash shortfall. If you haven’t worked with an invoice factoring company before, do yourself a favor and research your options before you sign an agreement.
First, look for a company that works with construction and understands your business. This will be your first hurdle, since only a handful of invoice factoring companies will work with construction subcontractors. The vast majority have written (or unwritten) policies against you. From their perspective, some of the payment terms and contract language for construction subcontractors is simply too complicated and too risky.
If it sounds too good to be true, it probably is. Beware a company that offers to advance more than 90% of your invoice. Remember, the average advanced percentage of an approved invoice is between 70% and 80%.
Be honest with yourself when it comes to payment schedules. Delays in construction receivables are almost inevitable. Most factoring companies will charge a fee for the first 30 days the invoice is outstanding and then an additional fee for every 5-10 days after the first 30 days. Make sure you consider honestly the actual time between invoicing and receiving your payment so you will know the actual factoring costs and adjust your project bid accordingly.
Invoice factoring companies can be a great help to your cash flow, however most will require that they have the first position lien (UCC-1) in order to approve your invoice. That means if you have a current MCA or bank line of credit you are unlikely to qualify without first paying them off or getting them to subordinate their UCC position to the factoring company. This can be done but it can also take time to accomplish so make sure you account for the time it may take.
Invoice factoring, by its nature, requires the cooperation of your General Contractor. Your GC will have to approve or verify your invoice and through the Notice of Assignment (NOA) the factoring company serves on the GC they will then be obligated to send the payment directly to the factoring company. Some GCs have policies against factoring receivables, while others may be resistant to agreeing to this change, you should read your contract and have the discussion with your GC to let them know what you are trying to accomplish and how it will help their project overall by helping you to perform.
Lastly, invoice factoring can be an “all or none” solution. Many factoring companies require you factor all receivables for that particular job, even if that wasn’t your original plan.
If you rely on factoring, you must ensure you have enough cash on hand to make it to that first pay app. After the first pay app, be extra careful to spread out the advance in order to cover your project costs through your next billing. If you’re working on multiple projects, that may result in taking funds needed for another job — essentially robbing Peter to pay Paul, which is a risky option.
Other funding options for construction subcontractors
If factoring falls through, many subcontractors will turn to an MCA. Don’t! MCAs seem like a shiny, quick fix, but too often one MCA leads to a crushing cycle of debt that can seriously damage your company’s cash flow and overall financial health (and your sanity).
There’s also Accounts Receivable Financing, which is similar to factoring in that your unpaid invoices are being used to secure funding. In AR financing, your accounts receivable is the collateral for a line of credit.
The truth is that, while options like invoice factoring and AR financing may help, they don’t solve the REAL problem subcontractors face. You’re short on cash from Day 1, and playing catch-up until retainage checks start getting paid.
You need money before the invoice just as much as you need it after.
The key is to secure financing before the project begins, and then work with a partner that understands your business’s needs and challenges.
That’s where we can help.
We offer funding when you need it AND we know the right factoring companies to work with.
Invoice factoring, traditional bank financing and MCAs were either under-servicing, or actually hurting, a lot of great construction subcontractor businesses. They needed a better option, so we created one.
Mobilization Funding offers funding when you need it — up front, before the job even begins, so that you can cover project costs, from bond premiums to payroll, materials, equipment rental costs, and more. Rather than advancing cash based on your credit worthiness, we’ll review your contract and schedule of values and work with you to understand your needs and generate a custom funding and repayment schedule.
And, if we find that invoice factoring is the best option for your business right now, we are going to do the right thing and happily connect you with a factor that knows how to work with commercial subcontractors and contractor companies. Call us at 813-712-3073 or click here to get started.
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