What is Construction Financing?
Posted July 28th, 2020
Construction funding for contractors helps cover the costs of payroll, materials, insurance and more before the project begins. Many subcontractors, and GCs who self-perform, are caught in a cycle of robbing the cash from one job to get started on the next. Why? It is NOT because most contractors are bad with money. They are not. It is because the majority of costs associated with starting new work have to be paid, weeks or even months before the first pay app is issued. Construction financing for commercial contractors alleviates this burden by providing the capital contractors need when they need it most — at the start of the project.
Types of Construction Financing for Contractors
Not all construction funding solutions are the same, and your choice can make a HUGE difference in the success — and the ultimate profit margin — of a new project.
We’ve written previously about many of the lending products available to contractors. Invoice factoring and Asset-Based Lending, for example, are common in the industry, but since they do not provide funds before an invoice is generated, we will not cover them specifically in this article. You can read more about invoice factoring and ABL credit here.
Merchant Cash Advances
Let’s get this monster out of the way first. Merchant Cash Advances are, unfortunately, a very common method for contractors to get the capital needed to start a job. The money is quick and feels easy to get, which should be your first warning. If a lender or broker really understood construction they would not recommend a loan product that has daily or weekly payments to a company that collects money once per month.
MCAs are BAD for construction contractor companies. Even just one small MCA can spiral into a whirlpool of debt that drowns you and your company. Before you take an MCA, we invite you to read our guide: The Real Cost of a Merchant Cash Advance.
Contractors who cannot secure traditional bank funding but have personal assets such as home equity, personal savings, or retirement funds, may choose to dip into these to cover the upfront costs of a new project.
This strategy works, but it carries a tremendous personal risk. The construction industry is infamous for delayed schedules and slow payments. Be careful when putting your home or retirement fund up as collateral for your business project needs. In construction, a job can go bad through no fault of your own, or because a General Contractor or owner takes 90 days to pay an invoice.
Cash flow in construction is complex; every project has associated costs and an expected profit. In order to keep your company cash flow positive and growing, it is important to treat available cash not as a first resource, but as a last one. Keep a good reserve of cash on hand for emergencies, and leverage other funding options to mobilize on new work that will ultimately result in even more cash on hand.
Bank Lines of Credit
This is the gold standard for working capital lending. The funds in your LOC can be used for anything, including financing the upfront expenses on a new job. Similar to cash, though, it is important to use your LOC to drive business and fund monthly operations while saving some availability for more critical needs should they ever arise. It is also important to pay the LOC back when you receive the cash back each month – banks like and need to see the money used this way.
There are alternative lenders who specialize in providing funds for construction materials. Typically, this type of funding is not a loan, but an agreement between the contractor, the supplier, and the third-party lender. The lender pays the supplier directly and the contractor pays back the loaned amount after a certain time period.
Meeting payroll needs is one of the biggest challenges for construction companies, especially on a new project. The demand for labor is highest at the start of the project, but the cash from the job won’t come for at least 30 days after you submit an invoice.
Payroll financing is a type of invoice factoring, where you agree to sell your AR to the funding company. In return, they provide up to 90% of the AR value in the form of a loan for payroll.
We believe that commercial construction contractors can succeed at their highest level of performance when they have the funds to hire the right amount of labor, supplies, and materials needed for the job. When contractors have PEACE OF MIND that the costs of insurance, permits, and bonding are covered too, they can dedicate 100% of their energy and focus to the task at hand: safely and successfully completing a project on-time and on-budget.
That is the goal with every loan we make. Here is how we do it:
Our short-term construction funding loans are tied to the specific project. The money can only be used for project costs — materials, supplies, labor, bond premiums, etc. The repayment plan is aligned to your pay apps, which reduces the overall strain on cash for the business and relieves the stress associated with how you are going to pay for the project related costs. The repayment of the loan is in line with when you are paid for the project so you can pay off the loan as you earn the money.
Are we the only game in town when it comes to commercial construction contract financing? No, but we are confident that we are the best option. Let us prove it to you.
Every new project is an opportunity to build your reputation and grow your business. Don’t let the upfront costs of new work keep you from realizing your true potential. Call us today at 813-712-3073 to discuss your construction financing options.
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