Construction Contract Financing for Subcontractors
Posted November 20th, 2020
Construction contract financing for subcontractors solves one of the biggest challenges subcontractors face when they are awarded a new project—financing the upfront costs associated with the work. Materials, equipment, bonding premiums, supplies, and of course labor are all expense types typically incurred before you, the subcontractor, ever invoices your general contractor, let alone sees a payment. More than just a problem-solver, when used strategically a subcontractor can use contract financing as part of their strategy to win more bids and grow their business.
How does Construction Contract Financing Work?
Most forms of financing available to subcontractors relies on proof of work performed. Contract financing is unique in that it uses your contract, not your invoice, as collateral. The lender (hopefully us!) will assess the value of your contract and your ability to perform the work. The value of the contract is the collateral itself, and the loan amount is based on a percentage of that contract value. This option gives you the cash you need to start a job in the most efficient way possible. You can start with and put the right size labor force on the job when you want, order and stage materials in advance, and build efficiencies into the schedule.
Combine the power of construction contract financing with a cash flow projection tool (you can get ours for free by clicking the link below) and you can actually solve your own cash flow shortages AND potential delays in the schedule for your general contractor.
What You Should Know About Construction Contract Financing
Contract financing depends on the subcontractor having a signed contract with a general contractor, property owner, or other party. The contract should layout the job requirements, payment schedule, scope of work, and the total value of the contract.
In addition to reviewing the contract, the lender will need to evaluate your ability to perform the work specified in the contract. For example, we look at the type of work being contracted and compare it to work that company has performed in the past. If the project falls within the normal project specs of your company, great! If the project is bigger or more complex than your previous work, what is your plan to execute it? A bigger project isn’t a bad thing — it’s actually great and a sign that you are growing — but your lender needs to be confident that you can perform the work and get paid by your customer. Finally, your company’s financial health will get a quick check-up. The contract is the collateral for the loan, but it isn’t a lifesaver for your entire business. A lender will want to ensure that the rest of your company will be able to operate throughout the loan’s lifetime.
Another important aspect of a construction contract loan is that the cash from the loan is used for project-related costs for that job. The money can only be used for project costs such as materials, supplies, bond premiums, or labor. This ensures the project moves forward, the subcontractor invoices for the work completed, and ultimately the subcontractor (and the lender) gets paid. Imagine doing the extra jobs you want to do or have passed up previously due to cash flow concerns without putting any stress on your existing business. That is what a construction contract loan does for you.
We accomplish this through what is called a “funds directive.” This is the same document a bonding company would use when they approve a bond for a project and have a funds directive stipulation; it is an accepted form in the construction world we all live in. We set up a project-specific bank account in our clients’ business name and their tax ID, and direct all project-related funds in and out of that account including the funds from the loan that are available to use before ever invoicing the project. Need to pay a supplier for materials? It would come out of the project account. Weekly payroll for the project? All comes out of the project account. General contractor ready to pay your first invoice? It goes into the project account. When it comes time for our repayment, that also comes out of the project account and is in line with when you are paid from the project so you don’t have to stress the cash flow of your normal operating business.
How Contract Financing Can Help You Win More Bids
How does a construction contract loan help you win more bids? It depends on your lender. When you work with a lender like us, you get much more than just a loan. You get a financial partner who will help you estimate and plan the project’s cash flow before the work starts.
We sit down with every client to determine what their markup or margin on the project really needs to be. What is your company’s overhead? What is the retainage on this project? What expenses do you expect to incur as part of the project? Having REAL numbers and a breakdown of estimated cashflow for the project signals to the General Contractor that you have done your homework and know what it takes to get the job done right.
You can also ask your lender for a financial capability letter, which shows the GC that you have the capital to perform the job and that the funds will be used exclusively for this project. A financial capability letter is especially important when bidding on government projects.
Construction Contract Financing Helps Subcontractors Succeed
We know that commercial construction contractors can succeed at their highest level of performance when they have the funds to hire the right amount of labor, equipment, and purchase the materials needed for the job. You don’t have to take our word for it! Our customer Andrew Ammons shares how he was able to save time and increase his profit margin with a construction contract loan.
With construction contract financing in place, subcontractors can stop worrying about start-up costs and confidently dedicate 100% of their energy and focus to the task at hand: safely and successfully completing a project on-time and on-budget.
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