Alternative Lending Solutions: Why They Exist for the Construction Industry

Today, we are going to talk about a variety of alternative lending solutions and why they exist.  Why this topic?  Well, the construction industry is dynamic, as you know, and one day, the likelihood is pretty high that you will need some type of financing.  Given the state of how contractors get paid and payout, traditional lending sources and loans don’t always work.   As we review this, don’t assume needing lending options for funds is a bad thing!  One of the most common mistakes business owners make is to view debt as a thing to fear rather than as a tool for growth. The reality is plenty of business owners borrow money not because they need it to survive but because it is the smartest way to capitalize on an opportunity, run the business, or manage the cash required to operate the business in the most effective way.

Financial lending solutions are not one-size-fits-all.   In order to build a financial plan that will allow you to run the business and support your plans for growth, it is important to use the right funding option for each opportunity. Using debt or other financial instruments for those purposes is excellent; however, oftentimes, business owners find themselves taking on debt to fix a problem or series of mistakes that were made instead. In these situations, debt can also be good and certainly can make the business owner and business feel a lot better, but it still may not be what the business needs to grow. Here is a list of alternative lending solutions your company can take advantage of, when it is best to use them, and when it is not.

The first option is the Traditional Bank Line of Credit (LOC).

This is the gold standard in lending. If you have a bank line of credit, your company has solid financials and a proven track record of performance. You can use the money for anything, including financing the upfront expenses of a new job. Lines of Credit are meant to give you access to cash when you need it and then be paid back down when you are paid for the work you do. A bank wants to see the LOC drawn on and paid back down frequently. They do not want to see it used like a long-term loan. That means using it to bridge the gap in times when cash is needed is ideal. Making payroll every week before you are able to invoice a project, paying the supplier bill that is due this week but you will not receive your payment for that material till next month, or investing the cash needed into some pre-construction work for a new project, you will not be able to invoice for 30-60 days.  The downside to an LOC is this: The size of your Line of Credit is typically determined by your past 24 months’ financial performance, not the next 24 months.

If you are growing fast, you may outgrow your line of credit and need other lending options to support your growth.

Next is the Small Business Administration or SBA Loan.  This is a long-term loan from a bank with an SBA Guarantee.  The first thing to know is the SBA does not issue loans, banks do. What does a guarantee mean? Basically, it means that if the loan is made to you under certain terms and conditions that the SBA approves in advance, they will guarantee some portion of the loan the bank made to you. In the event you don’t repay the loan, the bank can go to the SBA to be repaid a portion of the loan (typically 80%).  These are often easier to acquire than a bank line of credit IF you qualify as a small business. For commercial construction, the SBA defines a small business as one with no more than $39.5 million in average receipts. The loans also have maximum loan amounts and terms for repayment that need to be considered. SBA loans also require a LOT of documentation, and you need to find the right sponsor (i.e., bank) to make it happen. The biggest downside in terms of growth is that once you hit the cap, you no longer qualify.

Another option when looking at alternative lending solutions within the construction industry is Invoice Factoring.  Simply put, invoice factoring is a way to use the Accounts Receivables (the money you invoice your customers and they owe you for the work you performed) of the business to generate cash by selling those invoices to a factoring company. The factor will give you an advance on the amount that is owed to you (usually about 80%), and then they will wait for your customer to pay under the normal terms of payment. When they receive payment from your customer, they will take the fees that are owed to them and then remit the balance to you. This process can be repeated over and over each time you generate an invoice for your customer(s). While invoice factoring shrinks the time between when you invoice and when you receive some cash, it doesn’t get you funding before the work starts. While financing your company between payments is absolutely a normal part of the construction industry, many subcontractors and general contractors have a negative perception of factoring. There are several reasons why general contractors have a negative view, but the most common reason is it affects the contractual terms they have with you in the subcontract agreement and their ability to set off payments that are owed to you. When a factor purchases a receivable from you, they typically will require that the invoice is verified. The process of verifying that invoice involves the GC certifying they do, in fact, owe you the money invoiced and that they will pay that invoice when it is due and in full. It’s that step of verification that the GC typically does not like as it removes their ability to set off that payment in the future should they want to, based on something related to your performance on the job, a negative change order, or one of your vendors is required to be paid.  

Similar to factoring, there are asset-based lines of credit.  Like invoice factoring, an ABL line of credit can regulate cash flow by speeding up the time between invoice and payment. This allows you to have more cash in hand to run your project and overall business.  For both invoice factoring and ABL credit, you need to make sure you aren’t paying for future growth with the money you need for present demands. This is one reason we recommend setting up a dedicated payroll checking account, keeping your operations account for just the operations of the business. Invoice factoring and ABL lines of credit require great administrative capabilities in your business and financial discipline. When you receive money from your invoices, it is critical to make sure you use the funds for the project you were advanced on—paying the subs, vendors, and suppliers when you are paid. Maybe you don’t pay them in full, or you provide partial payments, but nonetheless, the money you receive is marked for specific job-related costs, and if you use the money for something else, you will not have that money 30-45 days later when it is time to pay them, and that can be the cause of major issues for you on that project. Then those major issues can carry over into the main business!

As much as I don’t think this next option is one of the best alternative lending solutions for construction businesses, we must also address the Merchant Cash Advance option.   These have nearly ZERO benefit to construction contractor’s plans for growth. In fact, these high-risk cash advances can destroy your ability to get paid for the job you’re on now and crush any dreams of future growth. These are the daily or weekly payment “loans” that have been out and available for the past 10+ years. You can get funded very fast, in just a matter of 24-48 hours, and the deposit will come straight into your business operating account. 

Here’s how they work:  The MCA lender will assess the number of deposits and activity you have in your checking account on a monthly basis and then provide you an “advance” on those future deposits. They then add their advance fee to the amount that is being advanced to you (for construction that fee is typically between 33% – 50%). The repayment of the advance is typically between 6-12 months. I am here to tell you as clearly as I possibly can this is NOT a financial product for construction contractors. 

Last but not least, a loan program designed specifically for construction contractors, Mobilization Funding!

This loan program is designed to help a company execute the work they have available to them by providing access to cash at the start of a project or contract. When the company has revenue in the form of a contract, purchase orders, or a service agreement, Mobilization Funding can help them. These alternative lending solutions provide the money needed to pay for labor, materials, or other project-related costs before the company invoices their customer. This allows the company to get started on the project in the most efficient manner by removing the barrier of, “Do I have enough cash to do it the way it should be done?” They can get on a project with the right amount of labor, order the materials needed in the best form and timing, use the right equipment, and so on. That means You, the business, can do the work in the most efficient manner and not lose sleep about how you are going to make payroll each week or pay the vendors, subs, and suppliers.

This construction financing program was built to help you grow. You can confidently bid on bigger projects because you know you won’t have to finance the labor out of your own pocket. You can take on the extra work without putting a financial strain on the business but still do the work and grow the business. The Mobilization Funding loan structure is designed to be paid back as you get paid on the project. 

Having a financial partner can greatly improve the strength of your company. A financial capability letter from that partner will also improve your bid, winning you more work.

Mobilization Funding’s client service and project funding partners work with their clients to align your repayment plan to your pay apps, minimizing the strain of repaying a loan on top of managing your business. Finally, they have a network of experts in industries like insurance, legal, equipment, and more who are ready to help when clients have a question.

All of these alternative lending solutions can help your business go from surviving to thriving, but remember, understanding your cash flow cycles to incorporate repayment of borrowed capital will also be the key to its success!ng the right talent this industry desperately needs.