Construction payments are notoriously slow. There are a lot of misperceptions about why that is. Raise your hand if either of these statements sounds familiar.
“General contractors NEVER pay on time.”
“Subcontractors are terrible with money.”
Of course you have; they are two of the most common complaints made in the construction industry. The trouble is that both of these statements over-simplify a complex issue and pin blame where it doesn’t really belong.
Why are subcontractors always chasing down payments? Why can’t GCs ever seem to pay on time?
Slow payments, of course.
Getting paid in construction is like trying to run a marathon where the road is pocked with potholes and carpeted in broken glass. It is an arduous, uncertain journey that starts at the bid and ends . . . whenever (if ever) the subcontractors finally get paid. And retainage—that’s a whole other conversation!
Our industry is just starting to talk about slow payments. It’s about time. If we can change the conversation from the cliched stereotypes about irresponsible Subcontractors and miserly General Contractors, we can instead focus on solving the actual problem.
The Reality Behind Slow Payments in Construction
It’s no secret that construction has the slowest payment timelines of any industry. Levelset’s 2019 National Construction Payments Report detailed that about half of all US contractors do not get paid on time, with a staggering average wait of 83 days. The majority of those are subcontractors, who already operate on extremely tight profit margins. They also finance the bulk of the expenses in the early stages of a project.
On the flip side, the same report showed that most general contractors are paying their subs before they get paid by the owner. General contractors are putting their own business’s profitability at risk to cover payments to subs and suppliers because they aren’t paid on time, either.
A late payment doesn’t only impact one project. One late payment on a project can be the rolling stone that starts an avalanche — especially for subcontractors. Subcontractors often rely on the payment from job X to cover the mobilization costs on new project Y. If that money doesn’t show up, they scramble to find a funding solution. The results are often ugly. Desperate subcontractors grab quick cash from Merchant Cash Advances that end up bankrupting their business and ruining their lives.
Sound far-fetched? The 2018 Bloomberg series, Sign Here to Lose Everything, tells the story of Jerry Bush, a plumbing contractor who attempted suicide after MCA debt crushed his business. One of the lenders told Bush he would pursue him “until his death.”
Slow payments is a serious problem, impacting everyone in the industry. This is the battle cry our industry needs: We have to attack this together. We CAN solve it together. It will take technological advancements in construction finance, operational shifts within contractor companies, and collaboration between General Contractors and subcontractors. That’s right; you guys and gals need to get comfortable talking about cash flow on the project.
But first, let’s look at some of the ways technology is making it easier to get paid.
Getting Paid is Easier Online
The trouble with payment in construction starts with the process to simply request a payment. It’s a marathon of paperwork for the subcontractor, and that is only the first step. The financing on almost any construction job is like a precariously built Jenga tower of invested parties — including the General Contractor, developer, owner(s), lenders, and so on. A mistake in the paperwork chain at any point and the whole thing comes tumbling down.
The process is confusing, prone to failure, and entirely inefficient. Thankfully, there’s hope on the horizon.
Like many industries before ours, the digital transformation is solving some of these challenges. Levelset made waves when it secured $30 million in funding for its cloud-based SaaS company that allows contractors to quickly send a payment app or file a Mechanic’s Lien. On the financing side, Rabbet has created a streamlined, AI-driven construction draw process that makes it easier for lenders to receive, review and approve payments. We’ve undergone our own digital transformation at Mobilization Funding. We utilize digital solutions to make applying for funding, requesting disbursements, and making payments faster and more efficient.
But, technology hasn’t yet solved the subcontractor’s main dilemma. How do I finance 3 months of labor, equipment and materials on this job without a single payment from the job?
That’s where a good old-fashioned conversation can help.
Tear Down the Stereotypes
Before subcontractors and GCs can start talking about money, both sides need to adjust their perceptions of each other.
General Contractors — subs aren’t necessarily bad with money.
Subcontractors — the GC isn’t sitting on a stash of cash and delaying your payment out of malice or neglect.
Both of you were hired to do a job. Both of you are trying to do that job to the best of your team’s ability. Both of you are dealing with the constraints of the construction project, and You BOTH want to SUCCEED. So rather than butting heads over a situation neither of you is responsible for, why not work together?
Acknowledge Reality from the Start
Why wait until the first late payment to talk about what to do next? Subcontractors need to start talking about funding and payments in the bidding stage. Include late payment penalties (and early payment incentives) in your bidding contracts. When estimating your project costs, remember to include the cost of your funding. Because let’s be honest — you have to get funding from somewhere to float three months’ worth of labor, materials, equipment, and so on. Small Business Loan, Line of Credit, Mobilization Loan, “borrow” it from another project, MCA — Just kidding, please don’t take an MCA ever again — there is an associated cost. If you don’t build it into the bid in advance or you didn’t build it in at all, it will come out of your profit margin and you just might end doing the project for no profit at all. In the case where you take out an MCA you most likely are doing the job to just give all your profit to the MCA lender in addition to ruining your company’s cash flow.
Create a Plan Together
General Contractors and Subcontractors need to sit at the table, put the numbers between them, and figure out how to complete the work at a profit margin that keeps both businesses growing and flourishing. Stop seeing each other as Customer/Vendor and start treating each other as what you really are: Partners.
You have a shared goal, remember: a successful project completed at a profit.
Talk honestly about contingency plans, incentive deals you can kick up to the owner, and discounts or credits you can leverage with suppliers. Build a strategy that reduces tension around money, ramps up collaborative success, and allows you both to focus on the performance of the project.
It is a long road ahead of us to solve the slow payment crisis in construction. It’s a marathon, but it doesn’t have to be hell on Earth. The first step is communication.
Now, go get paid.
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Contract financing is a way for businesses that operate through contracted work to secure funds in advance of the work being performed. If you’ve ever turned down work because you didn’t have the cash flow for the initial labor, materials, or other costs associated with the project, contract financing might be the financial solution for you.
What is contract financing?
Contract financing alleviates the cash flow gap that occurs when you have expenses related to a new project contract, but will not be paid by your customer until after the work is underway or completed. The financing is a loan collateralized by your contract. Contract financing differs from invoice factoring in that the advanced funds are available before you send an invoice. Also, you still own your receivable.
Funding limits vary, but typically a contract financing firm will lend up to 20% of the contract value. (That is Mobilization Funding’s funding cap on contract-backed loans, as well.)
Who does it help?
Contract financing works best for businesses that have a solid performance history and are growing faster than their free cash flow can accommodate. These businesses usually have their operational cash flow management under control, and may even have other forms of funding available such as SBA loans or credit lines from their bank. However, contract financing allows them to grow securely by accepting large contracts without straining their cash flow or drying up their other funding options, which are better utilized elsewhere.
For example, let’s assume Lightning Man Inc. is an electrical contractor in Tampa, Florida, owned by Joe Mitchell. The company has an annual revenue of about $2 million, and is in a phase of rapid growth. They’ve just been awarded a $1.8 million contract with a GC. The work includes all electrical systems in a new corporate campus park. The contract is Paid When Paid, with monthly billing at the end of every month. Joe knows he’ll have at least three payroll periods for his crew, not to mention supplies and materials expenses, before he’ll even submit his first pay app.
A contract-backed loan allows Joe to cover those expenses without dipping into the cash flow for his other projects or the operating cash he needs to pay for his overhead expenses. It also means he can save his bank line of credit for other organizational costs associated with Lightning Man’s growth.
Contract financing isn’t only for construction contractors. If you earn revenue through contract work, and you could use funds to cover the initial costs of that work, contract financing may be a viable funding solution for you.
How does contract financing work?
Let’s stay with our friend Joe aka “the Lightning Man” for a bit longer. Joe knows he needs payroll money before he sends an invoice, so invoice factoring can’t help him here. He calls Mobilization Funding — we’ll use ourselves as an example to keep things easy — and asks about contract financing.
After a quick preliminary chat, one of our team members tells Joe, “It sounds like you’re a perfect fit. You have a great work history, this work is right in your wheelhouse, and your business sounds solid. I’ll send you a follow-up email with our next steps.”
Here’s what a contract financing company typically asks for:
- A complete loan application
- Owner identification
- Copy of the contract for the project
- Company financial documents such as bank statements, tax returns, income statement, balance sheet, and an accounts receivable report
With the copy of the contract, Joe and our Project Funding Manager sit down to create a Cash Flow Schedule. (We have a sample Cash Flow Worksheet available on our site. Click here to access it.) This shows Joe when his project will have cash flow gaps that our loan can cover, and when the project will be self-funding. We align our repayment schedule to when Joe’s customer will be paying him, so that he doesn’t have to use his organizational cash flow to pay us back.
The loan documents are executed, and a bank account under the name and Tax ID of Lightning Man Inc. is opened for the funding. Since the loan is based on the contract, it is imperative to the lender that all funds for this job stay on the job. Through the execution of a funds directive, all monies associated with the project come through this bank account.
In the end, we loan Joe $200,000 for labor and sub-labor on the project. He pays us back in installments as he receives payment from the general contractor. Joe is able to start the job with the right amount of labor and all the materials he needs, which actually ends up saving him money through his team’s efficiency. He completes the project and earns a healthy margin. Best of all, the GC appreciated Joe’s ability to expedite his work and stay ahead of schedule. Lightning Man Inc. has a new and important ally in its quest for growth.
When your business has the cash to start new work without sacrificing other projects, or cash that can be used for other business expenses, your team can get to work with total confidence and YOU can focus on your real job — growing your business.
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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.
Download Our Cash Flow Tracker Tool
(Don’t forget to get the instructions,too)
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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Cash flow management is particularly critical for small and mid-size businesses, as these companies often have less free cash flow to help them cover unexpected costs, delays, work shortages, or their growth.
Before we talk about good cash flow management and share a few tips to improve cash flow at your business, let’s back up a bit. What is cash flow, and why is it so important?
What is Cash Flow?
If you’re not entirely sure what we mean when we say “cash flow,” don’t worry—you’re not alone. Cash flow is simply the money coming in and out of your business. A positive cash flow means you can pay all of your company’s overhead costs, debt payments, and other expenses, still have some money left over in the bank account and hopefully provide a buffer against any future issues or challenges. If you have positive cash flow, you can reinvest in your business, take advantage of growth opportunities, and weather financial downturns with less stress.
Cash flow comes in three forms: operating, investing, and financing. We’ll focus on operating cash flow, which is the money your business makes from selling goods or services. Basically, the money your company makes doing whatever it is your company does. Financial cash flow shows the money you use to fund your business, including debt, equity, and dividends. Investing cash flow is money created from investment opportunities.
How Does Cash Flow Management Affect My Business?
Here’s an easy question: Do you know how much cash you have in your business each and every day, what the expenses of the business are that week and how much cash you need in order to manage the week’s needs? If you answered NO to all or any part of that then this is especially for you! (Checking your bank account at any given moment to determine how much cash is there is NOT sufficient to give a Yes to this question.) A report given to you weekly or daily as the business owner is key to your cash flow management success.
Managing your cash flow sources and the consequent uses of that cash can literally make or break your business. A U.S. Bank study showed that 82 percent of small businesses fail because of poor cash flow management. We cannot over-emphasize the importance of being able to estimate, track, and forecast the money coming in and out of your business, especially if you are planning to grow.
Prolonged cash flow shortages can lead to insurmountable debt, while short but chronic shortages can lead to stricter payment terms with vendors and lenders, who know longer trust your ability to pay. It can also impact your company’s credit score, which means banks will be less likely to lend to you when you need funds to grow … or survive.
Cash Flow Management Tips for Small Businesses
Hire an accountant and likely a bookkeeper too. If this is the only thing you take away from this article, it would still be a valuable read. Hiring an accountant is THAT important to your business. Don’t rely on Quickbooks or your friend’s mother-in-law, unless she is a CPA. You need a trusted professional who can help you navigate your cash flow statements, ensure you maximize your cash flow, and help you craft your business growth strategy. If you are saying to yourself, “I can’t spend the money on an accountant or they are too expensive” then you either need a new accountant because the one you have is not helping you, or you are being penny wise and pound foolish.
Know your numbers. The first step toward better cash flow management is to know your numbers so you can perform a cash flow analysis. “Know your numbers” may sound cliché, but it is so critical to your success or failure. You have to know what costs you have in your business—the fixed costs (salaries, rent, debt service, insurance, vehicle payments, etc.) and the variable costs associated to your products or services.
If you use an accounting software—or even better, if you work with a CPA like we mentioned above—you should be able to get an accurate breakdown of your cash flow sources and uses in a cash flow statement.
We all go into business for a completely different reason than “know your numbers” but that does not mean we get to ignore them. If you do your business will most likely fail despite your best intentions.
Estimate, track, and forecast. By looking at a cash flow statement, you can see if you are accurately marking up your products or services to cover the overhead expenses of running your business. Here’s how you determine the accurate markup:
- Add the fixed cost of all recurring monthly expenses to get the total monthly cost. Multiply by 12 to get the Total Annual Expense of those fixed costs.
- Determine what the estimated Total Annual Revenues will be for the year.
- Divide the Total Annual Expenses by the Total Annual Revenues to get a percentage.
- That percentage is how much of each dollar you sell will need to go toward paying your fixed overhead expenses. If you add that percentage to every product, project, or bid you will break even and have no profit at the end of the year. What amount or percentage you add above that is what your profit will be.
The next step is to track your cash flow. This is especially true in businesses where costs can change. We specialize in working with construction and manufacturing companies, and their project costs can shift quickly and often. The same could be true for a restaurant, if the prices of ingredients suddenly skyrocket due to a shortage. Tracking your cash flow on a daily, weekly or monthly basis (depending on the nature of cash flow in your company) helps you stay ahead of any potential cash flow issues.
Download our free Cash Flow Tracker Tool.
Make sure to get the Cash Flow Tracker Instructions too.
Finally, when you have a history of cash flow tracking and analyses under your belt, you can start to forecast or predict your cash flow, which is the key to making an effective cash flow plan for growth. You now have the ability to run your business and make good decisions in the moment but also proactively. Decisions like when to buy new equipment, bulk order supplies when there is a good deal, take an owner’s distribution, hire a new employee, give bonuses, etc.
Have an emergency fund. Free cash flow is cash that you do not have to spend on overhead and that you could re-invest into the business. This is the ultimate indicator of financial health. Most accounting professionals recommend you keep three to six months of working capital in reserve. If this seems daunting, start small. Sit down with your cash flow analysis and determine what percentage of your cash can be saved. Then continue to save that percentage even as you grow.
Negotiate terms with suppliers. If you need something, you NEED to ASK for it. Remember that the customer/supplier relationship works both ways. You need their products; they need you to stay in business and keep paying them for product. If you need credit or extended payment terms, you need to ask for it. Get them invested in your success by sharing how the new terms will help you grow and order even more.
Get paid on time. The best way to avoid a cash flow shortage is to get paid when you expected to. In construction, the wait to get paid is often 60 days or more. One easy way to keep cash flowing in is to create a process around submitting invoices so that they are correct and on-time. It can also be helpful to setup reminder emails to clients if you have extended terms of payment.
Why Do I Need a Cash Flow Plan for Growth?
Growth phases are one of the most exciting but also most vulnerable times in a company’s life. Having a cash flow forecast built on solid cash flow tracking will help you determine how much extra you need in order to meet your growth goals. If you plan to grow by 25% next year, a cash flow plan will help you break down what that growth will do to your overhead and other expenses, and how much of your free cash flow can be utilized to cover the cost of growth.
There’s nothing wrong with taking out a loan to grow, but it should be part of a comprehensive financial plan that supports your growth without accumulating too much debt or the wrong kind of debt.
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Construction Management Solutions to Streamline Your Cash Flow
We talk about merchant cash advances a lot. Our clients do too, because so many of them have been burned by these not-quite-a-loan financial products. Taking out a merchant cash advance when your cash flow is pinched can be the “help” that ultimately bankrupts your business. That’s not an exaggeration; there are plenty of MCA horror stories on the Internet, and we hear them everyday from prospective clients looking for a way out.
When someone who has been burned by a merchant cash advance before comes to Mobilization Funding, one of their first questions is, “How are you different?” We are happy to share exactly how we compare with “quick cash” MCAs.
Lender Versus Broker
In most instances, you don’t purchase your MCA from the lending company. You get it from a broker. This is the guy or gal who calls your business promising “quick, easy cash.”
When a broker sells an MCA they add their own markup to the deal, as much as 10% of the loan’s value. That commission becomes part of the total cost of your loan, which, in a way, means YOU pay the broker for the service of delivering you to the MCA company.
We don’t use brokers. We have strategic partners—people and companies who align with our purpose and values. When a referring strategic partner, like a factoring company, brings a client to us, we don’t tack a commission for the referring company on to YOUR loan. We send them a referral fee and a thank you, because that’s how we believe business should be done.
Basis of Funding
Merchant cash advances are basically an advance on future sales or receivables. The funding you receive is based on the average amount of cash flowing through your business’ bank account on a monthly basis (and your credit score — we’ll talk about that in a minute).
The trouble with the MCA’s basis of funding comes when a majority of the cash that comes into the business isn’t profit. If you are a commercial roofer, and your monthly cash flow shows $250,000, but you pay $100,000 to suppliers and vendors, and another $75,000 in payroll, guess what? The MCA company only cares about that first number.
We base our loan on your contract or purchase order. We sit down with every prospective client to map out the weekly cash flow of the project and review their expected margin. It’s important to us that (1) the work gets done, (2) our client succeeds and builds on that success, (3) we get repaid.
By putting people and performance over profit, we can protect our business AND our clients. That’s something merchant cash advance lenders just can’t say.
Personal Credit
We don’t check your personal credit. Merchant cash advances do; they have to, because they base their approval on it and if your business defaults, they want to be able to come after your personal finances as well.
Worse, if a broker is shopping your advance around to several lenders, they can each run your personal credit report. The inquiries alone can negatively impact your credit score.
Cost of Funds
Merchant cash advances do not have “interest” rates. Instead, they have a “factor rate” applied to the loan. The factor rate is a percentage of the borrowed amount, and the percentages vary widely from high single digits to as much as 50 percent or more. That is why a $200,000 merchant cash advance on average is almost three times the cost of a Mobilization Funding loan.
Repayment Structure
Look at that chart again. Merchant cash advances are almost always sold with a daily or weekly debit from your account. That debit typically starts right after funding is received (the next day or possible the next week). A daily debit from your account might be fine if you are a popular restaurant or retailer, but it is almost always a problem for construction and manufacturing companies. Your cash flow cycles simply do not support a daily debit and likely even a weekly debit.
In construction and manufacturing, businesses wait to be paid between 30 and 90 days after they submit an invoice or pay application to their customer, typically at least 30 days after some portion of the work has been completed. That means contractors and manufacturers are perpetually in need of cash to mobilize on each new project, but won’t be paid for the work for at least 60 days. That is not a cash flow cycle that can support a daily, or even weekly, draw on your bank account.
Our CEO Scott Peper puts it like this, “If you have money coming in daily, you may be able to handle a daily debit. If you don’t, you can’t.”
MCAs are based on future sales at a pre-determined factor rate, so it’s actually more expensive as it relates to an annualized interest rate to pay them off early and no benefit to you. (It is possible, but very rare, to find an MCA that offers a lower rate for paying it off early.)
Merchant Cash Advance or Mobilization Loan?
The answer is clear.
We put a purpose behind our business, “to help those we come in contact with.” If our loans aren’t the solution to your needs, we will help you find the right loan provider. If you have questions about how our loan works, we will answer them openly and honestly. (We have several videos on our YouTube channel addressing common questions about our loan program.)
It is our goal to arm you and every member of our community with the information you need to make smart, strategic decisions. When it comes to merchant cash advances, the smart decision is to avoid them at all costs.
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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.
Personal Financing
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.
Available Cash
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.
Materials Funding
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.
Payroll Funding
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.
Contract Financing
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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Why the Commercial Construction Industry Benefits from Alternatives to Traditional Lending
In construction finance, many lenders (ourselves included) utilize some type of risk mitigation in order to ensure that the project goes well and that the money lent is protected and will be repaid. Construction, in general, has risks that all parties in the construction process must account for in order to do their jobs properly and achieve the desired outcome. Whether it is a bank lending money to a developer/owner, a government entity spending the tax dollars they collect from their citizens, or a bank lending to a specific company in the construction process (GC or Subcontractor), they all want the project to go well so they can be repaid. The lender you choose — and who you are in the construction process — matters a lot. Each company in the construction process plays a different role and therefore has different risks, needs, and concerns they must manage. The lender for the developer or owner has a different set of circumstances than the lender for the GC, and the lender for the subcontractor has different circumstances than either of the former.
We administer a “funds control approach,” when we make a loan to one of our customers. This means we use a separate and specific “disbursement account” to make sure the money on the project stays on the project, including the proceeds of the loan to our customer. Because the cash from our construction finance loan is provided when the project starts, and before any work is completed and invoiced, it is important to make sure that the money is used for project related expenses. For our customers, the account is in their business’ name, and is used exclusively for disbursements of and payments associated with the project we are funding. Need to pay this week’s payroll on the project? It comes out of the disbursement account. General Contractor sending you a check for work completed? It goes into that same disbursement account.
A funds control approach protects you and the project you are working on, yet many new clients are nervous about it for one simple reason: They don’t want to tell their GC they have a financial partner, even though everyone else in the construction process has one.
We get it. Talking about money on a project can be awkward, stressful, and frustrating. But, it doesn’t have to be.
Be Confident
General Contractors KNOW the truth — that no subcontractor can finance 60-90 days’ worth of work at the beginning of a project without outside funding. We’re talking about hundreds of thousands of dollars for payroll, equipment, insurance, materials, and more, all coming out of the subcontractor’s bank account and with no expectation of making it back for two to three months when work is completed, invoiced and then paid!
In the past, a subcontractor might have had funds from the contract in advance of the project starting or the customer’s bank would often provide the upfront funds a subcontractor needed. That all changed with the Great Recession. So, if funds used to be advanced or provided and now are not, why wouldn’t a subcontractor need and seek out a lender now?
Approach the conversation with confidence. This is business as usual. A construction finance partner is what allows you to execute and perform, which is what the GC cares about most.
Is your company on track to meet your goals for growth? Get “built for growth” with our free strategy. Click here to get the Built for Growth Checklist.
Acknowledge the GC’s Perspective
Just like you, General Contractors must protect their business, the project, and their customer (i.e. mitigate risk). Chances are they have been burned before by subcontractors with bad, or just the wrong, financial partners. When a subcontractor goes under because of crippling Merchant Cash Advance (MCA) daily debit loans, it is the GC who must fill the void. When work slows down because a subcontractor can’t order materials because of bad credit, the GC is the one who has to solve that problem and manage it with their customer.
The best thing you can do is acknowledge their fears and then lay them to rest.
Be Transparent
Reassure your General Contractor by explaining who your financial partner is — their credentials, experience, and how their construction finance program works. (If that information doesn’t help your case, you may want to consider a new finance partner in the future.)
Our clients can tell their GCs that our loan is, “ … only for use on this project and can ONLY be used by us to purchase materials, equipment, and to fund the labor needed. This ensures we can get the labor and material needed to maintain our schedule and protect you and the project overall.”
Once you and the GC are on the same page regarding the need for a finance partner, give them their call-to-action. What do they need to do in order to make this work?
Typically, it means payment must be made — check mailed or deposited via wire or ACH — to the specific, funds-control disbursement account. Be sure to tell the GC, “You are still paying ME directly, not a third party and you are not changing your contract with me.”
Frame the Conversation
Framing the conversation is a great way to let your General Contractor feel positively about your finance partner right from the start. Framing a conversation is simple and can be incredibly effective when done right.
Start by thanking them for the opportunity to perform for them. Remind them that they hired you for a reason beyond price.
Then, name the reaction you want them to have. “You will be relieved/excited/happy” are all good examples. When you tell the listener what reaction you expect, they are more likely to receive the message in a way that elicits that response.
The key part of this is you MUST believe it to be a good solution too. It must be a genuine feeling.
Your final message might sound something like this:
“Hi, [GC Name]. Thank you again for the opportunity to work on [Project Name]. My team is excited to get to work, and you will be happy to hear we have lined up the funding needed to get started. Our financial partner, [Financial Partner Name], allows me as a business owner to meet the performance obligations and schedule this project demands and do our best work for you!
[Financial Partner Name] administers a funds control approach to the project. They manage an account exclusively for disbursement of funds during the project. The capital in the account is for use on this project ONLY and is reserved for project-related uses such as purchasing materials, renting equipment, and to fund the labor needed.
[Financial Partner Name] is aligned with our project’s success. This is the secret to how my company is able to perform and succeed.
What does this mean for you? It means you don’t have to worry about stopped work or delays due to cash flow problems and you can rest assured I will get the project done. After all, we know that the great majority of problems on a construction project are due to a lack of cash. I don’t have that problem and it is because of my finance partner relationship.
The only action you need to take is to mail or wire our payments to [Details of Funds Controlled Account]. Don’t worry — the checks are written out to me. I am not selling my invoices and you are not paying a 3rd party. The checks simply have to go to this address.
Thanks again. Let’s get to work!”
You can see how the message above thanks the GC, names the emotion, and reminds the GC why a financial partner is needed — so you can do your “best work!”
Construction Finance Takes Teamwork
Like everything else in construction, it takes teamwork to finance a project. When you introduce your financial partner as another key member in the project’s success, your GC can view them as an ally rather than a headache.
And if you continue to perform, meet deadlines, and exceed expectations, then your ability to secure funding can raise your reputation as a dependable business partner and help you win even more business. Now that’s teamwork.
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Our CEO Scott Peper recently joined the good folks at Levelset for a webinar on construction financing and how your funding choice could impact your ability to get paid.
We have already listed out the many types of construction financing available to contractors — the good, the bad, and the ugly. Let’s dig into how each of them can help, or harm, your ability to grow your business.
Bank Line of Credit
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 on a new job. The downside is this: The size of your Line of Credit is 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.
SBA Loan
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. SBA loans 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.
***Important to Know*** Not all SBA loans, or banks that provide them, are the same! Finding the right bank to sponsor your SBA loan is very important and how they present your business is critical as well as how you present to them. The bank is still taking a risk on your SBA loan and their assessment of your business and the perceived credit risk is just as critical to the approval process.
Invoice Factoring
While invoice factoring shrinks the time between when you invoice and when you get paid, it doesn’t get you funding before the work starts. And while financing your company between payments is absolutely a normal part of the construction industry, many General Contractors have a negative perception of factoring.
Hesitant to talk to your GC about payment and financing? Read this blog next: Why Subcontractors Need to Talk About Slow Payments with General Contractors.
Invoice factoring CAN help you grow. Done right, it can balance out your unpredictable cash flow, which gives you a chance to fund more strategic growth initiatives.
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 invest in growth opportunities.
For both invoice factoring and ABL credit, you need to make sure you aren’t paying for future growth with 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 operations of the business.
Merchant Cash Advances
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.
Don’t believe us? Here’s a quick story: A commercial glazier in Texas had a healthy balance sheet and a line of credit at his local bank. The line of credit had been in place for years, and was a little too small, but they were making due and all signs pointed to continued success.
Until there was a delay on a project, which resulted in a cash shortage. The owner needed to make payroll, so he found a quick and “easy” solution — a Merchant Cash Advance. And when he couldn’t keep up with the daily payments, he got another.
He almost went bankrupt. He almost lost everything.
Merchant cash advances don’t work for construction companies. Need more proof, read this next: The Guide to Merchant Cash Advances.
Mobilization Funding
Our construction financing program is 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. A financial capability letter can greatly improve the strength of your bid, winning you more work.
We work with our clients to align our repayment plan to their pay apps, minimizing the strain of repaying a loan on top of managing your business. Finally, we have a network of experts in industries like insurance, legal, equipment, and more who are ready to help when one of our clients has a question.
If you are interested and would like to learn more, check out How Our Commercial Loan Process Works.
Having the right construction finance partner behind your growth can help you streamline your cash flow and boost your company’s financial health. That allows you to focus on PERFORMANCE — making sure your team has the tools, equipment, training, and resources it needs to do great work. A history of great work boosts your reputation with General Contractors, which puts you in a better position to negotiate new contracts.
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Is there such a thing as “good debt?” Yes, there is. What is the difference between good debt and bad debt? Good debt helps you grow. Bad debt weighs you down.
For example, meet Kelly, owner of Kelly’s Creations.
Kelly has owned and operated the small manufacturing company for 10 years, ever since her dad retired. Kelly is very proud of her fiscal responsibility. In her early twenties, she had a small mountain of credit card debt, which she has paid off. Now, she pays for EVERYTHING in cash, both in business and in her personal life.
One day a customer comes to Kelly with an order too big to fill with her traditional materials budget. It’s a huge opportunity for her company, but she’ll need a funding source. Kelly thinks she’s a shoo-in for a small business loan. She’s never missed a payment to any of her vendors and she has a solid chunk of reserve cash in her bank account.
But what Kelly doesn’t have is credit history. Since she’s never borrowed before, there is no way for the bank to ensure she’ll be responsible with the debt. She is denied the loan.
Debt is not inherently bad.
As Kelly learned, debt is not inherently bad. We know this is true on some level, because most of us take out a mortgage when we buy a home. We may even take out a loan to buy a new car. We accept these forms of debt as necessities. But when it comes to business, many leaders try to avoid debt like the plague.
It is not the plague, though. Debt can be an important part of your business strategy, if you use it wisely.
Types of debt, good and bad.
There are commonly held beliefs on what constitutes “good debt” versus “bad debt.” Examples of good debt are:
- Mortgage
- Lines of credit
- Small business loans
- Automobile loans
- Student loans
These are loans that either pay for an essential in your life, like a house or vehicle, or represent an investment that will pay you a return. Bad debt, on the other hand, has no chance of generating long-term income and/or pays for something that quickly loses its initial value. Bad debt examples typically include:
- Credit cards
- Payday loans or cash advances
- Automobile loans
Did you notice something odd? Automobile loans is on both lists. That is an important point — automobile loans allow you to purchase an essential life item, but the loan itself does not generate income and the item in question quickly loses its value. (Unless you are buying a classic, like the 1969 Dodge Charger, in which case … drive safely!)
Which brings us to the point: It’s not the debt that is bad or good. It’s how you use it.
Good debt is all in how you use it.
It may be convenient to classify one type of debt as “good” and another as “bad,” but these labels do business owners like you a disservice. They strip you of the power to decide how debt will impact your business.
For example, credit cards are commonly thought of as bad debt. But, if you are a small business using a credit card to purchase supplies and you pay the card off every month, this is actually good debt! You are using the money to leverage your buying power and capacity to grow your business (generating long-term income) and you are building a solid credit history.
Let’s talk about another suspect on the lists above: student loans. Investing in your education is great, except expected median salaries haven’t kept up with the cost of a degree. For example, if you borrow $80,000 to get your bachelor’s but only earn a $70,000 salary afterward, you’ll feel the pinch of those payments when they get added onto the rest of your household debt. The situation is even worse for students who take out loans and do not receive a degree.
Even merchant cash advances, which we talk about at length and warn manufacturing and construction subcontractors away from, are not inherently bad debt. Are they risky? You bet. Do we caution business owners in industries like manufacturing and construction away from them? All day every day. But, plenty of business owners use MCAs effectively. They understand the payment structure and know their cash flow can support it.
See how it gets complicated? The real question is not in whether a source of funds is good or bad, but whether you will use the money in a way that allows the investment to pay for itself through business growth and revenue generation.
The ability to borrow in order to capitalize on big opportunities, like Kelly and her customer’s big order, can be the difference between growth, stagnation, or decline for your company. And here’s a tip: Stagnation is decline you haven’t noticed yet.
So now you know that debt is neutral until you use it. The next question is, how much debt should your company have?
How much debt is too much debt?
Now we come to the crux of the matter: balancing opportunity with debt. How much debt is too much debt? There is no hard and fast answer; it depends on your business’ growth plans, the type of debt and cash flow. You can and should keep an eye on your company’s overall debt, especially as it compares to your total income.
This is something your CPA should be reporting on each month — you do have a CPA, right? If not, read this next: 4 Signs You Need to Hire an Accountant for Your Commercial Construction Business.
The fate of your debt lies in your hands.
Are you worried about Kelly? Don’t be. She found the funding she needs, and has since opened up lines of credit with a few of her suppliers and hired a CPA to help her develop financial strategies that will grow her business. She still pays for most items in cash — old habits die hard.
YOU can learn from Kelly’s mistakes. Debt is not an evil boogeyman lurking in the shadows waiting to destroy your business. Debt, when used correctly, can open doors to new opportunities for your business, help you achieve your goals, and give you the foundation you need to GROW.
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“You’re either growing or you’re dying” is a popular business idiom. For some companies to grow, they rely mainly on customer referrals and organic market growth. For everyone else, you either need to generate more leads, capitalize on bigger opportunities, or some mixture of both.
Here’s another business quote, “You have to spend money to make money.” In order to execute a lead generation strategy or say YES to the next big job, you will need extra capital. Borrowing capital makes a lot of business owners nervous, especially in cash-flow volatile industries like construction and manufacturing. We wrote this article to show you how to borrow money the smart way in order to grow your business.
Know WHY you are borrowing and for WHAT.
Do you need a short-term loan in order to take advantage of a supplier’s discount, or an influx of cash to move forward on a new location or launch a new service line? Knowing WHY you need the money — the goal behind WHAT the loan is expected to do for you — can help determine which funding option is right for you.
Are you borrowing capital to fund a marketing or advertising strategy? Make sure you have clear goals around the campaign. Ultimately, the new leads generated by your marketing should more than cover the cost of the loan. Marketing is a long-term investment, so your funding options should have longer payback schedules.
Are you ready to take on a larger project, but need funds to cover the first few months of work? Commercial construction subcontractors often need a cash flow boost when they mobilize on a new job. It’s just the nature of the industry. This kind of short-term need benefits from short-term funding options that can be paid back once you start getting paid for the job.
At the end of the day loans for existing businesses fall into two categories:
Loans for tangible investments, like property, vehicles, or equipment. This is used for items you need and can pay off using the existing cash flow of the business. In other words, your business should be able to handle the monthly payment of the loan.
Working Capital Loans allow your business to take on existing work and are needed when certain costs are incurred by the business that fall outside of when you are paid by your customers. If you need money to purchase materials or pay for labor associated to existing work you have not been able to invoice or be paid for yet, this would be the loan for you.
Only borrow what you need.
When lending partners tell you how much they could loan to you, it can be hard to walk that number back. Think of all the things you could do with all that money, right? Wrong. Borrowing more than you need is a great way to increase your company’s debt right when you’re trying to grow.
Figure out exactly how much you need to accomplish the goal you identified previously. Borrow that much and no more. Remember, if you need cash later it will be easier to get if you have successfully paid back your first loan.
Getting more money than you need and therefore using the wrong type of loan to pay for the wrong items will put your business in jeopardy if something goes wrong.
Research your funding options.
Every funding option has advantages and drawbacks. It’s important to do your research and choose the one that best works for your company and your business goal. A daily debit or Merchant Cash Advance (MCA) may seem like the perfect “quick cash fix” for your short-term growth goal, but they come with a host of challenges for commercial construction companies. Here is a “cheat sheet” of the common funding options to get you started.
Small Business Loans are one of the most traditional form of small business funding. Whether you secure your loan through a bank or a lending partner, most small business loans have competitive interest rates — fixed or variable — and a set repayment schedule. They require a strong credit score and collateral to back up the loan in order to qualify. Since the Great Recession, it has become significantly harder for companies in industries like construction and manufacturing to qualify for traditional loans like these. These loans will rely heavily on your personal credit.
SBA Loans are small business loans of which up to 80% of the principal of the loan is guaranteed by the Small Business Administration. This reduces the lender’s risk and opens new funding opportunities for small business owners. The requirements for an SBA loan are similar to a small business loan, with the addition of your business qualifying as a small business according to the SBA. These loans also will rely on your personal credit and have a minimum credit score requirement of 650.
Commercial Credit is a pre-approved amount issued by the bank or lending partner that your company can access at any time. Commercial credit is often used to cover unexpected costs or to take advantage of a sudden business opportunity.
Working Capital Loans cover a company’s routine operational expenses such as payroll, rent, or debt payments. This type of loan is good for companies that experience uneven or cyclical cash flow cycles. For example, many manufacturing companies need short-term funding during the fourth quarter, when their customers are focused on selling the goods already made. The manufacturing companies repay the debt in the spring and summer, when orders pick back up.
Invoice Factoring is commonly used in commercial construction and manufacturing. The factoring company works directly with your GC or customer to verify an invoice is accurate and owed to you, then you are advanced up to 80% of the invoice amount. When the factoring company receives payment for the invoice, it repays itself the amount advanced to you, plus a fee. Any remaining balance is sent to you. This is a good option when you have invoiced your customer already and are just waiting for your customers to pay you, but they are not paying fast enough. This is not good if you need cash before you are able to create the invoice.
Purchase Order Financing is like invoice factoring. The PO financing company will pay your supplier to fulfill the order. The customer pays the PO financing company directly. It deducts its fees and sends any remaining balance to you.
It’s important to note that in both Invoice Factoring and PO Financing situations, the lender is most often directly involved with your General Contractors, customers, suppliers, and vendors.
Merchant Cash Advances (aka Daily Debit Loans) are “quick-cash” solutions designed for industries with a daily cash flow cycle, such as food and hospitality or retail. MCA repayment involves a daily or weekly draw from your checking account, which can make forecasting your cash flow even harder than before. While MCAs work in industries like hospitality or retail — where a daily cash flow can potentially meet or exceed the daily debit — it is almost impossible for commercial construction companies to keep up, especially in the months after a project is completed but the loan is still active.
MCA loans are very easy to get and can be deposited in your account within days which make them very tempting to take on. However, like most things that are easy they can come with some significant drawbacks. Anytime the repayment cycle of your loan does not fall in line with how your revenue is realized you will likely have a problem. When those problems come the solution is NOT TO TAKE ON ANOTHER ONE!
Read why MCAs don’t work for commercial construction subcontractors.
Borrow capital to grow.
Once you have identified the goal of your funds and the potential funding sources, it is time to make sure you and your company are ready to capitalize and mobilize. Forgive us one more aspirational quote, “When opportunity knocks, be ready to open the door.”
What do you need to do to maximize the potential benefit this influx of cash could give your business?
- Make a game plan for the funds based on your goal.
- Get your business and personal financials in order. That includes credit reports and tax returns.
- Establish relationships with other partners and vendors. If any of them can cut you a deal if you act quickly, that can be part of your funding strategy.
- Talk to the experts about your funding options and YOUR unique business needs.
Growing with Mobilization Funding.
If you are a commercial construction subcontractor or manufacturing company looking for a funding partner who can help you grow and succeed — you’re in the right place. We have structured our lending platform and services to serve the unique cash flow cycles of your industries. We work WITH you to create the unique lending solution that works FOR you.
You can apply online here, or give us a call at 813-712-3073. (Don’t worry — a real person will answer the phone and be ready to help you.)
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