Business Financing for Your Construction Company
There are more than 1.5 million construction firms in the U.S., and it's likely that every single contractor knows the reality of financing a construction business: job costs must be covered, payroll must be met and subs need to be paid despite the inevitable lag between the time the work is done and the time the customer pays. There's absolutely no surprise when a vendor demands immediate payment for materials, even though it will be a month or more before you are paid for the associated job.
Of course, uneven cash flow is just one of the problems contractors must deal with. There's ongoing worry about the weak recovery of the commercial and residential construction markets, seemingly endless change orders from clients, ever-rising insurance costs, and skilled labor shortages, too. And don't forget heavy competition for every job.
Finance is just one of many concerns in the construction industry but, since access to funding is often the deciding factor between firms that thrive and firms that fail, it's probably the one that keeps the most contractors up at night.
In an ideal world, your construction company would have access to a line of credit to help manage cash flow and weather the gaps between progress payments on big jobs. But veteran contractors know it's not easy to get funding from traditional banks. In the rare cases where conventional bank financing is available, it almost always requires a 30- to 60- day approval process. And that delay can be a deal breaker when a customer or general contractor is ready for your firm to start work.
Having a ready source of funding will help you keep the bills paid and give you the ability to take advantage of opportunities as they arise. Plus, there are several additional benefits:
Keep the cost of materials low to maximize profits. With cash on hand, you may be able to negotiate with vendors to get special pricing or discounts based on fast payment.
Negotiate better pricing from subcontractors. When subs know you'll pay them quickly they are more likely to offer you their best rates.
Make payroll consistently. Your skilled tradesmen will be a lot less likely to leave for other jobs if they know they'll be paid on time.
Land public-sector jobs. Many public sector projects include mandates and incentives to hire local, minority-owned or women-owned subcontractors. If you're in one of those groups, you'll land more jobs if you have access to working capital.
Sources of Funding
Because financing is so important the success of your construction company, it's important to understand the options that are available. Here's a list of common funding sources, plus pros and cons that every contractor should understand:
Bank line of credit. As noted above, a line of credit is an ideal financing tool for a construction company. With a line of credit, you'll have relatively low-cost access to cash when you need it. The downside? It's almost impossible for many small firms to obtain a line of credit from a traditional bank.
SBA-backed loans. The Small Business Administration does not actually loan money to businesses; instead, they provide a partial guarantee to approved lenders. SBA-backed loans feature competitive interest rates and business-friendly repayment terms. Unfortunately, approval rates are low due to relatively strict underwriting requirements. Also, personal collateral is required to secure most bank loans.
Equipment leases. By leasing construction equipment, you can free up cash for operating expenses. Plus, the entire lease payment is considered a deductible business expense. Leasing can be arranged for most types of equipment, but it may be a more expensive option than other types of financing, and it has implications for the long-term ownership of the equipment.
Alternative financing. Alternative business loans and revenue-based financing are widely available and can provide funding quickly with minimal paperwork. While the cost of alternative financing tends to be higher than other options, it is important to consider that in comparison to the relative inaccessibility of conventional bank loans.
Business credit card. In practical terms, a small business credit card is simply a personal credit card with the business name on it. These can be a useful source of short-term financing for materials and supplies, but the financing cost can be high and usage will be restricted by the owner's credit limit.
Equity financing. Some construction businesses may have the option of selling an ownership stake in return for operating capital but it can be difficult and time consuming to find a potential partner who wants to invest in your business. Plus, when you take on an equity partner, you'll dilute your share of the profits and you may have to give up some operational control of the business.
Ways your business may benefit from alternative financing.
While there are a number of financing sources that are at least theoretically available to your construction business, it's important to understand that many of those options might not be available when you need them. The relative inaccessibility of a bank line of credit or SBA-backed loan highlights the key benefits of alternative financing options:
- Alternative financing is widely available to many construction firms
- Very little paperwork is required
- No collateral is required
- Funding is available quickly when you need it
Also, alternative financing may be available even if a bank has already turned you down. Similarly, you won't be disqualified if you have a tax lien with a payment plan or if you have a bankruptcy that has been discharged.
There are two primary forms of alternative financing available to help construction companies deal with the challenges of uneven cash flow:
Revenue-based financing can provide $5,000 to $250,000 in funding in exchange for a portion of your future business revenue. Revenue-based financing is not a loan; it is a financing agreement where you agree to sell a portion of your future revenue at a fixed discount.
A business term loan can provide up to $250,000 in funding based on your revenue and the strength your business. This alternative loan option features fixed daily, weekly or monthly payments over a preset term.
Most alternative financing options can be accessed with a simple online application. Once you have connected with a funding partner and finalized a funding agreement, money will be deposited in your business bank account within days.
The funds you receive are available for any business purpose, including:
- Purchase equipment
- Finance vehicles
- Buy materials
- Pay subcontractors
- Cover payroll
- Buy out a competitor
- Pay insurance premiums
- Make tax payments
- Debt consolidation