How Construction Companies can use Financing to Manage Projects

When it comes to project costs, timelines, and milestone payments, the construction industry is one of the most volatile types of companies among small businesses. Project materials can suddenly spike as the cost of goods and equipment has been volatile over the past couple of years; dependable workers have become more difficult to find, and customer demands have always been stringent in the industry. 

One of the most prudent ways to ensure that individual project deliverables are met, however, is to take out financing. Borrowed funds can assist contractors in overcoming cash flow bottlenecks and getting through every phase of a project to help meet both milestones and deadlines.

What are Typical Project Challenges?

From the design stage to project closure, construction companies face various challenges through the lifetime of projects. Construction companies are often immediately working with thin profit margins to begin with, so financing every stage of a project can be difficult. The problem of finding working capital for new construction projects often comes up due to project delays and slow-paying clients. Most contractors need to have cash readily available to pay for. Some of the most common challenges are:

• Equipment costs. Some projects may suddenly require specialized equipment; software or aging equipment may suddenly need repairs. Some projects may require updated or new project management software, while others may require augmented reality (AR) equipment or drone usage to survey construction sites. In some cases, subcontractors may require new, specialized equipment to complete a project.

• Unreliable clients. Clients can often be late making upfront or milestone payments, which can cause delays in supplier payments or covering other costs. Various types of financing can be used to provide bridge financing for slow-paying invoices.

• Unexpected cost overruns. Overruns on cost may be caused by weather, thus driving up costly delays. This can often lead to contractors scrambling to find financing for construction payroll gaps and other cost overruns.

• Supplier costs. As the tariff policy keeps changing, supply chains could be disrupted thus driving up supplier costs. The problem of how to fund construction materials upfront often comes up during the execution stages of projects.

• Worker shortages. A shortage of reliable labor is a problem that has been plaguing small businesses for years now, and the construction industry has been no different. Some projects require specialized workers, which would represent surprise costs for the contractor. 

• Insufficient productivity. Contractors often face the problem of unreliable subcontractors that miss deadlines and often don’t show up to work. This problem can lead to delays that could cost contractors money.

How Can Financing Help?

Project risks can create serious drag on cash flow and can delay projects, thus creating funding gaps in projects. Fortunately, there are several forms of no collateral construction loans available to help construction companies complete projects, especially ones with multiple milestones payments and deadlines. Financing can give construction companies cash when they need it to help them with surprise expenses during a project and get them to the next milestone.

Some common forms of financing that construction companies use to finance their projects:

1. Term loan. With a term loan, a construction company would get a lump sum of money with the agreement to pay back principal with interest over a pre-agreed upon term. The term can be short-, intermediate- and long-duration, and can be used at any time during a project's cycle.

During the lifetime of a project, however, a construction company may want to obtain a term loan before any construction begins, perhaps during the design or procurement planning stages. A short-duration loan taken at the early stages of a project, such as the procurement planning or preconstruction stages of a project, can provide a construction company with cash on hand while paying off the loan as the client pays during the lifetime of the project.

2. SBA 7(a) Loan. An SBA 7(a) loan is essentially a term loan that is, in part, guaranteed by the SBA, and offered by an SBA-approved lender, and therefore typically offers lower rates than term loans offered by private lenders. They can be short-, intermediate- and long-term in durations. SBA-backed loans, however, usually have more stringent requirements such as higher credit scores and more paperwork.

3. Revenue-based financing. Revenue-based financing can be a good alternative to bank loans for construction companies, as it provides a lump sum of cash to a construction company in exchange for a percentage of estimated future receivables, or in the case of construction company, a percentage of future payments from the client. This is often an appealing option to construction companies because it’s a form of financing that has a short application process relative to other forms of financing.

Therefore, it can be an ideal form of financing to cover unexpected costs even during the execution stage of a project, such as the sudden need to hire additional workers or cover the cost of additional supplies. The length of the contract can be negotiated so that repayments are when clients make milestone payments during the life of a project.

4. Business Line of Credit. A business line of credit can be the most flexible financing tool for construction companies looking to finish projects, as it can provide fast mobilization funding for construction. A line of credit gives a construction company a predetermined borrowing limit. The construction company can draw on that at any time during the life of the credit line and only pays interest on the amount borrowed. Some lenders charge a variable rate while others charge a fixed rate. By taking out a business line of credit before the project execution stage, a small construction company can ensure it has the funds that it needs to cover any sudden cost that may arise.

5. Equipment Leasing/Financing. Sometimes crucial machinery breaks down and needs to be replaced or undergo costly repair. Equipment financing provides a loan that pays the full cost of new machinery that is paid back via fixed payments with interest. Equipment leasing allows a construction company to use equipment in exchange for monthly payments. There are two types of lease agreements – a capital lease allows the company to purchase the equipment at the end of the lease agreement, while an operating lease is an agreement in which the company pays to use the equipment for an agreed time.

How do Construction Companies Qualify for Financing?

Construction companies generally must have strong fundamentals, decent credit, and a diversified portfolio or projects to qualify for secured or unsecured financing. Different lending products have different requirements, but generally, before a construction company applies for financing, it should have:

• A strong credit score, depending on the specific financing product. A term loan or equipment financing application generally requires a slightly higher score than revenue-based financing.

• At least 6 months of bank statements. Lenders generally want to see a track record of positive cash flow and responsible financial management by the company before approving a loan.

• A strong portfolio of construction projects. Lenders want to see that a construction company is getting its revenue from several different sources, rather than being dependent on a single project for its revenue. 

• This includes personal identification, employee identification number, and several months of bank statements.

• At least one year in business. Depending on the specific financing product, financial institutions generally don't lend to small businesses that are less than one year old. For a product such as term loan, they might require at least two years in business.

Financing Can Help Complete All Project Steps

Construction projects can often face funding problems throughout each step, from a lack of qualified workers to suddenly volatile costs from suppliers. Financing during each step of the project, whether it is the procurement step or the project execution step, can avoid costly delays and smooth out unexpected cost overruns. Construction companies should make sure they are ready to obtain financing in every stage of a project to make sure deadlines are met to keep client satisfaction high.