Beyond Banks: The Rise of Fintech Contract Financing Lenders and Real-Time Funding

Industrial construction projects generally have a capital-intensive nature. There is a lot of upfront expense associated with labor, materials, equipment, and compliance prior to the first payment being made to contractors. In addition, managing cash flow over the long-term payment schedules is often one of the more challenging areas of contract work for contractors and small business owners.

Contract financing lenders have historically been banks and other large financial entities. However, due to developments in technology and the rise of fintech companies that are using technology to provide funding for contractors, this is now changing. In addition to providing additional funding sources for contractors, the utilization of Fintech for contract financing provides a number of benefits, particularly in the areas of speed, flexibility, and access to real-time information on the business account.

This article discusses this evolution of financing into newer lending institutions like online lending platforms and how they can assist contractors in making informed financial decisions when they work with contract financing lenders.

What is Contract Financing?

Contract finance is the type of finance that is generally derived from the contract value and terms of the contract rather than solely the financial condition of the borrower. An industrial construction contractor typically uses a signed contract, purchase order or a detailed scope of work to determine eligibility for contract finance.

Contract finance lenders generally analyze the type of contract, its value, the payment schedules and milestones to determine the amount of money that they can lend. This is particularly useful for construction contractors who manage large upfront costs such as mobilization, equipment leasing, purchasing of materials and payments to sub-contractors.

Unlike typical small business loans, contract financing loans may often be based solely on the performance of specific contract work. The repayment of the loans also typically follows the completion of contract milestones or the collection of accounts receivable. With this type of structure, the contractors usually have greater access to capital and ability to stabilize their working capital throughout the duration of long-term projects.

Why Contractors Often Struggle With Traditional Banks?

Banks remain an important financial institution for many businesses including industrial businesses. However, their lending models may not always be well suited to project-based industries.

Traditional banks are very reliant on historic financial data, collateral, and long-term history of credit. Many times, a small construction company or a newer service provider may have solid contracts, but they're also experiencing fluctuations in cash flow from project to project. Therefore, a bank may decline to lend money to an industrial construction company because the bank requires historical financial reporting to determine if they'll lend the company money.

Approval timelines can also be lengthy. Many small businesses wait weeks or months for bank loan decisions, particularly for larger business loans.

For contractors that are managing new contracts, delayed funding can put pressure on payroll costs, materials to be purchased for the project, and contractor payments. In this environment, contract financing lenders are proving to be helpful in addressing some of these issues.

The Emergence of Fintech Contract Financing Lenders

Online contract financing lenders use digital fintech platforms which help them streamline their lending procedures. These platforms largely focus on automation, data integration, and alternative underwriting tools and methods so that lenders can offer speed and flexibility in their services to small business owners.

Rather than relying only on past tax returns or fixed assets, fintech lenders usually also assess the following factors:

• Value and scope of project

• Customer payment history

• Accounts receivable status

• Status of complete project

• Historical trends regarding cash movements.

By doing so, contract financing lenders can offer quicker funding decisions while maintaining risk controls. This model may not remove risk entirely, but it does change how the risk is evaluated.

Owing to such benefits, fintech lending platforms are becoming popular. The Federal Reserve has noted in the past about the steady growth in non-bank and fintech lending to small businesses, particularly in industries with irregular revenue patterns.

How AI and Alternative Data Support Faster Underwriting?

A key difference between fintech lenders and traditional banks lies in their underwriting process. Fintech platforms often use automated systems and tools supported by AI models to evaluate creditworthiness.

Fintech lenders use AI powered systems to evaluate credit quality through the analysis of data (structured and unstructured) on the borrower and their business activities in real time. In case of industrial contractors, their credit quality might be ascertained using Invoice data, purchase orders, payment schedules from customer, etc.

While AI does not remove the need for human oversight, it can be used to expedite repetitive processes and reduce overall processing times. By speeding up the underwriting process, fintech lenders enable borrowers to act more rapidly with their required financing without subjecting themselves to the extended manual reviews that traditional banks may subject them to.

Real-Time Funding and Its Impact on Working Capital

Real-time or "near-real-time" funding has been regarded as one of the primary benefits of using fintech based contract financing lenders. However, real time does not mean that borrowers can get funding the day they apply for a loan. In practice, it often means approval decisions will be made and funds will be dispersed within days versus months after receiving an application approval.

For contractors in the industrial sector, access to timely working capital can be of great help. Quicker contractor finance can support:

• Covering large upfront costs

• Paying subcontractors on time

• Purchasing materials early to lock in pricing

• Managing short-term cash gaps

As access to financing solutions becomes quicker, it can reduce the need for contractors to rely upon both an emergency credit line and high-cost short-term borrowing sources.

Contract Financing Lenders vs. Traditional Banks

The distinction between contract financing lenders and banks is not about which is better. It is about which option suits particular financial needs of a business. They generally differ in terms of the types of lending products that they offer.

Banks often provide competitive rates for borrowers with strong collateral and long credit histories. But with fintechs, borrowers are likely to receive more flexibility and speed in funding decisions.

Following are some of the key factors of online contract financing lenders that make them different from traditional lenders:

• Quicker approval timelines

• More flexible repayment structures

• Easier digital documentation

• Contract-focused underwriting

However, fintech products generally have higher interest rates than traditional bank loans. Therefore, business owners must evaluate total cost and repayment terms before choosing an online lender.

If speed and flexibility is the priority, then online lenders may be a good option. However, if interest rates and total cost are the priority, then traditional banks may offer ideal terms.

Contractor Financing for Clients With Long Payment Cycles

Contractor financing for clients is particularly relevant in industrial construction. Large commercial and government clients often have extended payment schedules. While these clients may be creditworthy, delayed payments can strain the contractor's working capital.

Contract financing lenders often assess the reliability of the end client as part of underwriting. This can be helpful for government contractors working on federal or state projects. Government contract financing relies on predictable payment structures, even if timelines are extended.

Structuring the Business Loan Agreement

For a business loan agreement for contract financing, the loan agreement will likely be established based on milestones of completion rather than all the funds being available in one lump sum upfront.

The terms of such agreements often include:

• Funding limits: total amount approved for the contract

• Repayment Terms: payment schedule for the loan based on receivables

• Reporting requirements: all documentation necessary to keep both parties informed.

When developing a contract financing agreement, both parties must understand exactly what they are agreeing to so that there is no confusion or misunderstandings about repayments and fees. Contractors should examine the document to ensure that they fully comprehend what they have committed to and the associated fees.

Alternative Financing Options Contractors Also Use

Contract financing is one of several financing options available to contractors. However, there are other options that contractors can explore according to their needs:

• Business lines of credit

• Invoice factoring

• Equipment financing

• Traditional business loan programs

A commonly used alternative is invoice factoring, which provides advance cash for invoices that have not yet been paid. All of these financing options listed have unique costs, risk factors, and benefits; however, finding the best combination for your business is very dependent on your cash flow, contract size, and risk tolerance.

Risks and Considerations with Contract Financing Lenders

While fintech contract financing lenders offer speed and flexibility, they are not without trade-offs and may certain disadvantages.

Some of these disadvantages could include:

• Higher interest rates

• Origination fee and other hidden fees tied to contract performance

• Short-term repayment obligations

• Prepayment penalties

Conclusion

Contract financing lenders have emerged as an important part of the United States construction financing landscape. These alternative financing providers utilize technology to fill gaps in service offered by traditional banking institutions and provide access to construction capital using nontraditional data sources, which affects underwriting decisions.

For industrial contractors, the financing solutions offered by these lenders offer an opportunity to improve cash flow, reduce initial cash outlay, and stabilize working capital throughout lengthy project durations. However, as with any form of financing, careful consideration should be given when evaluating contracts, repayment schedules, and overall total costs associated with the loan.

Used thoughtfully, contract financing can serve as a practical tool rather than a replacement for established financial relationships.