Becoming a government contractor has a number of advantages, especially for small businesses. Government agencies buy most types of products and services year-round, they pay on time, and can be great customers.
Actually, the government gives small businesses incentives to work with them. There are a number of programs designed to help small companies win more government business. These set-aside programs help level the playing field and allow you to compete against larger companies. They are one of the reasons why small businesses should consider selling their products/services to the government.
Contracts can create financial challenges
Many entrepreneurs, especially new government contractors, usually focus their attention on the bidding process. They focus solely on winning the contract. However, they often overlook that finding and getting the contract is the easy part. The hard part is actually fulfilling the contract – providing the actual goods and services.
One of the reasons that fulfilling the contract is hard is that it can affect your finances. Even small government contracts can seem large from the perspective of a startup or new business. Unless you have adequate financial resources in place, you can run into two common problems.
Problem #1: Slow cash flow
The government usually pays its invoices 30 to 60 days after receiving your products/services. Few entrepreneurs consider this fact when they bid for a contract. However, it is very important.
You must have the funds to pay for all operational costs while waiting for payment. This can be hard, especially if you had to add resources (e.g., employees, equipment, etc.) to fulfill the contract. It gets even more challenging if you are working on multiple projects at the same time.
Problem #2: You need funds to pay suppliers
The government often purchases goods in bulk. Government purchase orders, even small ones, often exceed the funding capabilities of small businesses. This puts you in a financial bind. Most suppliers demand a prepayment before shipping goods to you. If you can’t pay them, they won’t ship. And if suppliers don’t ship the goods, you won’t be able to fulfill the order, and it will fall through.
Government contract financing options
Unless you have the resources to fulfill the government contract, you need to get financing. It is a good idea to get your financing lined up before or shortly after placing a bid. Finding the right solution to finance your small business may take some time.
You don’t want to be in a position where you win the bid but are not able to fulfill it because of financial reasons. Defaulting on a government contract has negative consequences, so plan ahead.
Option #1: Factor slow-paying invoices
One simple way to solve the cash flow problems created by slow-paying invoices is to use invoice factoring. A factoring program allows you to finance slow-paying invoices. Instead of waiting 30 to 60 days to get paid by the government, you get an advance from a factoring company. The transaction concludes once the government pays the invoice after 30 to 60 days.
Government invoices can be financed thanks to the assignment of claims act. This allows you to assign the proceeds of the invoice (though not necessarily the work!) to a third party, who can then provide the funding. A number of companies provide this service because the government is an excellent, but slow, payer.
Qualifying for an invoice factoring program is relatively easy, especially if you are a government contractor. The funding line can usually be put in place in a week or two.
Option #2: Finance purchase orders
Often, small businesses work with vendors who demand payment before shipping product. If you win a large order, this demand can be a problem because you may not have enough money to cover the prepayment. In this case, consider financing the government purchase order.
Purchase order financing is a type of funding that pays the supplier costs associated with a specific purchase order. It allows you to purchase the goods and fulfill the order. The transaction concludes and settles once the government gets the product and pays for it.
Purchase order financing has an important limitation. It can be used only by companies who resell finished goods. Unfortunately, it can’t be used by companies that do their own manufacturing. Also, keep in mind that purchase order financing is more expensive than conventional financing. Therefore, it can be used only by companies that have larger profit margins – usually above 20%.
Option #3: Finance your inventory
Companies that manufacture goods or have unsold inventory can fund orders by financing their inventory. The solution works like a line of credit that is secured by inventory. The line is usually repaid after inventory sells and generates revenues.
Inventory financing can help finance larger companies, but it has some limitations. Setting up the line can be time-consuming and expensive, since the initial inventory must be evaluated. Also, inventory is often valued at a percentage of its “distressed sale value.” This can be substantially lower than market value for some products. Lastly, maintaining the line can be cumbersome due to the required inventory controls.
Option #4: Use asset based lending
Larger companies that can’t qualify for a conventional line of credit can benefit from an option like asset based lending. Asset based lending allows you to finance your company’s assets – such as accounts receivable, inventory, machinery, and real estate.
The structure of the facility depends on the underlying asset that is financed. Lines backed by accounts receivable and inventory are structured to operate much like lines of credit. Lines backed by machinery and other assets usually operate like term loans.
This solution is available to companies that invoice a minimum of $1,000,000 per month and have reasonable financial and management controls. These lines are usually cheaper than stand-alone factoring and inventory lines.
Option #5: The SBA
The SBA has a number of financing programs in place to help small business owners. Very small government contractors can benefit from the Microloan program. This program provides financing to companies that need less than $50,000 in funding. Microloans are designed to help individuals launch small businesses, and they come with a number of resources to help you succeed.
Larger businesses should consider a 7(a) loan. These loans have substantially higher limits than Microloans but are harder to get. However, they can be a great tool for small companies that are growing quickly and need flexible funding.