How Construction Subcontractors Can Finance Their Companies

Most small and midsize construction subcontractors don’t have access to business financing. Sure, they need it and could use it. But it’s simply not an option. The main reason is that most subs are not adequately prepared to meet bank financing requirements – such as providing business plans, balance sheets, forecasts, etc.

To complicate matters, most banks are not comfortable lending to construction companies in general because of industry risk. Those that do lend to construction subcontractors will provide financing only to companies that have sizable assets, solid collateral, and a long track record of profitable operations. This option is not realistic for most subcontractors.

As a subcontractor, you do have some alternatives. Here are three common reasons why subcontractors look for financing and how to finance them.

Reason #1: You are just starting out

Unfortunately, there are few financing options for brand new companies. This rule doesn’t apply just to the construction industry – it applies to every industry. Getting startup financing is close to impossible. Realistically, your only bet is to use your own money to get started.

It’s really up to you. You will need to raise the capital privately, which often means from friends and family. This article provides some startup financing alternatives. But they often boil down to one option: your savings. For this reason, many subcontractors start small and grow slowly.

Reason #2: You need mobilization capital

It’s common in the industry for a subcontractor to need funds to get a project started. They need funding to cover some expenses, move equipment, place initial orders, hire subcontractors, etc.

Getting a project funded at this stage is possible, at times, but very difficult. The problem lies in the fact the the project has just started and no services have been provided. Lenders are concerned about the worst case scenario in which they pay for mobilization expenses and the construction contract is cancelled. That leaves them out of their money and everyone involved in a difficult position.

Companies that do provide this type of funding tend to work on local projects. As a result, making a specific recommendation is difficult. One alternative is to talk to local factoring companies – especially those that specialize in construction. Many of them get requests for mobilization capital and should be able to refer you to a provider.

Reason #3: You can’t afford to wait up to 60 days to get paid by GCs or commercial clients

Cash flow problems are very common for construction subcontractors. These problems usually occur because your general contractor (or commercial clients) can take 30 to 90 days to pay your invoices. However, you need to pay your own company expenses quickly – especially employees, suppliers, and subs. Most subcontractors are not prepared to handle this common situation. Fortunately, there are a couple of ways to fix this problem.

If you need less than $30,000, consider a Microloan from the SBA. Refer to this article for more details about Microloans. The biggest intermediary of Microloans in the USA is Accion.

Another alternative is to use construction receivables factoring. This type of financing provides you with an advance, using your invoices from commercial clients as collateral. Instead of waiting for payment, you can use the financing proceeds to run your business. You can settle with the finance company when the final payment is made.

The financing transaction is usually divided into two installments. The first installment, the advance, follows the flow of this diagram. The advance ranges from 60% to 75% of the net receivable value:

construction factoring

The transaction settles once the invoice is paid in full by the general contractor or commercial client. At that time, the factor remits the remaining funds, less the fee. This diagram shows the settlement part of the transaction:

construction factoring settlement

An advantage of construction factoring is that it’s easier to get than conventional financing solutions. However, factoring transactions work only if your customer – the company paying the invoices – has good commercial credit. Most factors check commercial credit via one of the well-known credit bureaus: Dun and Bradstreet, Experian, and Cortera.

Also, this transaction requires the cooperation of your clients and GCs. They need to approve the invoices and verify that the work was completed according to the contract. Obviously, this solution works only if you have a good relationship with your client.

Lastly, we also have a video that explains how factoring works in the construction industry. This video covers how to finance cellular tower construction companies.