Construction is one of the slowest-paying industries: In fact, contractors and suppliers wait an average of 83 days for payment for work or materials. This chronic delay makes it difficult for construction businesses to avoid cash flow problems. When contractors are dealing with payment delays, especially on multiple projects, they need alternatives such as contractor loans and financing options to help with their immediate cash needs.
Luckily, there are several options that contractors can take advantage of to help with cash flow. From credit cards to business loans to invoice factoring, there are a wide variety of ways to temporarily infuse cash into your business. We’ll take a look at some of them and give you the pros and cons of the main types of contractor loans, so you can make an informed decision for your company.
Contractor loan options: The pros & cons
Credit cards
Credit cards are probably the simplest and easiest way to get additional funds for your construction company. There are many brands to choose from, lots of low-interest offers and purchase rewards, and most are fairly easy to qualify for. If you’ve got decent personal credit, you should be able to get a card with a fairly robust limit rather quickly.
Be sure to shop around for the best deal based on your needs, and be sure to review the fine print of any credit card offer before you sign up. Know how much the additional credit is going to cost you.
Many cards have extremely high interest rates or annual fees, which can cost you lots of money down the road if you don’t pay the balance off each month.
Pros:
- Almost instant approval
- Purchase rewards
- Easy to apply for
Cons:
- High interest rates
- Possible high fees
- You need a decent credit rating
SBA-guaranteed loans
The US Small Business Association (SBA) can help small companies find appropriate loans to help them with their cash flow problems. The loans are distributed through local banks and the funds are guaranteed by the SBA, making banks more willing to furnish these types of loans since the government is backing them.
To qualify for one of these loans, you must be a for-profit business in the United States, have invested equity in the business, and have exhausted your financing options from other lenders.
The process of getting an SBA loan is pretty intense, so expect a lot of paperwork and waiting.
It can take weeks for loans to process, so this isn’t a quick-fix option. There are also company size requirements to qualify for these loans, so make sure you review them before talking to your bank. Business bankers at most banks can walk you through the process and tell you what information you’ll need to provide.
Pros:
- Funds are backed by the government, so interest rates are lower
- Helps those who may not qualify for traditional business loans
Cons:
- Lots of paperwork (bureaucracy)
- Long wait time
Business loans
A standard business loan from a local financial institution may be your best bet for long-term financing assistance. Most banks offer programs for local businesses to help them expand and get over short-term cash flow problems.
The process of getting a business loan is a bit more straight-forward than an SBA loan, but it still requires a credit check and a substantial amount of paperwork to be completed. It can also take several weeks for these business contractor loans to be processed and financed, so plan ahead.
Pros:
- You can finance longer-term needs
- You can finance for larger amounts
- Lower interest rate than other non-loan options
Cons:
- You may have to provide collateral to secure the loan (which leaves your assets subject to repossession if you default)
- Requires strong financial statements
- Requires good credit
Line of credit
A line of credit is a pool of money that is loaned to you by your bank and you can draw from it as you need it. You can withdraw and pay back the money as many times as you want, and interest only accrues on the amount that you withdraw. It’s like having an additional savings account that you only pay for when you need it.
A line of credit can either be secured or unsecured. An unsecured line of credit will carry a higher interest rate because it’s not guaranteed by any collateral. A secured line of credit typically comes with a higher credit limit and a lower interest rate because the lender can take your assets if you don’t pay back the money you withdraw.
Pros:
- Provides money only as you need it
- You only pay interest on the amount you borrow
- You can withdraw and repay the money as many times as you want/need
Cons:
- Has a higher interest rate than a traditional business loan
- Requires strong financial statements
- Requires good credit
Invoice factoring or receivables financing
Invoice factoring in construction is a process where you sell outstanding invoices or accounts receivable in exchange for some money upfront and the balance, minus a fee, when your customer pays. The factoring company (also called a factor) takes possession of the receivables and your customer pays them instead of you.
Here’s how it works:
You submit a construction invoice to your customer and sell that invoice to a factoring company, which pays you a percentage of the invoice’s value (typically in the range of 70-90%).
After your customer pays their invoice, the factoring company takes their cut (usually 1-5% per month for construction) and pays you the remainder. The cut that goes to the factor is known as the factoring rate.
Unlike collections, which are initiated after an invoice has become past due, factoring is only available for invoices from the time they are issued until they are due. It’s best done with customers you know will pay, but just take a long time.
Construction factoring can provide much-needed cash flow to contractors or suppliers upfront, avoiding the long delay between invoicing and payment.
Something important to keep in mind is that invoice factoring is not a loan. This can be a selling point for a construction company that wants to avoid putting debt on their books.
Pros:
- Your credit isn’t reviewed, just your customer’s
- No ongoing payments
- The factor is in charge of collections
Cons:
- Your customers may feel uncomfortable paying a third party
Equipment and material financing
Equipment financing operates like a car loan or mortgage: A bank gives you a loan to purchase it and uses the equipment as collateral. For construction companies, this type of financing may be used for heavy machinery, vehicles, tools, or pretty much any operational equipment that improves their workers’ productivity.
The more you want to finance, the higher the interest rate will be. Because equipment depreciates, banks don’t like to lend an amount equal to the full retail value of the equipment. However, there are some lenders out there that will finance 100% of the equipment value. More typically, the borrower will be required to put down a percentage of cash upfront.
Material financing is similar to equipment financing, in that a loan is exchanged for the purchase of construction materials. A financing company pays the supplier right away and then offers long-term payment terms to the contractor. These terms may offer contractors as much as 90 to 120 days to pay the finance company, which should be long enough for them to be paid by the customer.
Pros:
- Usually lower interest rates (since loans are backed by collateral)
- Added productivity from equipment can help pay for the cost of the loan
Cons:
- Equipment loans may require a down payment
- Requires a credit check and financial statements
- Equipment can be repossessed if payments are missed
When contractor loans are a good idea
- You have an established financial history with good credit, several years of audited financial statements, and interest rates are favorable
- You are looking for start-up cash or need to purchase equipment to expand your business
- You need a substantial amount of cash and need to pay it back over a longer term
When contractor loans are a bad idea
- You’re just starting out in the industry and have negative items on your personal credit history
- You need cash almost immediately
- You don’t have organized financial statements or tax returns
Long-term funding solutions for construction contractors
Most cash flow problems in construction come back to one thing: slow payment. Whether you’re trying to grow your business or simply trying to keep your head above water, speeding up your payments and reducing your days sales outstanding (DSO) can dramatically reduce or even eliminate a contractor’s need for a loan.
Some other long-term funding solutions that don’t directly require borrowing money include:
- Stay on top of your accounts receivable, making sure your customers are paying you on time and protecting your lien rights
- Apply for a line of credit at your bank when things are going well, so you have it in place in case of a slow down
- Establish a relationship with a factoring company and leave the invoice collection efforts to them
Learn more: Types of Capital for Construction Businesses