Small subcontracting firms looking to grow a business may be afraid to take on larger, higher-paying jobs for a few reasons. These jobs typically require a larger cash outlay, and the contracting firm often gets paid incrementally through installments over weeks or months. This can wreak havoc on cash flow — and then there’s the greater risk that the client won’t pay at all. Despite the credit-heavy nature of construction work, there are several ways subcontractors can grow business while minimizing their risk threshold.
Risks for Subcontractors
Construction subcontractors get paid through the general contractor rather than directly by the property owner. Sub-subcontractors have to wait for payment to trickle through an even longer chain of command. A break in the top of this chain — that is, a property owner who fails to pay or a general contractor who delays payment — can have trickle-down effects for all parties involved. Materials and labor are costly, and if customers pay late or fail to pay at all, cash flow suffers, making it harder for subcontractors to make payroll and stay in business.
A 2015 survey conducted by Taulia shows that nearly 50 percent of all subcontractors said they were paid late by clients. The average late payment came more than nine days after it was due, with 25 percent of respondents waiting more than 40 days to be paid.
What’s worse, the survey showed that subcontractors often agreed to discounted rates, even after the early payment deadline passed. Subcontractors shouldn’t have to accept less compensation in order to receive any at all. It’s not fair.
But these risks are not as dire as they sound. Safeguards like mechanics liens — available only to parties furnishing labor or materials in the construction industry — can help subcontractors secure payment and reduce the risks otherwise inherent to larger projects with significant cash outlay. Embracing these tools provides a significant boost to construction businesses looking to take on new projects, new clients, and grow.
Solutions for Subcontractors
Protecting a construction firm from nonpayment is essential to growing business. And protecting from nonpayment begins with understanding and employing lien rights. Mechanics liens and bond claims exist exclusively to help parties that furnish labor or materials on construction projects secure payment and minimize financial risk.
Unpaid construction parties may file a mechanics lien (assuming they met all preliminary requirements), which is a security interest in the improved property. If the claimant remains unpaid, they may enforce the lien in court, foreclose the property, and collect payment from the proceeds of the property’s sale.
If a construction firm successfully secures the right to file a mechanics lien, the risk of nonpayment is significantly reduced. This permits subcontractors to take on new business with confidence.
Many states require that construction parties send preliminary notice in order to secure the right to file a mechanics lien (or bond claim) in the event of nonpayment. However, preliminary notices do more than just secure lien rights. Even in states where preliminary notice is not required, sending one can reduce DSO (days sales outstanding) and decrease instances of nonpayment. This improves accounts receivable and cash flow, which are essential to construction businesses looking to expand.
To learn more about the additional benefits of sending preliminary notice, read “Why You Should Send Preliminary Notice Even When It’s Not Required“.
Conditional Lien Waivers
Lien waivers are commonly exchanged on construction projects as part of the payment process, and sometimes these documents present tremendous risk for subcontractors. When conditional lien waivers are used, however, subcontractors can actually speed up the payment process without exposure to financial risk.
Conditional lien waivers are a specific type of lien waiver that does not go into effect until a certain condition is met. Typically they are conditioned upon actual receipt of payment, so the signing party maintains lien rights until their invoice is paid.
Credit & Accounting Tools
Pursuing and protecting lien rights are not the only methods construction parties can use to reduce risk and consequently grow business. Checking the credit history of clients before signing a contract or agreeing to generous credit terms is generally a good way to identify red flags. This helps strike a balance between high-risk, high-profit jobs and customers who consistently pay on time.
Also, implementing accounting software can help identify payment patterns, for example, which clients pay upfront or on-time, and which clients tend to pay late.
Minimizing Risk: The Key to New Business
Lien rights remain the key to risk management in the construction industry. By sending preliminary notice when it is required, and by filing a mechanics lien when necessary, subcontracting companies can secure payment on any project, large or small. By taking advantage of these tools, subcontractors can grow business by taking on accounts that may be slightly risky.