Starting a construction business could be one of the most exciting times of a person’s life. Taking the plunge, going against the grain, and being your own boss all require a lot of courage. But, all the bravery in the world won’t do a bit of good if you don’t know how to start a construction company.
However, construction is a tough industry. It’s cash-hungry, highly regulated, and very competitive. You need all the background you can get on how to start a construction business before hanging up your shingle. This guide will help, as it will discuss some of the most important questions you need to ask yourself before you make the big move.
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How to start a construction company
Before you even consider submitting a bid, there are some essential questions you have to ask yourself when starting a construction business. The answers will help you structure your company for success.
1. What type of construction will you focus on?
The same way that a map doesn’t do you any good if you don’t know where you’re heading, you can’t start a business if you don’t know what type of construction business you want to run.
When a contractor starts out, they often feel compelled to take any project they can get their hands on. While this might work initially, the biggest construction companies in the US weren’t just overnight success stories. They started small, built their portfolio, and paid their dues. In an industry so reliant on cash flow, starting out too big too quickly is a recipe for burnout.
Also, understand that the type of construction projects your company works on will determine quite a bit about how you structure the business and the services you offer.
Larger GCs offer many services. They run several projects at a time, requiring a large staff to make the most of the smaller profit margins.
A smaller subcontractor who niches down into one specific area has fewer services to offer and takes fewer jobs — but they can maximize their margins and minimize their workforce.
2. How strong is the construction market?
A lot of chatter goes around about the strength of the construction market, but it really is a vital consideration in determining how to start a construction company. Slow markets can be stagnant, and the profit margins are usually pretty low. Booming markets are competitive, but the amount of capital it takes to feed the machine can be tremendous.
Ask yourself a few more questions:
- Are you going to start a business where you live?
- Are you open to moving to a new location and setting up shop?
- Are you ready to start competing with larger companies, or would you be better off starting in a slower market and then expanding?
Those are all key questions, but you also need to do some research. Take a look at national construction statistics and where you plan to operate.
Also, look at some of the leading cities to get an idea of how a booming market operates. Comparing those stats will reveal the strength of the market and help determine how to start a construction business in your area.
3. Do you have a business plan?
It’s true that many small construction companies operate without a business plan, but real growth requires it. It’s the foundation your entire business stands on, and there can be times when the business’s future depends on having one.
A traditional business plan contains several parts, but each is a gear in your business management machine. Those sections are:
- An executive summary that explains what your company is and why it will be a success.
- The company description provides detailed information about the company, including the solutions it offers, the customers it serves, and any competitive advantages it has.
- A market analysis explains the landscape of your target market. It covers competitors, trends, themes, and how you plan to take advantage of them.
- Break down who does what in your organization and management section. Explain the legal structure of the business, as well as an organizational chart that details who is in charge of what.
- Your business offers a service or product, and you need to go into detail about it in your business plan. What types of jobs do you perform? What’s your specialty?
- A section devoted to marketing and sales will not only explain who your customer is, but how you plan to attract them. This might be one of the most important sections, so take your time and nail it.
- Funding requests should have their own section, explaining how much you’re asking for and why. What do you plan to do with the money if you’re approved? This is the section to explain it.
- Your business plan isn’t complete without financial projections. Explain where the company is headed in the next five years.
- An appendix that includes credit histories, resumes, product pictures, letters of reference, and other pertinent documentation is also highly recommended.
For more information on putting together a business plan, check out the SBA’s guide.
4. What are the registration and licensing requirements?
Construction is highly regulated, and most states have their own unique way of looking at registration and licensing requirements. It’s up to you to know if you’re above-board with the appropriate boards, offices, and other overseeing entities.
Most states require businesses to register with the Secretary of State. Typically, this is for tax purposes and to ensure that a company is carrying the proper insurances to protect their employees, their customers, and any affected parties. Registration is usually fairly straightforward, requiring a fee, a FEIN number, and proof of insurance, but some states are easier than others.
Licensing, on the other hand, is an entirely different animal. Depending on the state you’re working in, you might have to carry a license for your trade.
- In most states, plumbing, electrical, and HVAC contractors are required to take and pass a trade exam before they’re able to operate.
- Some states require general contractors and specialty subs to pass a general business exam as well as a trade exam.
- Many states leave licensing up to the individual counties or cities, meaning a contractor might need to carry 5 or 6 licenses to work in their immediate area.
Not meeting these requirements could be a killer to your business. Not only are fines and jail time a real possibility, but unlicensed contractors don’t have rights to mechanics liens in some states. It’s important to understand the rules in all the states in which you work.
5. Where is your funding coming from?
At least twice already, the mention of cash flow and the construction industry’s dependence on it came up in this guide. You can’t start a construction business without knowing where the money is coming from.
Again, the type of work you’re performing will have a lot to do with how much start-up capital you need—especially when it comes to securing materials for the first few jobs. Small subcontractors might be able to get their start with a loan from family or friends, or even on a credit card if necessary. Large contractors will need significant funds to float jobs until their progress payments clear the bank.
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Do you have any investments you can pull from? Do you plan to secure a loan through a bank? Do you have the assets to do so? Have you considered going through the SBA for a small business loan? Again, these are all important questions you should be asking yourself before starting your construction company.
6. Who do you need on your team?
Whether it’s a small firm or a large operation, you need people you can rely on. But, how many of those people do you need? And what makes them the right people for the job? New construction company owners often fill the following roles themselves at first, but they quickly learn they can’t be everywhere at once.
Once a construction company’s office outgrows the cab of a truck, it needs an office manager. This person keeps the day-to-day operations running smoothly, and they’re critical to a company’s success.
Sales and marketing departments are the folks that keep the job funnel full. These folks bring attention to your company and seal the deal with prospective customers and other contractors. Once a company is able to afford a good sales and marketing team, they’ll pay for themselves.
Credit management personnel can make a significant difference to a construction company’s cash flow. Unless the company gets paid 100 percent of the contract value upfront, it’s extending credit to its customers. Hiring someone to manage credit can minimize the risk, and the amount of time it takes to get paid.
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Someone should be keeping an eye on the financing and accounting, as well. This person ensures that invoices are getting paid, both payable and receivable. They also make sure that the company’s cash flow is in a healthy balance, helping the company grow.
An estimation team you can trust is vital to the well-being of the company. This person needs to put together accurate, profitable estimates that will protect the company’s cash flow while also being competitive.
Finally, you need a construction team that will bring the project from plans to completion. Project managers, foremen, laborers, as well as dependable designers and subcontractors, are essential.
7. How will you manage your cash flow?
If you haven’t picked up on it yet, cash flow is critical to a construction company’s success, whether it’s a start-up or a long-standing corporation. If more money isn’t coming in each month than is going out, contracts mean nothing. And, when all other factors boil down, it’s cash flow that causes construction businesses to fail.
And here’s the thing: getting paid in construction takes a long time. The average days sales outstanding (DSO) in the construction industry was 83 in 2018. Figuring out how to shorten that window for your company and protect your cash flow is critical. A policy of sending a preliminary notice on all of your projects will help, as these documents protect lien rights and show that you know those rights.
And, when cash flow is drying up, being able to lien on a mechanics lien to ensure you get paid is critical. After all, “The Credit Overlord” Thea Dudley likes to say, “Everyone pays you until they don’t.” Hedging your bets with preliminary notices and protecting lien rights is critically important.
8. Can you grow sustainably?
Growth is always the goal, but it needs to be sustainable. Ensuring that you can grow at a pace that won’t turn cash flow inside out needs to be the real goal.
When a company grows too quickly, it often overextends all of its resources. Floating too many jobs at once can take the company from being in the black to the red. At that point, any small hiccup in the payment chain along the way can become a massive problem.
Another resource that a growing company needs to watch out for is manpower. When a company secures too many projects too quickly, they often don’t have the manpower to staff each job. This can lead to a mass hiring scramble, which takes time and resources. Experienced project managers often expect sign-on bonuses and perks, and professional headhunters don’t work for free. And, with qualified construction employees becoming more and more scarce, even labor can be challenging to drum up.
You need to know how to start a construction company the right way
If you don’t have a plan and your eye on the correct goals, there’s very little chance that your company will succeed. However, if you develop a well-thought-out plan, choose the best niche for yourself, and hire the right people, you’re well on your way to success. But, you can’t go anywhere without cash flow.
A word of advice: Don’t start a construction business until you understand the mechanics lien rights of the states in which you work. The only way for a construction business to be sustainable is to safeguard cash flow, which means preserving lien rights on every project. Protecting your rights means less waiting for payment and more sustainable growth for your new construction business.