At the risk of cutting down the time you spend reading this article, I’ll mention right up front that – as is generally standard when a question is posed in the title of an article – the answer is “no.”
But in order to get there, it’s worth spending a little bit of time examining the underlying issue, and why this seemingly obvious solution – that is, requiring up front payments on construction projects – may not only fail to protect against payment problems, but also be detrimental to your business.
Payment Problems In Construction
It’s an undisputed fact that there are problems associated with payments in the construction business, with the complainer’s project role usually dictating the particular problems complained about.
Historically, subs and sub-subs (and, to a slightly lesser extent, material suppliers and equipment lessors) have had a remarkably challenging time getting paid, and property owners, GCs, and developers have had difficulties properly controlling payments.
The credit-heavy nature of the industry makes it easy to see why this is the case. Instead of requiring payment prior to delivering materials or performing work, almost all materials and labor in construction are furnished on credit, with payment coming later (and in construction, it’s usually much later).
This is true from the general contractor all the way down the payment chain (see graphic, right), even when the value of the labor or materials furnished is quite substantial.
This credit-based payment scheme extends throughout the entire project, with most companies both extending credit and performing work on credit. For many parties, this can make cash flow management an issue, and payment of their own bills must wait until at least some payment is received from above.
Since parties must wait for payment to trickle down from the owner/GC/developer after already performing work or furnishing materials on credit, the financial risk on a construction project can increase in direct proportion to the distance a company is from those parties at the top payment where the money originates (and flows down from there).
Something to Think About:
There are many places for money to get delayed, and since the construction payment is interconnected and must flow through multiple parties, any little inconvenience, delay, or dispute about anything can impact payment for everyone on the project, whether or not they were even directly involved in the situation or mishap at issue.
When coupled with the complexity of the process itself (complex pay-apps, a back and forth exchange of legal documents on each payment), this can force companies to make choices regarding which invoices to pay and when.
What can happen next is that the companies that are forced to wait for payment from parties higher on the payment chain may not have enough ready cash to float the invoices received from parties below.
Payment Up Front – Not the Fix It Appears
So, if part of the problem is that labor or material is furnished on credit rather than construction participants “requiring payment prior to delivering materials or performing work,” then why isn’t the solution just requesting a higher percentage of the payment up front? After all, on the surface, this seems pretty straightforward. If cash flow is the issue, and cash flow can be improved by getting paid sooner, just get paid sooner, right?
Nope – it’s not the answer because everybody else is in the same boat.
The negative answer lies in the fact that, as mentioned above, companies that are forced to wait for payment may not have enough ready cash to float the invoices they receive from others.
It’s all well and good to make a decision to charge a higher up-front percentage, but when everybody in the industry has to deal with the same cash-flow issues (being in the same proverbial boat), what does that do to their ability or desire to accept your terms?
If you wouldn’t want to be put in the position of being required to pay your subs or suppliers up front, it’s no different for your customers. And, requiring a larger amount up-front prior to work throws a wrench in everybody’s cash-flow. If everybody else is willing to work on credit and get paid through the common scheme of progress payments, then you are going to be the expendable party, and that can hurt your business.
A Problem in the Real World
This isn’t just theoretical, either. I recently heard from a construction participant who provided a stark, real-life example of this very issue.
His business had been running into payment problems on too many projects. Because of that, he decided to start requiring 50% up-front, hoping to reduce the payment problems and improve his own cash-flow.
Unfortunately, that was not the result that this business owner ended up with. The outcome of this experiment was that his business started to drastically fall off, and he just wasn’t getting the same project volume he was previously.
Fixes for construction payment are rarely as simple as “need money faster, ask for more money faster.” And not only can taking this step not solve the payment problems it’s anticipated it will, it can also easily make your business take a step back.