Financing Alternative for Construction Subcontractors

Most construction subcontractors experience financial problems at one time or another. The industry is known for working with tight cash flows. This situation can create serious challenges for business owners and affect their ability to run and grow their companies. In this article, we discuss alternatives to solve this problem once and for all. We cover:

  1. Slow-paying clients create cash flow problems
  2. How to improve cash flow without financing
  3. How to finance progress payments and invoices
  4. “Pay when paid” clauses
  5. Qualification requirements
  6. Bonded projects
  7. Advantages and disadvantages

1. Slow-paying clients and cash flow problems

Construction subcontractors who work with general contractors (GCs) and commercial clients usually have to wait 30 to 60 days to get paid. This situation can be challenging because subcontractors are often responsible for a number of expenses that must be paid beforehand. This situation is a common source of financial problems for construction companies.

Companies often respond to this situation by juggling supplier payments and hoping for the best. This strategy can work sometimes, but it often leads to problems with suppliers. Furthermore, some expenses can’t be “juggled,” such as payroll, insurance, or taxes.

2. Improve cash flow without financing

Your first step should be to determine if you can fix your cash flow by improving operations. You should consider financing only if improving operations won’t fix your problem.

a) Improve invoicing and collections

Many small businesses encounter cash flow problems simply because their invoicing and collections are not well organized. Fortunately, this problem is easy to fix and can improve your cash flow quickly. Here are some suggestions:

  • Submit invoices according to your GC’s (or client’s) guidelines
  • Send supporting information (e.g., punch lists)
  • Verify the invoices were received
  • Follow up if payment is late

If you need additional information, read “How to Collect Slow-Paying Accounts Receivable.”

b) Offer early payment discounts

If your invoicing is working well, but you still have cash flow problems, consider offering discounts for early payments. These discounts are easy to implement. Simply provide the client a small discount if they pay within ten days. Here are some common ways to offer them:

  • 1%/10 – Net 30
  • 2%/10 – Net 30
  • 2%/10 – Net 45

The “1%/10” in the first example states that the client gets a 1% discount if they pay in 10 days. The “Net 30” means that if the client does not take the incentive discount, they can pay the total amount in 30 days. Keep in mind that these discounts are optional, and your clients decide whether to take them or not.

3. Finance progress payments and invoices

If your invoicing and collections are not working well and early payment discounts are not helping, consider financing your invoices using construction factoring. These plans provide immediate cash flow, which you can use to cover the costs of operations.

Factoring plans finance your invoices in two installments. The first installment is deposited to your bank account shortly after you submit the the invoice and the factoring company approves it. This installment covers up to 80% of the value of the invoice.

The second installment, less the factoring cost, is deposited to your bank account once your end customer pays the invoice in full. This payment settles the transaction. Construction subcontractors can use factoring as needed. To learn more about factoring, read “What is Factoring?” and “How Does Invoice Factoring Work?

While the process is simple, financing construction receivables can be challenging. This is because most construction companies invoice for progress payments that are also subject to a “paid when paid” clause. These invoices have a higher risk of being disputed. Only a few factoring companies specialize in this industry and often deal with “pay when paid” by using a letter of acceptance.

4. “Pay when paid” clauses

Invoices that have “pay when paid” clauses are riskier to finance than conventional invoices. The milestones that a GC has to complete to get a payment often involve several subcontractors’ work. This situation leaves you exposed to payment delays that are not related to the work your company did. Additionally, this clause can also be abused by a less-than-scrupulous GC.

Factoring companies reduce the risks associated with “pay when paid” clauses by asking GCs to sign an acceptance letter. The acceptance letter states that the work:

  • Has been completed
  • Is accepted
  • Will be paid on standard net terms (e.g., net 30 to net 60)

This letter effectively asks the GC to waive the “pay when paid” clause for your invoices. It’s a good idea to discuss this letter ahead of time with all parties involved since factoring companies will not finance a progress payment without a signed letter.

5. Qualification criteria

To qualify for a factoring plan, companies must meet these criteria:

  • Invoice more than $50,000 per month
  • Must be a subcontractor
  • Must invoice a GC or a commercial client
  • Your clients must have good commercial credit
  • Not have liens against invoices
  • Not work on a bonded project
  • No serious tax problems

You can find additional information here.

6. Why can’t my company be bonded?

Unfortunately, we cannot work with subcontractors who have a direct performance bond (a surety bond) for the project they wish to finance. The bonding company usually has a lien on the receivables, and factoring companies cannot purchase receivables encumbered by liens. However, we can work with subcontractors working for general contractors who have their own performance bond.

7. Advantages and disadvantages

Factoring lines have a number of advantages and few disadvantages. Advantages include:

  • Improves your cash flow
  • Grows with your sales
  • Easier to obtain than conventional financing
  • Enables you to offer net-30 terms to clients

However, the solution has a couple of disadvantages that business owners should keep in mind. Factoring is more expensive than conventional financing. Consequently, your profit margins must be high enough to support the cost of financing.

Factoring is a solution that is designed to solve one problem: cash flow issues from slow-paying customers. It’s great at solving this specific issue but won’t be of much help if your problems are not due to slow-paying invoices.

Get more information

We are a leading construction factoring company and can provide you with competitive terms. For information, get an online quote or call (877) 300 3258.