Only a few companies specialize in construction factoring. One reason that factoring companies avoid construction subcontractors is that progress payments are common in the construction industry.
Financing progress payments can be complicated and risky, at least from the finance company’s perspective. As a result, few factoring companies specialize in construction.
Although commercial clients also use progress payments, these payments are more common when the subcontractor is working for a general contractor (GC).
What is a progress payment?
In construction, a progress payment is a partial payment that covers the amount of work that has been completed up to the point of invoicing. There are several ways to structure these payments. The most common ways of billing for progress payments are:
- Billing by stage
- Invoicing by percentage of completion
For example, a subcontractor using the percentage of completion method could send an invoice when 30%, 60%, and 100% of the project is completed. Obviously, this billing method assumes that the contract allows them to invoice for these stages.
Why are progress payments difficult?
Progress payments are difficult to handle because they are often disputed. Subcontractors and general contractors often disagree about the amount and quality of work that has been completed. Disputes take time to resolve and often leave all parties with less than they expected. This dispute resolution makes financing these invoices difficult.
By the way, for this reason factoring companies don’t finance the retainage payment part of a construction contract either.
How do factoring companies finance progress payments?
Companies that offer construction factoring can finance progress payments. However, these factoring companies use a special type of invoice verification to lower the risk. The verification letter, usually called a no-offset letter, needs to be signed by the general contractor each time an invoice is submitted.
The content of this letter varies, but it usually states some or all of the following:
- The work has been inspected by the GC or client
- The work is of acceptable quality
- The invoice will be paid in full
The construction factoring company can finance the progress payment only after the general contractor has signed the letter. Since the factoring advance is contingent on this payment, it’s best if you discuss this letter with your general contractor (or commercial client) before you start the factoring process. This discussion reduces the chances of problems later on.
If you are looking for a finance company, you should read “How to Select the Best Construction Factoring Company.”
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