Due to the excessive initial expenses of beginning a project and the payment cycle, which often only pays for work after it is finished, many contract-based firms struggle to complete their contracts. Furthermore, a lot of institutions view financing to contractors as too hazardous.

Contractor firms may decline jobs as a result of these variables taken together. Particularly vulnerable to this outcome are smaller contractors, subcontractors, and minority and women-owned firms. Contractor finance can be a useful strategy for developing your business and completing contracts if you're having trouble meeting your loan requirements and managing cash flow.

Contractor Financing: What is it?

The range of financial solutions available to construction companies to increase cash flow is referred to as contractor finance. These choices might provide a contractor with cash up front or let them postpone paying their costs.

Without factoring in retainage, which might take years, the collecting cycle in construction may take weeks or months. However, contractors pay for equipment, supplies, labor, and other expenses long in advance of receiving the money required to pay for their expenses.

Many companies in other sectors of the economy may obtain low-interest financing for their operations from traditional banking institutions. Regrettably, construction businesses frequently encounter difficulties obtaining traditional finance sources due to the inherent financial risk associated with the building industry.

Forms of Contractor Funding

Businesses have started to provide a greater range of financing solutions designed specifically for contractors in recent years. These might offer a lifeline for contractors who want funding to expand their operations, take on more ambitious projects, or bridge consistent cash flow shortages.

Credit for Trade

One of the oldest forms of construction finance is trade credit, which enables distributors and suppliers of materials to let builders buy goods without having to pay cash up front. Usually, there are 30 or 60 days to make payments before interest or late fees are applied.

The supplier's credit manager will frequently request statements of income and trade references from the contractor as part of the application procedure, which normally calls for the completion of a credit application. Contractors who agree to sign a personal guarantee or consent to a UCC lien may still be granted credit by suppliers even if the applicant has insufficient credit history or references.

Credit Line

You may take out money from your bank's line of financing whenever you need it. Apr only gets on the cash that you remove; you are free to take withdrawals and repay the money as often as you choose.

There are two types of credit lines: secured and unsecured. Due to the lack of collateral, a standard line of credit will have a higher interest rate. A collateral line of credit usually has lower monthly payments and a bigger credit limit since the lender has the right to take the property if you don't repay the cash you withdraw.

Finance for Project Costs

More lenders are now allowing contractors to finance job expenditures upfront with terms of payback that align with the project billed cycle. These lenders have a thorough grasp of the business aspects of a contractor's company because they frequently only engage with the construction sector. Because of this, they are frequently not only a cash resource but also a useful project partner.

For instance, materials often account for 20–50% of a contractor's project expenditures. The contractor has the option to use a third-party source to finance the whole cost of the material acquisition instead of paying cash or using up all available credit. In addition to directly paying the supplier, the provider offers the contractor longer terms of payback, up to 120 days.

What is the Process for Funding Contractors?

Contractor finance bases a loan's underwriting on the value of an arrangement that the company has obtained, as opposed to more conventional components such as personal credit, corporate profit, or collateral. Like accounts receivable finance or invoice financing, the contract serves as collateral that a lender might use to guarantee repayment.

Most contract loans have a short duration; some are only intended to endure for the duration of the contract. Usually, they may only be used for costs associated with the contract, and the terms of repayment are set up to correspond with the terms of payment. Usually, the loan amount ranges from 20% to 30% of the contract's entire value.

Lenders or borrowers may have influence over contractor loans. Your lender opens a different account and receives payment directly from the organization awarding the contract for loans that are handled by the lender. This enables it to monitor customer payments and make sure it receives compensation first. In contrast, a loan under borrower control has repayment terms more akin to those of a conventional loan. Both the funds you get, and the lender's payments are under your control.

When to Take Advantage of Contract Finance?

In the event that you wish to grow your company. Although pursuing bigger contracts may eventually aid in the expansion of your company, it may also cause cash flow problems. Gaining larger contracts by using contractor finance can be a successful expansion tactic.

When you are not eligible for a conventional loan. If you're experiencing problems being approved for a typical loan, contractor loans may be a viable choice because they place less of an emphasis on personal assets and business earnings.

When your contract-exempt financing needs are satisfied. Contractor loans are often only used for the purposes specified in the contract since they are underwritten to that particular contract. You could be better off choosing a line of credit or a conventional term loan if you require finance for other aspects of your firm.

The Bottom Line!

Contractor financing is a way for construction companies to get the money they need to start and complete projects. Construction projects often involve significant upfront costs, and the payment for the work comes later, causing financial challenges for contractors.

Contractor financing provides various financial solutions tailored to the construction industry, such as trade credit, credit lines, and project cost financing. It becomes beneficial when a company wants to grow, faces challenges in obtaining traditional loans, or needs funds specifically for a contract. It's a practical tool to support the expansion and success of construction businesses.