Funding a construction business isn't easy. Your pay depends on a completed project, but your employees expect a regular salary, and, of course, there are the input costs of materials and supplies. Earnest money often can't cover all these needs, much less unexpected costs such as repairing or replacing equipment.
Most contractors first think about getting a loan, but it's not your only option. Our guide to funding your construction business will cover the most common financing options and some lesser-known alternatives. Use it to determine the best options to explore as you poise your business to not only survive but thrive.
Ways to finance your construction business
There are many options for financing your construction business, from SBA loans to equipment financing. Which you choose depends on your business's circumstance and financial strategy. Consult with a financial advisor if you are unsure which option could be best for your business.
This is often the first resort for small businesses of all kinds. SBA loans are guaranteed by the U.S. government through the Small Business Administration. They are much like commercial loans, but they often have better interest rates and terms due to the government backing.
There are two main SBA loans. The SBA 7(a) loan program is for operational expenses, working capital, purchase supplies, equipment, or real estate, or to refinance existing debt. The CDC/504 loan is specifically for purchasing land, improving property, or buying long-term equipment or machinery.
SBA loans can take up to 90 days for approval. You'll need to meet specific requirements in addition to standard loan qualifications. These include being within a qualifying range for net worth and annual income, demonstrating need and proving "good character." Read the full qualifications on the SBA website.
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Commercial loans are for a single lump sum, with a payback period set between one and 25 years. They are used for fixed assets, though they can be for working capital. (In the case of working capital, however, it's often better to get a line of credit, which we'll discuss next.)
Term loans are paid in monthly installments that include interest and principal. It's sometimes possible to get a balloon loan, where you make smaller payments with a large final payoff. This may appeal to construction companies, when big income comes at the end of a project, but it's not easy to acquire from banks, because the bank takes a risk in getting its money back.
Banks will want to know how you are going to spend the money and how it will help you grow your business. The application and underwriting process could take days to months. The average loan approval time should be shorter than with an SBA loan, because the bank does not need to get government signoff. However, the interest rates, closing costs and fees may be higher.
Line of credit
Think of a line of credit as a loan that works more like a credit card. You are given a maximum amount you can draw from, but you take only what you need when you need it and pay back just the amount you borrow, which then allows you to borrow again and again for the life of the line of credit.
Lines of credit have lower interest rates than credit cards and even term loans, plus lower closing costs. However, if you are late on payments or go over the authorized amount, your interest rates will increase. They are also for a set amount of time. For example, you can borrow up to $50,000 for the next 10 years; after that 10 years, you cannot continue to borrow, and you have another 10 years to pay off the amount you still owe.
Lines of credit are best for operating expenses, such as payroll and construction supplies, when you know the income to cover it is coming. It's also best to secure a line of credit before you need it. A healthy cash flow increases your chances of getting the line of credit, and you pay nothing until you draw from the account.
Alternative lending generally means a loan from a non-bank financial institution. These loans are usually smaller than conventional bank loans (up to $500,000) and have shorter terms – one month to five years. The interest rates and fees are higher.
Revenue-based financing is not a loan, but an agreement to sell a portion of your future revenue. It provides an average funding of $5,000 to $250,000 – usually about a third of your annual revenue. Repayment time ranges from one to three years, taken as a percentage of your revenue each month. Rather than interest, you repay the amount plus a percentage of the borrowed amount. That extra runs from 7% to 40%.
To secure this kind of financing, you need to not only show future income but also specify how you'll use the funds. Revenue-based financers are looking to lend their money for growth-oriented activities. Also, you want to be sure that you are not hindering your future growth with this financing strategy.
Peer-to-peer lending presents a good opportunity for businesses to get loans faster and with fewer restrictions, while also letting private citizens invest in businesses on a small but practical level. For a peer-to-peer loan, you apply very much like you would with a bank or financial institution, but the process isn't as restrictive, and exceptions may be made for worthwhile endeavors.
Some P2P lenders put your application through a vetting process, and if it passes, they post your application for investors to see. Those who believe you are a good investment or are impressed with your purpose then agree to fund part of your loan. It's important, therefore, to have a compelling story to go with your application. How will your project benefit the community? Generally, you have 14 days to get enough people to contribute to the funding of your loan.
Other P2P lenders have a committee that approves your loan outright and pull from multiple investors to fund it. These companies can fund you faster.
As the name suggests, equipment financing is a type of funding to cover expenses associated with necessary tools, machinery and other equipment, such as a new computer or company vehicle. You would then pay for the equipment with interest over time.
A perk of this type of loan is that you don't have to offer collateral upfront. Instead, the equipment you purchase serves as collateral. The loan terms are typically five to six years, with interest rates anywhere between 4% and 40%. Getting equipment funding is often quick; it can take as little as two days with limited paperwork, saving you time. [Read related article: Types of Fast Business Loans]
Business credit card
Nowadays, most businesses have a business credit card to cover expenses. They are typically easy to get approved for, provided you don't have any personal credit issues. In addition, business credit cards don't restrict what you can use them to pay for. As a bonus, tracking business expenses with a business credit card makes accounting easier, because all your transactions are on your credit card statements. If you have an accounting program such as QuickBooks, you could also integrate your business credit card with the software to track your transactions along with profit and loss numbers.
Most banks offer business credit cards; the key is to find a card that fits your unique business needs best. The rates and rewards vary between banks, and some cards have certain fees. For some business owners, the fees are worth the rewards.
5 things to consider before applying for financing
Consider these five factors before you apply for financing for your business.
1. Credit history
In general, banks want to fund growth in a business, not help you manage debt. They consider both your personal and business credit when considering you for a loan, so make sure your credit looks good. Get a free credit report to spot potential issues. Pay off small debts, and don't get into other debts at home or for your business until you have secured the loan.
2. Profit margins
You need to prove that you can pay off the loan, and the promise of customer payment, even bonded, may not be enough. The best way, as you may already know, is to keep a steady flow of diverse work to secure a stable profit margin. This shows the lender that you are a good risk.
3. Managing growth and working capital
Although the construction industry as a whole is slated to improve, fast growth does not always support a future business plan. You need to show steady growth for a long term – i.e., that you can pay the debt over years as needed.
4. Personal guarantees
A personal guarantee places the liability of the debt on the owner of the company. Unless a contractor has been in business for a long time or has a stellar record, most financial institutions want a signed personal guarantee. Be cautious about putting up your own home as liability in order to build someone else's.
The best thing a contractor can do is be transparent with the lender. Have all your documents available, and go over them yourself first to ensure you are putting your best foot forward. It also does not hurt to seek a third-party audit. Financial lenders look at third-party documents differently from internally prepared ones. If you are purchasing equipment, gather information about the specific machines you want to buy, and be ready to explain how they contribute to your project's success.
Documents needed to apply for financing
You may need the following documents to apply for financing. Ensuring adequate documentation is available to your lender will expedite the application process.
- Three years of CPA-prepared financial statements
- Jobs-in-progress schedule, with bonded and non-bonded jobs identified
- Accounts receivable, with bonded and non-bonded jobs identified
- Accounts payable
- Appraisals on equipment and real estate
- Personal financial statements for each owner
- Bonding company agreements
- References on credit history
- List of litigations in progress, if any
- List of previously completed work
- References on your company's job performance
Construction is a vital part of economic and community progress, but it's also a complicated type of business to finance. With its liquid capital, upfront expenses and multiple variables affecting success, it can be difficult to get a traditional loan. However, there are things you can do beforehand to show your company is a good risk for financing, and alternatives for when a traditional loan is not possible or isn't the best choice for financing your operation.
Marisa Sanfilippo contributed to the writing and research in this article.