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Financing Your Construction Business

Karina Fabian
Karina Fabian

Our guide lays out your options for funding.

You have several options for financing your construction business. Read about them in our guide to see which is best for you.

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 some of the most common financing options, plus some lesser-known alternatives. Use it to determine the best options to explore as you poise your business not only to survive but thrive.

Ways to Finance Your Construction Business

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SBA Loans

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 because of the government backing.

There are two main SBA loans. The 7(a) 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. You can find a list of the top SBA 7(a) loan lenders at Top Ten Reviews.com.

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, showing need, and proving “good character.” Read the full qualifications on the SBA website.

Commercial Loans

Commercial loans are for a single lump sum with a payback period set between one and 25 years and 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 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. There is an application and underwriting process that 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, 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, you will see increased interest rates. 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 used for operating expenses, such as payroll or 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.

Alternate Lending

Alternate 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 are for shorter terms, one month to five years. Interest rates and fees are higher.

Why look into alternative lending? These loans are usually easier to get and take less time. You can find reviews of some of the top alternative lenders at our sister site, Top Ten Reviews.com.

Revenue-Based Financing

Revenue-based financing is not a loan, but an agreement to sell a portion of your future revenue. It can provide 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 percent to 40 percent.

To secure this kind of financing, you not only need to 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 kind of financing strategy.

Peer-to-Peer Lending

Peer-to-peer lending presents a good opportunity for businesses to get loans faster and with fewer restrictions while letting private citizens invest in businesses on a small but practical level. In 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 its 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.

Unlike with crowdfunding, you need to pay back the loan with interest. You can find P2P funding sites at our sister site, Top Ten Reviews.com.

5 Things to Consider Before Applying for Financing

1. Credit history: In general, banks want to fund growth in a business rather than 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, remember that 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 incrementally 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.

5. Transparency: 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.

Some documents to have on hand when applying:

  • 3 years’ 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 company’s job performance

Construction is a vital part of progress, but it’s also a difficult business to finance. With its liquid capital, upfront expenses and multiple variables playing on 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.

Image from Monkey Business Images/Shutterstock

Karina Fabian
Karina Fabian
business.com Staff
Karina Fabian is a full-time writer and mother of four. By day, she writes reviews of business products and services for Top Ten Reviews and articles for Business.com, Business News Daily and Tom’s IT Pro. As a freelancer, she writes for Catholic educational sites and teaches writing skills. She has 17 published novels of science fiction and fantasy. Learn more at http://fabianspace.com.