As a contractor, one of the biggest challenges you may face is securing the necessary financing to fulfill large contracts. Traditional lending institutions are often skeptical of lending to contractors, especially smaller companies and those owned by minority groups. This can lead to missed opportunities and stalled growth for many contractors, but there is a solution: contractor financing.
Contractor financing, also referred to as construction financing for contractors or sometimes trade credit, can be a lifeline for companies struggling with cash flow or facing barriers to traditional financing. This type of financing is designed specifically for contractors and provides funding for materials, equipment, and labor, allowing businesses to complete projects without having to front the costs themselves.
To help navigate the world of contractor financing, below is a 101 breakdown of what this process is and how it works—all in an effort to help contractors improve their cash flow, take on larger projects and ultimately grow their businesses with confidence.
What Is Contractor Financing?
Contractor financing is a specialized form of financing that supports contractors’ financial requirements by providing easy access to funds. It is specifically designed to meet the unique and sometimes unpredictable cash flow needs of construction businesses, as it allows contractors to obtain loans with their contracts serving as collateral. In short, the loan amount is based on the value of the contract rather than the company’s profits. This makes it possible for contractors to increase their working capital, leverage business opportunities, and execute projects smoothly.
That said, construction financing for contractors covers a wide range of financing options that include small business term loans, trade credit, equipment loans, and lines of credit. This financing provides contractors with the funding necessary to pay for supplies, labor, and other expenses they incur while working on a project. Since banks are often reluctant to lend money to contractors, lenders specializing in contractor financing are highly beneficial to contractors seeking funds to fulfill their contractual obligations. Overall, contractor financing simplifies the borrowing process for contractors and facilitates growth in their businesses.
How Does Financing For Contactors Work?
Contractor financing is a type of loan that relies on the value of a contract secured by a company to underwrite the loan. Rather than relying solely on personal credit or collateral, financing for contractors focuses on the value of a contract that the business has secured. Similar to trade credit, the contract serves as collateral for the loan. These loans are typically short-term and made to cover costs related to the contract, with repayment terms aligned with the contract’s payment schedule.
Financing for contractors typically offers funds ranging from 20% to 30% of the total contract value. But depending on the loan terms, that could even sky toward 90%. Repayment terms are structured to align with a contract’s payment terms, and the loan is usually restricted to contract-related expenses. In addition, there are two types of contractor financing: lender-controlled and borrower-controlled. In the former, the lender sets up a separate account and collects money directly from the entity awarding the contract, whereas, in the latter, the borrower is responsible for making payments to the lender.
Types Of Contactor Financing
- Trade Credit – As one of the oldest financing options in construction, trade credit provides contractors with the opportunity to purchase materials from suppliers and distributors without upfront cash payments. Repayment terms are usually 30 or 60 days, and interest charges only attract late payments. To qualify for trade credit, contractors must complete a credit application, and the supplier may ask for financial statements and trade references.
- Line of Credit – A line of credit is a financial vehicle that allows you to withdraw the money you need as you need it. Essentially, it is a revolving loan that provides flexible financing options. You can make several withdrawals and repayments, and interest only accrues on the amount withdrawn. You can opt for either a secured or unsecured line of credit. Secured lines of credit have higher credit limits and lower interest rates, but they require collateral.
- Project Cost Financing – Project cost financing is an excellent option for contractors who need to finance job expenses up front, with repayment terms that match the project billing cycle. This financing option is ideal when contractors are taking on bigger projects or looking to grow their businesses. Essentially, a third-party provider finances all material purchases, with extended repayment terms of up to 120 days. The contractor then makes small weekly or monthly payments until they receive payment from their customer and ultimately repay the full amount.
- Home Improvement Financing – Home improvement financing provides contractors with a chance to act as intermediaries between homeowners and lenders. The homeowner applies for the financing, and the lender pays the contractor up front for the job. The homeowner then repays the loan to the financing company over time. This type of financing is particularly suitable for contractors looking to sell more expensive projects to homeowners with limited funding.
- Business Credit Cards – This option offers a simple way for contractors to fund their businesses, but they are not ideal for most cash flow problems. Without good financial management practices, credit cards can be a recipe for disaster. Credit cards are not the best choice for project-specific expenses, like buying building materials, as their billing cycles may be shorter than the billing cycle of the project. Additionally, many credit cards have high-interest rates or annual fees that can cause you to incur significant expenses if the balance is not paid off each month.
- Invoice Factoring – While other financing options provide cash before costs are incurred, invoice factoring becomes available after the invoice is submitted. Contractors sell outstanding invoices to a factoring company for 70-90% of the amount upfront. The factoring company then takes possession of the receivables, and the customer pays the factor instead of you. Factoring can be helpful in avoiding the long delay between invoicing and payment.
- Equipment Financing – Equipment financing is similar to a mortgage or car loan. The bank provides you with a loan to purchase equipment and holds the equipment as collateral. Equipment financing is beneficial when you need to purchase heavy machinery, vehicles, tools, or any operational equipment that enhances worker productivity. The higher the financed amount, the more interest you’ll pay. Additionally, equipment financing limits are typically below the full retail value of the equipment to compensate for depreciation.
What You’ll Need To Qualify
Ultimately, what you’ll need all depends on the lender. But in general, there are a few things you will need to have prepared ahead of time. First and foremost, you’ll need proof of your awarded contract so that your lender can understand the terms and structure the loan accordingly. They may also want to inspect your business’s financial history, although this will carry less weight than other loans. You may also need to provide references or proof of previously completed projects. Finally, if your loan is lender-controlled, they’ll likely want contact information for the entity awarding the contract to ask questions about the contract and payment.
Know Your Options With Simonson Lumber
The construction industry is exceptionally competitive, and contractors need to have access to the right resources to stay ahead of the game. Financing for contractors can be the perfect solution no matter where you are located. Overall, contractor financing can be a tricky topic to navigate. However, Simonson Lumber aims to alleviate some of the stress by extending financing support through Simonson’s Estimating service. This invaluable service lays a sturdy foundation for project cost, providing contractors with the necessary tools to refine various aspects of their project’s total expenses. Backed by decades of industry experience, contractors can have the peace of mind of knowing their construction projects will receive the support they need to succeed. Better yet, succeed both on time and on budget.
Don’t let financing be a roadblock in completing your projects. Contact Simonson Lumber today and learn more about how Simonson can support your next successful construction project.