To have long-term success in the construction business, a company needs to ride the ups and the downs and navigate the surprises that present themselves on an all-too-regular basis. The business cycle can be “feast or famine,” and neither is good. So how does one stay financially prepared for every bump in the road?
Survive and Thrive
Even in good times, cash flow can be choppy. Challenges such as a new project’s startup costs, one-off expenses or weather-related challenges can negatively affect cash flow. These are all typical scenarios, but the businesses that survive and thrive are the ones that develop a good strategy for sustaining the cash needed to support their operations through all seasons.
Contractors must know their options and understand some secrets to gaining access to funding fairly quickly in a time of need.
What About a Line of Credit?
When talking about funding for business operations, most people think of a line of credit. The typical line of credit is based on receivables, but in the construction business, few companies can carry a line of credit based on their receivables, making this a rare type of lending for entrepreneurs.
Often lenders are wary of extending a receivables-based line of credit because, with a construction receivable, there’s a risk of
intervening lien holders. This can occur if the contractor doesn’t pay a subcontractor, or if a subcontractor does not pay its subcontractors. The result could be a subcontractor placing a lien on the job and obtaining priority over the lender’s lien on the receivable.
Know Where the Equity Is
How can a contractor solve the problem? Equity may be the key.
Before approaching a potential lender, first understand which side of the balance sheet has the equity. Many construction businesses have a significant amount of equity in their equipment. For example, when looking at a contractor’s balance sheet, most folks would immediately go to the bottom right side to look at the equity account. This is where a traditional lender, like a bank, will often look.
But what traditional lenders tend not to see is the equity in the bottom left side of the balance sheet, where equipment might be depreciated down to a nominal amount when compared to its fair market value.
Seeing Things Differently
An independent equipment finance company looking at the same balance sheet may see a very different story. Equipment may have equity, or value, beyond what is reflected on its financial statements, and that equity can be borrowed against. It’s helpful to find a lender that has the experience to quickly evaluate this type of transaction.
Consider a hypothetical example of how this would work. Say a company’s financial statement shows about $6 million of equipment at cost, and around $4 million of accumulated depreciation. That equipment is reflected on the company’s books for around $2 million. In reality, that same equipment may actually be worth a lot more than $2 million. That is where a significant amount of the equity in the business may be hiding.
A good lender, familiar with the construction industry, will know where to identify the real equity in a company’s equipment.
Funding based on equipment equity can actually be approved fairly quickly—often in just a week—but this can only happen when the lender is intimately familiar with the business and equipment. They need to have seasoned personnel who can travel to a facility or jobsite to inspect and evaluate the equipment—in other words, a very service-oriented company that is agile enough to respond to the needs of the business.
Vetting a Lender
- The questions a contractor should ask a lender (aside from the obvious loan terms, etc.) are:
- How often do you lend operating capital for other customers?
- Do you outsource any of the process, or do you handle it all internally?
- Do you use third-party appraisals? (Third parties can greatly slow down the process.)
- What is a reasonable timeline?
- Will you fund against all makes of equipment? (Captive lenders are often restricted to lending against their own products.)
- How do you determine loan value?
The answers to these questions can help determine if the lender is the appropriate partner for this type of transaction and, more importantly, the contractor’s business culture.
When a business has equity in equipment, it has plenty of options. The way to build equity in equipment is to buy good equipment, finance it and maintain it. That equipment will be there for a rainy day, no matter when that day comes.