The construction industry is burdened with company failures. In fact, construction routinely leads all other industries in failure rates.
The razor-thin margins, significant cash demands and payment timing issues all add up to an industry that can be disastrous for participants that fail to take precautions to guard against these all-too-common occurrences. Given the interconnected nature of construction payment, a failure by any project participant can be felt up and down the payment chain.
Luckily, there are strong protections built into the law of every state that, when used appropriately, can shield a company from other contractors’ failures and help safeguard its own interests. When proper use of available financial security tools is coupled with an understanding of the risks giving rise to the elevated rates of contractor failure, companies are best insulated and protected against financial risks. This two-pronged approach of understanding and avoiding the problems internally and preparing for and protecting against the mistakes and failures of other parties makes good business sense and is constructed to best position the company over the long term.
Know and Prevent the Leading Factors that Cause Contractor Failure
In order to avoid becoming a statistic, contractors of all tiers must understand the common risk factors and risky behaviors that can lead to financial problems and ultimately failure. Understanding what the common causes of failure are is the first step in avoiding those pitfalls. It’s no surprise, but cash flow problems, specifically running out of cash, are some of the most common triggers of contractor failure. The unfortunate reality is that the nature of construction payment can cause payment delays and choke cash flow.
The construction industry is always cash hungry, but it helps to take a moment to consider that more business requires more cash, so the dangers of too much potential business can be just as devastating as the problems of too little. In order to best protect the company from these risks, the following steps should be taken.
- Get financial documents in order and make cash projections each month. Use these projections to guide the company as to which projects to accept, and which to discard.
- Always plan ahead to secure cash financing and availability before the company gets desperate.
- Don’t get greedy and take on too much work.
- Be careful with bids and estimates and don’t promise to do projects for too low a fee, relying on good luck or change orders to make up for unexpected costs.
- Take steps to improve the timing of payments by providing notices and remaining in a secure position.
Prepare for and Protect Against the Mistakes and Failures of Other Parties
Understanding the default risks and taking proactive steps to keep a company healthy is only one part of the equation. By itself, it is not enough. Exercising extraordinary discipline and good cash management practices are crucial components of avoiding failure, but the poor practices of other companies on the construction project can easily create problems for companies with even the most diligent cash practices.
The interconnected nature of construction payment means that one company’s default, delay or poor workmanship on a project—no matter where that company is on the contracting chain—can cause problems for everyone. Keeping the company’s own house in order is only one critical part, but equally critical is preparing for everyone else to be a mess.
While the ways that construction companies can gain protection against others’ defaults are numerous, by far the most effective is to always protect mechanics lien and bond claim rights. A mechanics lien or bond claim filing will enable the company to skip right past the defaulting contractor to seek payment directly from the prime contractor or property owner, or actually foreclose on the property itself in order to get paid (this is important if the company has contracted directly with the property owner). If a customer is having cash problems or is slow to pay, these security instruments can be incredible tools, and the difference between a write-off and cash in hand.