Financing and debt are often misunderstood in the commercial construction industry. Many construction business owners perceive taking on debt as too risky, or avoid debt because they believe it’s a sign of poor business management. In the right context, however, debt can be an opportunity to accept more and bigger construction projects and grow the business.
Believing in misconceptions about construction finance can hold your construction business back from reaching its full potential. We’ll explore 4 common myths about construction financing, but not before giving a brief rundown on construction finance and how it works.
What Is Construction Finance?
Commercial construction is a capital-intensive business. Contractors must buy building materials before starting construction projects, and those costs are sometimes up to 50% of the cost of the project. There are employees and subcontractors to pay during the construction process, along with all the overhead that comes with running a business. Adding to the challenge, every contractor knows that getting paid can take months, especially when dealing with commercial customers. Few construction businesses can finance all their capital needs from retained earnings. Instead, smart business owners turn to construction finance.
There are many construction financing options, such as:
- Traditional bank loans
- Business lines of credit
- Construction equipment financing
- Invoice factoring
- Material financing
Financing may be particularly useful if you need to purchase new equipment, expand your business or meet working capital needs.
How Does Construction Finance Work?
Construction finance allows you to borrow money and pay it back with interest. Different forms of financing vary in their requirements, timeline, how much money can be borrowed, and fees/interest. Therefore, it’s important to choose the right type of financing to suit your needs.
For example, if you can put up collateral, have a long track record in business, and need a large amount of money for a multi-year project, you might want to apply for a bank loan that can be repaid over several years.
However, if you simply need some working capital to get you through a slow season or tide you over until a customer pays, a large bank loan wouldn’t work. It would take too long to get, and you’d be taking on years of debt for a short-term need. In this case, a short-term financing solution such as material financing could be the best way to get money quickly.
The Most Common Funding Myths in the Construction Industry
Although avoiding debt and using cash on hand appears preferable, it’s not always viable or beneficial for the business in the long term. If you don’t have the cash you need, your project could come to a grinding halt.
Construction financing allows you to use debt strategically to make your business more efficient, productive, and successful. However, a number of myths have corrupted subcontractors’ perception of financing; these misconceptions erode their trust in something that could, in actuality, greatly serve their business.
These myths include:
- Myth: Construction financing takes too long. Lenders have long viewed construction project loans for builders as risky. However, that view is changing. New alternative financing options in construction make it easier for lenders to assess your project and business’s risk, thus slashing the traditional timeline.
- Myth: Borrowing money is a sign of failure. Every construction business struggles to get paid on time—it’s the nature of the industry. Whether your business is just starting out or ramping up for explosive growth, having access to capital through financing will ensure you can move full speed ahead.
- Myth: Borrowing will cut into my profits. Construction financing can actually help boost your profits by enabling you to take on more and bigger jobs. The key is to make sure you use financing responsibly and figure the costs into your financial projections.
- Myth: My business can’t qualify for construction financing. There are more financing options available today than ever before. Whether your construction business is a small startup business or has been around for decades, there’s a financing method to suit your needs.
Benefits of Construction Finance for Contractors
Contrary to the myths, construction financing has many benefits for contractors. Here are some things it can help you accomplish:
- Get capital quickly: While construction loans from banks may take a long time to be approved, you can get the money you need as soon as the same day, provided you choose the right type of financing partner.
- Improve cash flow: Access to capital smooths out the ups and downs of the construction industry. Even if you have to wait 60, 90, or 120 days, it won’t throw a wrench into your projects because you have the money to keep moving forward.
- Bid on bigger jobs: Bigger construction projects can mean more revenues and profits, but they also require a bigger cash outlay upfront. With sufficient financing, you can confidently bid on larger projects, knowing you’ll be able to cover the costs of the project.
- Grow your business: When you have the funds to pay subcontractors and employees on time, complete jobs on time, and market to more prospects, your construction business’s reputation will benefit, and it will be easier to grow your business.
The Costs of Construction Financing
Every type of construction financing costs money. In general, a bank or SBA-guaranteed business loan will be the least expensive with the lowest interest rate. However, these loans generally take the longest to get and have the most stringent requirements—especially since construction lending has long been viewed as risky for banks. Such lenders will want to see a raft of documentation, including financial statements, tax returns, and more. They’ll take longer to make a decision, which can delay your construction projects if you need the financing to get started. Alternative financing methods generally offer greater convenience and speed when it comes to getting the financing you need. However, the trade-off may be a higher interest rate.
When thinking about the costs of construction financing, it’s equally important to assess the cost of not getting the money you need.
- What opportunities might you miss?
- What customers might you disappoint?
- What bills would you have to delay paying?
- How would all of that affect your business?
Whichever type of construction financing you choose, knowing how much you’ll pay for the loan is key to maintaining profitability. So look for a lender that is clear about fees, interest rates, penalties, and any other costs of capital.
