The construction business is booming, even despite the downturn in the economy post-coronavirus. Construction projects are considered “essential work” and job sites are still functioning and moving forward despite all the shelter-in-place restrictions we’ve seen across the country (with a few notable exceptions in a handful of states).
As a matter of fact, in early April of 2020, Keith Prather, a market intelligence expert for the business management consulting firm Pioneer IQ, said that the future of construction is not just solid, but very optimistic. He said that supply chain issues from foreign imports, combined with sourcing from local industries is going to see a “construction tsunami” starting in the third quarter of 2020, driven by historically low interest rates and “a tremendous amount of liquidity being pumped back into the market.” In other words, if we can wait out the tenuous next few months, the future is downright rosy.
So how can you get in on the action? How can you ride the wave of this construction tsunami and get into the business in time to secure some of these lucrative contracts?
The answer is to get funding now.
There are myriad ways to secure funding for a construction business, and there is no time better than the present. With a solid business plan, a good history, and a good credit score, there’s nothing to stop you from securing the kind of construction business financing that you need to get your company off the ground.
While there are multiple ways to get loans, there are also multiple types of loans for different expenses. Typically, a construction company will have to pay salaries, office expenses, equipment costs, rent/real estate, and other miscellaneous expenses. The type of loan you’d look for to pay rent is different from the type you’d look for to purchase equipment.
Let’s look at some of the loans available:
SBA (Small Business Association) Loans
An SBA loan is typically the first type of loan sought by a new business owner, or a business owner who has been operating for a few years and is in need of an injection of cash. There are many benefits to an SBA loan, not the least of which is that it is guaranteed by the federal government and as such tends to have better interest rates than many other types of loans.
There are two main SBA loans. The 7(a) is for operational expenses, such as working capital, purchasing supplies and inventory, equipment and real estate, and refinancing existing debt. On the other hand is the CDC/504 loan, which is used for purchasing land, improving land, making refurbishments to buildings and property, and buying long-term equipment and machinery.
The main downside to an SBA loan is that it takes a relatively long time to get approved and get the funds deposited in your account. The whole process can take 90 days or more. You’ll need to meet specific requirements on your application, such as showing your financial statements, balance sheets, profit and loss reports, and annual income for the past few years.
The SBA loan is a good loan, but they’re picky and they want to make sure that you’re a stable company that they’re taking a risk on. They’ll likely ask you for your credit score, both your personal credit and the credit of your company. You can read the full list of qualifications on the SBA website.
The next most popular loan choice is the commercial loan, which can take many forms, but which generally deposit a large cash sum in your bank account with a payback period ranging anywhere from one to twenty-five years and are used for fixed assets. (They technically can be used for working capital, but there are other options that are better for working capital which we’ll discuss later, particularly lines of credit.)
Term loans are paid monthly, not unlike an auto loan: you pay interest and principal at the same time until the principal is entirely paid off.
It’s possible to get a balloon loan, in which you make regular payments of the interest but not the principal, until you reach the end of the loan term at which point the entire principal is due. These types of loans can be dangerous if you don’t have a plan for them, as being suddenly hit with owing a large lump sum can be extremely difficult to pay off, but if you’re in a situation where you are expecting a large influx of cash (say, for example, that you are about to complete a construction project and will be paid a large amount in six months, then getting a balloon payment could be just the type of commercial loan that is what you need.) However, due to the riskiness of balloon payment loans, you will need to prove you have cash incoming when you file for your loan so that the lender is more likely to see it as a good investment.
Commercial loans are typically faster to be approved and faster to deliver cash than an SBA loan, because there are fewer hoops you have to jump through. The application process could take just days and the processing and underwriting process could be weeks to months–though some online lenders can turn this around much faster than a typical bank. However, because this loan is not an SBA loan backed by the government, the terms will not be as good and the interest rate will likely be higher.
Line of Credit
A line of credit is different from a credit card, though people often conflate the two. With a credit card you have a credit limit and you use the card to make payments and pay interest which increases with the amount you’ve put on the card. With a line of credit, the lender still gives you a credit limit, but the money is accessible through your checking account. There is a maximum amount you can draw from, but you only pay back what you use. A line of credit is so common as to be considered a standard operating procedure with most companies.
Lines of credit are used for day-to-day operating costs, such as salaries, office expenses, inventories, and other similar purchases. A line of credit is generally not used for larger purchases, such as to purchase equipment, vehicles, or real estate.
Like a credit card, if you are late in making payments, or if you go over your credit limit, you will face penalties, most commonly in the form of increased interest rates. These lines of credit are also for a certain amount of time, unlike a credit card which is indefinite.
Depending on the type of the line of the credit, you may or may not make monthly payments, which is another way a line of credit differs from a credit card. A line of credit, for example, may give you a $25,000 credit limit with a ten year term, and you can use that credit to make purchases and pay bills until that ten years is up and the $25,000 (plus interest) is due.
Revenue-based financing is not exactly a loan, but an agreement with a lender that you will take a sum of money from them, and then you will return a percentage of your revenue every month to them until the sum of money is repaid.
These typically range from $5000-$250,000 for no more than three years, and you will need to prove through financial documents and projections and forecasts that you will be receiving enough revenue to pay them back every month. Rather than interest, you pay a certain amount of your revenue, which can range anywhere from 7% to 40% depending on the terms of the financing.
This is a good type of financing if you see a lot of growth in your future and are confident that your revenue will grow in accordance with the payments you return to the lender, but can be problematic if you have a downturn and start generating less revenue.
Things to Consider Before Applying for a Loan for Your Construction Business
1- Credit: You will need to prove, with any type of loan, that you have a good credit history. Some lenders will look not only at your business’s credit history but also at the credit history of the principals of the construction company, so you want your personal credit to look as good as possible. This may be true if you are a small contractor with only a few employees and relatively small annual revenue–they will be more concerned about you’re history (and reliability) than the history of the company.
2- Profit and Loss: You’ll need to provide profit-and-loss statements to a bank or alternative lender (depending on the loan type) to give them as much information as they can get about your history. They are in business to help you grow, not pull you out of debt, and they want to make sure that you’re making profit, not just barely squeaking by.
3- Annual Revenue: A lender is interested to see how much money you’re bringing in every year–you may have good profit margins, but if you’re only making a small amount of money with small construction jobs, they’re less likely to spring for a large loan. They’ll want to help you grow, but they’ll want to be realistic, too.
Some documents you’ll want to have when applying for a loan:
Each lenders required documents will vary. A traditional bank, as an example, will require more documents than an alternative lender, such as Small Business Funding.
- 3 years (or as close as you can get, depending on how long you’ve been in business) of CPA-prepared financial statements
- Project schedule, with income forecast. They’ll want to know what construction projects you’ve got on contract and what money you’re expecting to bring in.
- Accounts receivable. They’ll want to know how much money you have coming in, and is owed to you.
- Accounts payable. Likewise, they’ll want to know how much you owe to others.
- Appraisals of owned equipment and real estate
- Personal financial statement of each of the company’s principals
- Credit history references
Where to Apply for Construction Business Financing
There are several options to seek out financing for your construction business. Between traditional banks, credit unions, and alternative lenders, you have no shortage of options.
At Small Business Funding we are committed to providing you access to quick and easy working capital to meet your construction company’s needs. Every business is different, and we make it OUR BUSINESS to understand your unique needs.