Written by David Schmidt. Published October 21, 2014 in Construction Business Owner.
For contractors, financing is a key step to securing the equipment needed to keep their businesses running. As we finally begin moving past the recession, many companies are starting to see business growth in certain areas of the country, increasing workloads and the need to purchase additional equipment. In spite of this, for those looking to finance equipment, the process can often be difficult and confusing. By recognizing the top five challenges contractors face in financing and understanding why these occur, contractors will be able to navigate the financing process with an arsenal of knowledge.
1. Credit History
Credit history is a key factor in the financing process and is often at the root of financing issues. While a history of delinquent payments or judgments would seem like the biggest concerns for a lender, the financing department also takes a hard look at how the contractor managed through the recession and the company’s recent performance. Many lenders look at the handling of lending relationships and how the contractor followed through with the commitments made during the recession. If the contractor can show a history of commitment, even in a difficult situation like a recession, the financial department will be more open to exploring all possible avenues to assist.
2. Profit Margins
Unfortunately, parts of the country have yet to bounce back from the recession. For contractors in Florida or California, the market is often difficult to work in due to competition. The competitive environment has a tendency to limit the market growth for those in it, leading to weak profit margins. Weak profit margins often worry lenders, because they are not sure that the contractor can ultimately pay the debt owed. In a competitive market, the bidding process is key. It is important to accurately bid jobs in these markets, as underbidding to win jobs can quickly damage profitability and cash flow. By keeping a steady flow of diverse work, contractors can show a stable profit margin that will assist in the financing process..
3. Managing Growth and Working Capital
For portions of the country experiencing improvement from the recession, fast growth does not always support a future business plan. The balance sheets of many contractors cannot support the development they are attempting to achieve. While previous performance may be good, it is important to show the work in progress that is supporting the ability to repay the incremental debt. It falls to the management team to have a clear plan, and it is critical to effectively communicate the business plan to lenders. By planning appropriately and showing lenders detailed projections about cash flows, who the contractor is working with and the leadership to manage the growth, this potential issue can be minimized.
4. Personal Guarantees
A small to mid-size contractor or closely held company may find it helpful to provide a personal guarantee. A personal guarantee places the liability of the debt on the owner of the company. For lenders, a guarantee acts as a checks-and-balances system, as well as a secondary repayment source. Because the owners are personally responsible for any debt accumulated, they are less likely to abuse the privilege. Unless a contractor has been in business for a long time or has stellar record, most financial teams want a signed personal guarantee. When the recession hit many contractors were personally impacted by company debt. Today, many contractors are resistant to signing a personal guarantee, making it difficult for a lender to approve a loan. By working closely with a lender and realistically managing growth expectations, a contractor can minimize the likelihood that the guarantee will need to be enforced..
The best thing a contractor can do is to be transparent with the lender. Most lenders would like to see two years of financial statements, work in progress and revenue projections. Contractors should be willing to share this information with lenders—after all, the contractor is asking the lender to loan money. By providing high-quality, complete information, the contractor already proves a level of responsibility and transparency. It also does not hurt to seek a third-party audit. Financial lenders often look at a third-party document differently than one that was internally prepared. By walking into the situation with a level of openness, contractors can help to assist in the financing process. As the industry continues to move past the recession, profit level growth will persist and contractors will need to turn to financing to keep up with the market. It is important to be realistic about growth projections. When looking to finance equipment, it is essential to assist in the process by having information readily available and being open with lenders about the business’ needs and future. By heeding this advice during the financing process, contractors can make the process smoother, allowing them to focus on growing their business.