Construction is booming. Entering 2016, Wells Fargo measured optimism among industry leaders at a record high; the first quarter of 2016 saw 24.4% growth in non-residential construction projects, and employment is up 4.7% over the same period in 2015. Yet pessimism persists both among investors and banks; banks, in particular, are hesitant to lend to subcontractors, and not all financiers are up for the challenges the industry brings. The slowdown in China, combined with a drop in United States GDP from 1.4% in 2015 to .05% in the first quarter of 2016, has contributed to the general pessimism felt by many investors.
Yet, we love working with this market. Although most subcontractors are experienced and knowledgeable of their trade, that doesn’t mean they necessarily have expertise in running a business.
If we know what to look for, we can try and avoid mistakes along the way. There are three unique challenges that can cause difficulty when factoring to this niche market:
Yet, we love working with this market. Although most subcontractors are experienced and knowledgeable of their trade, that doesn’t mean they necessarily have expertise in running a business.
If we know what to look for, we can try and avoid mistakes along the way. There are three unique challenges that can cause difficulty when factoring to this niche market:
Risk
What happens if the job laid out in a contract that we’ve funded isn’t performed properly, the client fails to execute a project appropriately, or a job isn’t finished on time?
We know problems arise… and we have faith our clients can handle them.
The client’s ability to execute on what they say they can do is crucial when entering a relationship. For us, underwriting the client is about far more than examining their contracts, receivables and payables. We have to understand their profitability, but even more important, we need to understand their ability to handle a problem. We know problems arise… and we have faith our clients can handle them. That’s what a credit score doesn’t show you.
Liens
Regardless of a subcontractor’s knowledge or years of experience in the industry, some clients don’t fully understand each state’s standard practices that protect their rights to payment. Lien laws are continuously changing. Many clients don’t have the internal processes in place to ensure they are meeting the strict deadlines that protect those rights.
Sometimes, clients are hesitant to enforce liens. We get it – that’s never a fun thing to do. We recently had a client who was very resistant to our insistence that he file his lien in time. We eventually filed for him, letting him save face – and protecting $600,000 in payments.
Contract risks
At times, clients agree to terms in a contract that they don’t fully understand. We never want this to happen, because if our clients unknowingly agree to terms they can’t execute, the risk may lie with us. In particular, we see this happen when clients agree to terms that limit them to getting paid in a certain time, have unrealistic reporting requirements, or many other items they may not even be aware of. This is where overseeing each project meticulously and ensuring our clients fully understand the conditions of a contract is vital. Otherwise, they may end up agreeing to terms they aren’t capable of completing. Review, review, and review again; it’s worth the painful conversations to ensure we’re both on the same page.
Avoid the unavoidable
Since it’s impossible to fully avoid these risks – we’re all human, after all – we have to find ways to mitigate any issues by closely managing these relationships. This process starts with the initial evaluation of our client’s business and capabilities and extends throughout the lifetime of the relationship.
Even when all the boxes are ticked and all the background checks are completed, even when collateral is present and their books are updated, clients are human. Broken promises and intransigent clients are going to happen; we may miss a tiny red flag that becomes a bigger problem later.
We bet on people first…
On our end, we find it useful to flip the usual underwriting process and start by evaluating the entrepreneur themselves: their character, their background, and how we can help them achieve their goals in life. We bet on people first, and then we check their credit, evaluate their collateral, and ensure their books are in order; if we can successfully evaluate character, the rest is just details.
When we listen to our gut, though, this is an industry worth financing, with relationships worth having.
This post, originally published in The Commercial Factor, is republished here with slight modifications. You can download the original article here.
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