At this stage in our economic recovery, very few factors and almost no banks provide working capital funding for construction companies. For contractors operating primarily in the public works sector, where there is somewhat more stability and somewhat less account-debtor risk, banks are still very reluctant to finance contractors and subs.
Factors will find that there is ample opportunity to work with contractors engaged in public works construction, considering that there are nearly 400 major “shovel-ready” projects where designs are complete and a combination of Federal/state funding is in the pipeline. Expectations have been greatly elevated because the President has made high profile policy speeches about “putting construction and building trade people back to work”. He even identifies independent contractors and subs, a number of them family-owned small enterprises, for the public works opportunities.
Factors on the firing line of finance know that the President has been creating a serious disconnect because many of the contractors and subs in question lack working capital. Their financial capacity is weak or non-existent, their credit scores are problematic due to the challenges they confront during this current economic downturn, and their financial statements are distressed. (The most recent government regulations, like Dodd-Frank, make it prohibitively difficult for banks to put loans to these business owners on their books!) Furthermore, for the same reasons this contractor is not able to qualify for the surety bonds required to participate in most publicly funded projects.
(I get questioned: “Where is the evidence to back up my assertion?” No bank will confess that they are unwilling to finance these contractors and subs. Typically, they go through an application exercise with these prospective customers to act politically correct. This is today’s “HIV of financing” where everyone is afraid to confront it because of stigma and embarrassment.)
Factors which have typically rejected opportunities for deals in public works construction should now examine the potential, especially when they can partner up with another factor which already has the technical knowledge and invested capabilities to monitor such a project and handle disbursements through a funds control program.
For a glimpse at the contractor’s capacity, a comprehensive examination of budgets, estimates, and costs should be conducted by the factor to determine that the contractor can handle the project’s terms to completion.
The factor must confirm the ability of the contractor to pass through significant increases in the cost of materials sold or manage escalation clauses. The factor’s receivable is diminished in value if the contractor is unable to satisfy their responsibilities under the contract for whatever reason.
Establishing the size of a factoring facility created for a contractor is a key ingredient in this program. The factor will set the bar on the credit line extended to their contractor client. It should be more than the maximum amount the contractor anticipates having outstanding at any given time in a six-to-eight week period, depending on the average turn time of their receivables. It should take into account the line limits for projects which are anticipated will fall under the line extended or the anticipated approved projects.
Knowing the contract’s payment terms, how invoicing will be executed, the payment schedule of the owner or General Contractor (GC) and the amount which the contractor is contractually able to progressively invoice at each step in the process will determine the line limit. It is also important that the factor checks for change orders in the contract. Typically, factors who specialize in working with construction contractors will only allow invoices for change orders that are approved by the owner and/or GC to be included for factoring.
After this start-up work, the factor must implement proper financial and performance monitoring via disbursement procedures set up for each project. The review inherent with the disbursement system will organize the project over its time-span to ensure compliance with the contract and the schedule of values. Most contractors do not have in-house depth when it comes to financial or project administration. Normally, these abilities require significant investment in staff and software, which can eat up a lot of time and expense.
Factors specializing in working with construction contractors realize that their advancing of funds to a contractor based on the purchase of a progressively billed project receivable falls within the trust laws of the state requiring those funds to pay project expenses before they can be used for any other expenses. These laws are designed to prevent funds from Project A paying expenses associated with Project B or general overhead.
If the re-directed funds deny the rightful recipients of those funds, (i.e.: subs and suppliers) a lien could be placed on the project. The factor is then unable to collect on the receivable until the lien holder’s claim is satisfied. Thus the requirement for a funds control program for the disbursing of project advances and proceeds. This process not only lowers the risk associated with construction factoring, it also saves the contractor money that comes with the overhead expenses. It brings meaningful experience to the transaction which may be able to help minor capacity issues.
To give a construction executive a sense of funds disbursement by factors:
—payroll must only be issued for hours, days, or units of work completed on the project for which invoices are being factored.
—checks are written by the disbursing agent from a segregated account in the name of the contractor for payroll, benefits, subs, suppliers, and taxes (including 940/941, Social Security, FICA, Worker’s Compensation, and related withholdings).
—job specific overhead and expenses such as equipment, materials, and project overhead personnel must be allocated and tracked against the schedule of values and project budget.
With the Miller Act (and similar laws in different states), most public works projects must have bonding from a Treasury Listed surety, rated by A.M. Best. While the involvement of a surety implies their first position on the project receivables, the factor who performs good funds control, should not have any problem with this perfection. The factor has already paid the statutory lien holders on the project. The factor is therefore, perfecting the payment side of the bond which complements the surety’s agenda.
On the other hand, if contractors (because they lack the working capital) are unable to qualify for the required bonding—the factor may be able to help the contractor by providing the working capital so that they can become bonded, resulting in a win-win circumstance for all parties. The contractor is capitalized and bonded, the surety is relieved that the factor is providing working capital and funds disbursement and the factor is pleased to get their money “working on the street” with limited credit risk.
Granted, this underwriting process often requires more time and effort than the typical deal which the factor is used to putting on their books. However, if this is executed correctly, especially given the latest abundance of opportunity and enormous need right now—the factor can see substantial profits.
With the current administration’s commitment here, the factors should consider the excellent revenue potential in the role of a catalyst. Factors should reach out to pro-actively educate contractors about how they can gain access to capital through non-traditional means and the growing acceptance of these forms of financing throughout the public works construction sector.
By Earl Harper, Senior Vice President, RMP Capital Corporation (WWW.RMPCAPITAL.COM), a ten-year old national factor focused on public works construction, with headquarters in Islandia, New York, with additional offices in Massachusetts, Texas and South Dakota.