Seven Questions Contractors Should Ask Before Seeking Outside Financing
Construction companies can leverage loans, lines of credit and other such products to help ensure positive cash flow, build creditworthiness and fuel business growth. But the options can seem limitless and overwhelming. Here are seven questions to discuss with your leadership team to help determine whether now’s the time to pursue outside financing and, if so, what kind.
1. Why Do We Need the Money?
This may seem like an obvious question, but you need to be able to answer it as specifically as possible. Many commercial lenders require applicants to submit a stated purpose — with the expectation that the funds will be used for that reason alone.
Perhaps you need a cash infusion to finish a project or mobilize on a new one. Or maybe you want to buy a key piece of equipment, but paying the full amount upfront would deplete cash flow too much.
It’s also important to have a clear plan for exactly how the money will be used to execute the cited purpose. Knowing your objective and how you’ll go about fulfilling it will help you target precisely the kind of financing you need while also enabling lenders to assess the risk of the prospective financing arrangement.
2. What Type of Financing Best Suits Our Needs?
A variety of financing options are available to construction businesses. While a credit card or revolving loan for everyday expenses may fit the needs of one company, a long-term, fixed-rate loan may be a better option for another business — particularly one experiencing tremendous growth. A few other options you may encounter include:
A commercial line of credit. Ideal for making smaller purchases, a line of credit provides access to a fixed amount of funds for daily cash flow needs. Much like a traditional credit card, it allows you to use only what you need and pay interest on the outstanding balance.
A leaseback program. Under this arrangement, a construction company seeking to free up working capital can sell an asset (such as a building or piece of equipment) to a lender and then rent it back from that same lender. Some arrangements include the option to buy back the asset.
Automated Clearing House (ACH) cash advances. Also known as cash-flow or revenue-based loans, ACH cash advances are made against your company’s future bank deposits. Often demanding a high interest rate and costly fees, this option tends to suit contractors with sizable checking-account balances but imperfect credit.
Invoice factoring. Businesses can convert current, unpaid invoices into immediate cash by selling them at a discount to a third party called a factoring company. This option is also referred to as “contract financing” or “accounts receivable financing/factoring.”
3. What Should We Look For in a Lender?
Although it’s important to shop around for the best products, rates and terms, it’s equally imperative to look for a lending institution that fits your construction company’s size and culture. For instance, you may not want to work with a large bank that requires in-person branch visits to originate a loan or make external fund transfers between banks.
When talking with lenders, ask about the types of loans they offer, interest rates and fees, closing costs, repayment terms, online banking options, and mobile tools. Also, ask each lender whether it has a rep who specializes in the construction industry.
4. Can We Afford the Payments?
As you’re well aware, construction businesses usually get paid only after completing a project or job phase. So, it’s critical to perform cash-flow forecasts to determine whether you’ll likely be able to afford the monthly payments on a commercial loan or other product — including both principal and interest.
5. What’s Our Credit Score?
Businesses have credit scores, too. Lenders will consider yours, as well as your construction company’s financial history, when determining whether to approve a loan or line of credit.
Generally, commercial lenders want to see a credit score at least in the high 600s. They’ll also consider other factors, such as your loan-to-value and debt-to-income ratios. To check your business credit score, you can go to the usual “Big Three” credit bureaus: Dun & Bradstreet, Equifax and Experian.
6. Are We Ready to Apply?
The application process approval timeline for a loan or line of credit can vary depending on the product and provider. Be prepared to submit detailed documentation. Lenders may ask to see items such as your tax returns, financial statements, bank records and business license.
7. Who Can Help?
Applying for any type of reputable business financing can be a lengthy, daunting process. Contact us. We’d be happy to help you determine whether and how your construction business should go about it.