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The growth in business opportunities presented by a growing economy can only be a good thing for those in the construction industry. After all, a rising tide raises all ships, right?  

Well, not exactly. In the construction industry, subcontractor failure is three times more likely in a growing economy than it is during an economic downturn. The easiest explanation to explain why any business fails is that the business simply ran out of cash. But in most industries, business growth corresponds to a growth in cash.

Isn’t that the way the construction business works as well? Why are expanding construction businesses more likely to fail than those that aren’t?

It’s the Construction Cash Crunch

Simply put, a typical construction company must have access to a large amount of cash reserves just to kick off an average construction project. The 3 main areas driving this need for cash are:

  1. Floating project/job costs up front is expected. Cash starts going out the door on a new project/job immediately.
  2. Slow payment in construction is the norm. The cash coming in from customers is slow to arrive.
  3. Retainage, change orders and underbillings are prevalent. Construction-only practices like these all serve to further complicate the collection of construction payments, which has a negative impact on cash flow.

When a construction business is growing and taking on additional new projects, these problems are multiplied. In other words, each additional project requires an additional pool of cash reserves in order to get that project off the ground.

Companies that take on too much work too quickly -- something that’s pretty tempting to do when the work is there, especially when the work is back after an extended downturn -- can find themselves suddenly running out of cash. And those that can’t get access to some form of bridge financing may find themselves up against a looming financial disaster where even the company’s survival is threatened.

What Can Be Done?

Unfortunately, it’s very difficult for construction businesses -- and especially for contractors and subcontractors -- to gain access to capital sources from banks and other traditional lending institutions. Commercial lines of credit might be an option for some, but many will have difficulty meeting the financial requirements necessary to get credit. Receivables factoring and other forms of invoice factoring are an option for some, though those financing tools can come with a high cost.

It may be somewhat surprising, then, that one of the best ways to deal with the construction cash crunch is to get the customers to pay invoices faster. The faster the payments come in, the more cash there is on hand to fund taking on new jobs and growing the business.

Send Preliminary Notice -- Get Paid Faster

Slow payment is just the way that it goes in the construction industry, but companies that send preliminary notice get paid faster on their projects that the companies that don’t send notice. Why? Because most of the larger, sophisticated property owners, and nearly all developers or large GCs, go to great lengths to track who is filing and not filing notices in order to know which parties have protected lien rights and remain in a secured position.

So, when it comes down to who is going to get paid first on a project, the companies that have secured their lien rights (by sending a preliminary notice) are always going to be paid before the companies that haven’t, because the fear of a possible mechanics lien is just that great.

The companies that didn’t secure their lien rights are always going to be better candidates for delayed payments because without the ability to file a lien, there’s nothing they can really do to make the payment come any faster.

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