Construction business loans and alternative financing are structured specifically for the special needs of the construction industry. Since most construction projects are completed in various stages; and carry significant risks, construction financing can become complex.
Operating a construction company often requires a significant amount of financing in order to achieve sufficient profitability since most aspects of the industry require considerable investment. The tools and machinery, the staffing, and the raw materials are all expensive on the best of days.
Uses for Construction Loans
Construction companies face a variety of expenses that require financing solutions. Some of those expenses include:
Purchasing equipment/machinery. There are power tools and hand tools to go along with vehicles and other construction equipment. Safety equipment, scaffolding, lifts, and more might be necessary depending on the sort of construction projects your company takes on.
Hiring new employees. You’re more than likely not doing it alone. Construction business owners need a whole team of people to help things get built.
Expanding operations. Small business loans can help you start building in a new market or adding new types of projects and capabilities to your existing market.
Renovating/Improving office space. When a client first comes to you to talk about building their home or business, you want to make a good impression. You don’t want to sit them down in a dingy space with outdated logistics technology. Some construction financing can be used to make your office a modern, comfortable space for your team and your clients alike.
Covering unexpected expenses. A project might end up over budget. You may need to hire extra hands quickly. Maybe a supplier offers a huge discount you can’t afford to miss. No matter why you need money, sometimes commercial construction loans are the best way to take advantage or protect your company from unexpected expenses.
Financing large projects. You may need to put up capital into get started on the gigantic projects that really drive business.
Purchasing raw materials in bulk. Lumber is expensive. So are the other raw materials that go into building things: fasteners, roofing, siding, flooring, plumbing, and beyond. Buying large quantities can provide a discount.
Increasing working capital. Your company just needs breathing room. It’s dangerous to operate without much working capital, or money left over after your obligations are paid in a given time period. That’s why many small business owners look for working capital loans, or financing that simply helps build a bit of financial wiggle room.
Refinancing debt. You don’t want to pay interest on expensive loans if you don’t need to. That’s why many business loans are used to refinance older debt. That refinancing sometimes results in longer-term loans to pay off existing ones, leading to lower monthly payments (and more left over in your bank account each month).
Types of Business Loans and Alternative Financing for Contractors and Construction Companies
Term loans are small business loans that can be sued for any of the above purposes. You can use a term loan to buy a building, pay an employee, or boost working capital.
In a term loan, a lump sum of money is borrowed and repaid over a set period of time, usually with a fixed interest rate. The loan is usually repaid in equal monthly payments over the loan term, which can range from several years to a decade or more.
Within term loans, there are two main subcategories.
As their name implies, short-term loans have repayment terms that tend to last for anywhere from 18 months to three years. Lenders typically saddle short-term loans with smaller loan amounts and higher interest rates. After all, the longer a borrower is paying back a loan, the more interest they accrue. If a loan can be paid back within a year and a half, that isn’t a ton of time to generate the sort of interest that boosts lender profits.
On the other hand, long-term loans provide lots of time for lenders to get paid, and that’s why they typically come with larger loan amounts but much lower interest rates. Long-term loans can last decades and are best used to buy expensive and long-lasting purchases like real estate, vehicles, and the like.
The United States Small Business Administration funds several programs to help encourage lenders to underwrite loans to small businesses. They guarantee these loans but don’t fund them directly. That means if a borrower is for any reason unable to repay a loan, the government pays the lender up to 85% of the value of the loan. Like term loans, SBA loans are also subdivided:
SBA 7(a) Loans. The 7(a) program funds term loans of up to $5 million. This is the SBA’s most popular loan program and is often the least expensive type of loan you can get if you qualify. That’s perhaps the biggest downside to SBA loans. Because the SBA wants to be careful about guaranteeing loans with taxpayer dollars, the process moves slowly and methodically. You’ll need to have great credit and lots of patience. SBA 7(a) loans can be used for as wide a variety of purposes as you can think of, though there are a few industries that aren’t eligible.
SBA 504 Loans. Unlike 7(a) Loans, SBA 504 Loans are only doled out for specific uses. In particular, 504 Loans are meant to be used on buying or upgrading land or infrastructure in ways that create jobs. Like 7(a) Loans, they can be underwritten for up to $5 million, and repayment terms can last for up to 30 years, particularly when being used for real estate purchases.
SBA Microloans. If you’re only looking for a few thousand dollars, the SBA microloan program fits the bill. They only get as big as $50,000 and are financed through certain SBA-designated nonprofits. On top of that, microloans tend to move and fund faster than other SBA loans.
In the construction industry, equipment is everything. There are dozens of power tools, heavy machinery, vehicles, hand tools, and more, particularly if your company has an area of specialization. And on top of all of that, if you maintain an office you’re looking at furnishing and equipping that area too. It’s a ton of equipment.
Equipment financing makes it much easier to get your hands on everything you need to run your company. Once you’ve determined that you need to buy, lease, upgrade, repair, or replace a piece of equipment, you seek out an equipment loan. Most lenders will require you to make a down payment on that equipment of about 20%.
After you’ve made that down payment, the lender finances the rest. The catch is that they also hold that equipment as collateral, meaning that if you can’t pay back the equipment loan, the lender will repossess it, sell it, and recoup a significant portion of the loan.
That protection from losing money is why equipment loans are appealing to lenders. Even if they can’t make as much money as they’d like on the loan itself, they can still make money by selling equipment. For a construction business, equipment loans are some of the wisest financing options available since so much of the overhead in a construction company comes down to equipment.
Business Lines of Credit
A business line of credit is a type of loan that provides a company with a predetermined amount of credit it can draw upon as needed. It is a flexible source of financing that can be used to cover unexpected expenses or support ongoing business operations.
Lines of credit are good for construction companies because they can provide access to funds as needed for short-term projects, cover unexpected expenses, and smooth out cash flow. Additionally, interest is only charged on the amount used, making it a cost-effective way to finance operations. You don’t know when you’re going to need some extra cash, and a line of credit is always available to cover any shortcomings.
On top of loans, there are several other types of financing available for construction companies. These are typically transactions based on revenue.
Merchant Cash Advances
A merchant cash advance (MCA) is a type of financing in which a company receives an upfront sum of cash in exchange for a portion of future credit card sales. MCAs are often used by businesses to quickly access cash to cover short-term expenses such as equipment purchases, payroll, or repairs. Instead of making fixed monthly payments, the company repays the advance by allowing the lender to take a portion of daily credit card sales until the advance is paid back.
One advantage of MCAs is that they are often easier to obtain than loans, as they are based on a company’s credit card sales rather than its credit score or financial history. This can be especially beneficial for small or new construction companies that may not have established a strong credit history or collateral. MCAs are also faster to obtain than traditional loans, as they do not require the same level of paperwork or review.
MCAs can be a good option for construction companies because the repayment process is tied directly to the company’s sales. This can help to ensure that repayments are manageable, even during periods of slow business. Additionally, MCAs can provide access to much-needed funds for short-term expenses such as equipment purchases, repairs, or unexpected expenses, without requiring a long-term commitment. This can be especially valuable for construction companies that face unpredictable expenses or need to quickly respond to new business opportunities.
Invoice factoring is a type of financing in which a company sells its outstanding invoices to a third-party factoring company in exchange for immediate cash. The factoring company advances a portion of the invoice amount, typically around 80-90%, to the selling company and then collects payment from the customer. This can help alleviate the burden of slow-paying customers and provide a company with much-needed cash flow.
Invoice factoring can be a valuable tool for businesses in industries such as construction that often have long payment cycles and need to maintain a steady flow of cash to cover operational costs. By selling outstanding invoices, a construction company can access the funds it needs to pay suppliers, hire workers, and purchase equipment, without having to wait for customers to pay their bills. The factoring company assumes the responsibility of collecting payment from the customer, freeing up the construction company to focus on its core operations.
The LCF Group is Here to Help
The LCF Group is a boutique marketplace business financing firm with over 11 years of experience. Our financial experts use their small business ownership experience to provide the funding solutions you need without the confusing terms and technical jargon you might see from other lenders.
Business owners have all sorts of loan options available in today’s lending environment. Finding a lender that’s willing to find the right financing with the right interest rates and repayment terms is key to ensuring that your restaurant can function as intended. The best medical practice loan for one business isn’t going to be the best one for another. Our lending experts can help find the right option for you.
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