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Why Contractors Have Hard Time Getting Business Funding

construction loans

Even in a favorable economic climate, where housing starts are up, contractors have a hard time getting loans in the traditional sense but Excel specializes in Construction business loans.  Since no more so than ever banks view contractors as high-risk and they are subsequently far more selective when underwriting loans. The lack of financing options makes it difficult for many contractors to meet payroll obligations, purchase new equipment, and access capital when there is a lull between jobs or if payment from clients aren’t received in a timely fashion.

In most instances, the concern over the inherent risks of lending to contractors appears justified. In his book Analyzing Construction Contractors, Dev Strischek indicates that contractors have a higher failure rate than other small businesses and these failure rates only increase during economic downturns or recessions. It then becomes apparent, based on both the failure rate and the correlation with economic cycles, why contractors are considered high-risk.

Here are some of the additional reasons why small business owners and contractors might have a hard time securing financing through traditional channels:

  • Inconsistent Revenue or Cyclical Business – a business may depend on the weather, there might be downtime in between contracting jobs, or there could be a sustained recession that is having industry-wide impact
  • Home-based Business – lack of a traditional brick and mortar shop lends itself to the notion of a transitory or unstable business
  • Lack of Collateral – a contractor that works out of his or her home and leases the majority of their equipment may lack any assets that can be put up as collateral for loans
  • Bonding Obligations – contractors are often bonded. Banks recognize that these bonding agencies hold a legal claim on assets above any creditor should the business fail
  • Perceived Lack of Business Acumen – contractors may be highly skilled in their jobs, but the perception may be that they lack the marketing, bookkeeping, and business skills necessary to run a successful small business
  • Heavily Impacted by Downturns in the Market – as stated before, a contractors business is often directly tied to the state of the economy and, more precisely, the housing market

The lending practices of banks have left a definitive gap in the marketplace, but there have been third party institutions springing up to meet the needs of contractors and attempt to fill that gap. In her article “Online Banks Fill Funding Needs for Small Business,” author, and former SBA Chief, Karen Mills indicates that there is reason for optimism in the alternative financing realm. She states, “the outstanding portfolio balance of online lenders has grown about 175 percent a year.”

So it is not all doom and gloom for contractors. There are alternative options for securing loans. Here are just a few of the non-bank financing options available to contractors:

  • SBA – the Small Business Administration is not a direct lender. Instead, the SBA works with local banks to guarantee small business loans. Their guidelines are as restrictive as the banks, but a guarantee on a loan greatly increases the chances of contractors obtaining financing.
  • Online Banks – there are on-line banks that supplement the brick and mortar banks that offer additional opportunities to secure financing but typically have similarly restrictive lending practices.
  • Non-traditional Funding Sources – this is the greatest source of optimism for contractors. These online, non-traditional lending partners are changing the face of contractor financing. They include direct lending, peer-to-peer lending and even factoring companies.
  • Equipment Lease Options – if the proceeds of a loan are for the sole purpose of purchasing equipment, contractors should consider leasing as an option. Leasing requires less capital and can come in different term lengths to meet the specific needs of the contractor

Despite their relative small size, non-traditional and online funding sources have the potential to change completely the way contractors obtain financing. They focus on customer service, are more open regarding their requirements, and they ultimately foster greater competition for the contractors’ business. Some of these alternative lenders include Prosper, Lending Club, Excel Capital Management and Funding Circle.

To improve the chances of securing financing – whether it’s through traditional or non-traditional sources – contractors should focus on the following areas. Addressing each of the following will drastically increase the chances of success.

  • Be prepared to provide tax documentation and a well-maintained balance sheet
  • Define exactly how the money is to be used and how it will impact the business’ bottom-line going forward
  • Address a plan for market downturns by soliciting referrals, utilizing direct marketing, or focusing on a Social Media strategy. This approach will demonstrate a realization of the cyclical nature of the business and provide evidence that the owner is attempting to mitigate the impact.

Contractors and business owners need to recognize that, as with most present-day industries, the traditional lending model may no longer fit the market. Innovation has extended well beyond technology products to impact everything from taxi cabs to startup funding to grocery shopping. There has been innovation in small business lending as well, and contractors and business owners have begun to turn towards this burgeoning alternative funding market to finance their long-term success.