The factoring of construction related receivables is certainly one of the more difficult niche areas of factoring from the transactional standpoint, but one all brokers should become very well acquainted with. Why you say? Because the need for financing in this segment is so great that some brokers can actually focus 100% of their marketing efforts on construction factoring and make an exceptional living. To do so, however, you need to become an expert in all aspects of this important niche area.
First, you need to know that construction factoring provides services to several different categories of prospective clients. And when factors finance in this sector, one size does not fit all. From a product knowledge standpoint, there is quite a bit for brokers to learn.
When focusing your marketing efforts in the construction sector, you will have three possible types of clients or prospect groups for your marketing campaigns . They are:
- SUB-CONTRACTORS: Those actually performing the work on a job site and being paid for that work by a General Contractor
- GENERAL CONTRACTORS: Seeking to get advances on progress payments made to them by project owners or banks
- SUPPLIERS: Businesses that supply materials to the job site. This is everything from lumber and trusses to bulk hardware.
Of the three groups, sub-contractors will be your largest market and the easiest to actually interact with. The second most promising group will be suppliers. The general contractors themselves are the smallest group and by far the most difficult to finance. In fact, few factoring brokers working this sector actually market to general contractors.
The factoring of sub-contractor receivables is the most common in this niche. Here, the invoices being factored are those payable by a general contractor to the sub-contractor for its work on the job. What makes this area difficult? Here are a few risks not typically associated with “plain vanilla” factoring.
- RETAINAGE: Most sub-contractor invoice payments are subject to something called retainage. Retainage (usually 10% of the invoice face amount) is a holdback the general contractor retains for (sometimes up to a year) to offset poor craftsmanship that may show up well after the sub-contractor has left the jobsite. Because of retainage, all sub-contractor invoices factored are subject to having additional reserve held of 10%. A normal 80% initial advance becomes a 70% or even 65% advance.
- SETOFFS: General contractors most often enjoy something called rights to setoff. This means that an invoice payment for a current job performed may be reduced or “setoff” by a chargeback on a job performed months prior.
- VERIFICATION: While the verification process is usually very straightforward in most everyday factoring transaction, it can be problematic in construction. This is because the invoice verifier, in the normal chain of command in a construction deal, is the project manager who will typically be on the job site and difficult to access.
- CONDITIONAL LIEN RELEASE: Prior to paying an invoice, the general contractor will require a conditional mechanic’s lien release which protects it from the sub-contractor filing a lien against the job after being paid. This creates some additional paperwork for factors and it can also create a logistical problem since the general contractor will not pay without the release and the release must often be signed in person at the general contractor’s offices.
Learn This Niche
For professional brokers, becoming an expert in the niche area of construction receivables factoring should be one of your priorities since this represents a very robust opportunity in most markets. The construction industry is famous for the slow payment of invoices from general contractors to sub-contractors, often due to causes such as inclement weather delaying overall construction on the job (and the “progress payments” from the banks financing the job) as well as simply paying subs slowly to conserve capital during the construction process. In the construction trade, “paid-as-paid” is common and it means that the sub-contractor gets paid when the general gets paid it’s progress payment. It is not uncommon for sub-contractors performing their services early in any given progress phase of a construction job to wait 60 days or longer for their invoice payment and especially if the weather doesn’t cooperate.
Brokers with a well-rounded knowledge of the construction industry can literally make their living (and a good one) by focusing on this niche industry. When marketing, it is important to focus on general contractors (the account debtors) as well as the sub-contractors who will be your clients. There are significant benefits to general contractors when their sub-contractors factor their receivables but these benefits usually need to be pointed out to them. In fact, “reverse factoring” programs can be utilized by general contractors to conserve capital and also provide a complete “quick pay” system for all of their subcontractors. When marketing, make certain you adhere to the basic rule that construction factoring only pertains to commercial construction and not residential construction. The account debtor must be a creditworthy general contractor when factoring receivables due to a sub-contractor. The account debtor cannot be a home owner. ONLY COMMERCIAL!