Alternative Financing for Construction Companies Skittish banks have forgotten the combination to the vault, leaving contractors scrambling to meet payroll, survive cash flow squeezes and even bid on the few jobs in the offing. With little to indicate that trend will turn around - despite stimulus incentives for banks to loosen the purse strings - many builders are seeking alternative financing options.

While some look for other sources of debt financing - hedge funds, insurance companies, pension plans, etc., others are turning to their equity and even their assets to make ends meet or take advantage of business or expansion opportunities.

Equity financing - raising money by selling shares of the company - has been a common method used by many types of businesses. It reduces or eliminates the monthly principal and interest payment, and it reduces the company owners' exposure by spreading the risk. Shareholders have no recourse if a construction company fails. Lenders still must be paid back. While attractive in these respects, equity financing also means surrendering some control of a firm. Many construction companies are family-owned and operated. Handing over autonomy may feel like turning over a child to a foster family. If equity financing is unavailable or too heartrending for you, you may consider capitalizing on the value of your assets. Loans backed by high-dollar assets such as real estate, contractor-owned construction equipment or supplier-stocked inventory make lenders less skittish in the down economy. When the economy goes south, banks are sticklers for maintaining strict standards for underwriting loans. When contractors need quick cash to fund operations, asset-based lenders become more amenable.

"The key for an asset-based lender is the collateral and its availability," Commercial Finance Association Chief Operating Officer Brian Cove told the Wall Street Journal. "Even in a tough economy where providers of credit are really tightening up lending, [asset-based lenders] are still out there. The key for an asset-based lender is the collateral and its availability. Most asset-based lenders keep a close eye on that collateral, with some even making regular visits to the client's warehouse to spot-check inventory."

Accounts receivable is another asset a financier may lend against. This is another common practice for many businesses, though it may not be as widely accepted for contractors because a significant amount of a builder's receivables likely will be in the form of progress payments due. Enter the factor.
Factors are becoming the financing source of choice for many contractors and other business owners faced with impending obligations but far-off windfalls. Factoring allows contractors to sell an invoice (or more than one) in order to obtain cash in a hurry. It allows the factor to turn a profit (the greater the risk the invoice won't be paid, the greater the profit for the factor if it is). Similar to invoice discounting, where invoices serve as collateral for a loan, factoring can be a life saver when short-term debt comes due or when an attractive opportunity arises.

For example, a contractor's $50,000 payroll is due in two weeks, and he's out of cash. A $100,000 progress payment from an owner is due in 30 days. The contractor can sell that invoice to a factor, receiving $70,000 in the nick of time to prevent his employees from revolting because of bounced paychecks. In 30 days, when the owner pays his bill, the factor pays the contractor another $25,000 or so and pockets a tidy $5,000 profit - his fee for letting the contractor use his money for a couple of weeks and, in non-recourse factoring, for accepting the (usually slight) risk that the owner would default.

Alternative financing also can serve as a way to pay off debt more quickly, buy out a competitor, or lease or purchase equipment.

Still, as with any financial decision, you should consider the disadvantages of using factoring as a funding method:

• Factors are in the business to make money. They often charge an initiation fee as well as interest based on when the invoice is paid.
• If you don't understand the terms of the factoring agreement, you could be in for a nasty surprise. With recourse factoring, if the client defaults on the invoice, the factor can seek redress from you. "One of the most common traps for small businesses using factoring is the assumption that outsourcing the function means outsourcing the responsibility," writes Gregg Elberg, president of Gregg Financial Services in San Anselmo, Calif.
• Client relations could suffer if the factor uses business methods different from those used by the contractor - methods customers may have become accustomed to.

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