Profit is the goal of every business, but it is preserving cash flow that is often the most pressing challenge.

QuickBooks research found that 61% of small companies struggle with managing cash flow, and a U.S. Bank study of businesses that failed found that 82% did so not because of demand or profitability issues, but because of cash flow challenges.

Like all businesses in today’s economic climate, the construction sector must contend with significant challenges that include high interest rates and inflation. But construction companies are often affected more acutely by evolving economic factors compared to other industries, such as swings in fiscal policy and fluctuations in demand and consumption.

According to the U.S. Bureau of Labor Statistics, almost 40% of construction companies go out of business within five years of inception, and nearly 55% succumb within 10 years.

The Construction Industry & Economic Volatility

So why is the construction sector so hard-hit by economic volatility? These businesses are, by nature, capital-intensive and cash flow challenged. The unfortunate impact of rising costs has been reported in the trade press and many construction-related insolvency filings.

The high price of fuel has a disproportionate impact on this industry, which is reliant on petroleum-burning heavy equipment. Materials costs, driven high during COVID-19, have not recovered fully. A skilled worker shortage has also led to increased costs.

While numerous massive government stimulus and infrastructure programs have been introduced to boost activity, these programs, ironically, are sometimes perilous to construction companies because of the slow flow-through to shovel-ready projects and the bureaucratic friction associated with government oversight. Delays kill projects and construction companies because they rely on the purchase and maintenance of heavy equipment, pre-purchase of materials, and pre-assembly of staff to bid for and complete jobs.

Capitalizing on emerging opportunities is a gamble requiring considerable risk. Scaling up for projects is necessary, but profit — and perhaps solvency — may well depend on getting the timing just right. And due to the dynamics of contractors and subcontractors, the failure of one company can cause a receivables nightmare that cascades through a network of interdependent companies.

Construction companies need nuanced capital strategies to maintain perfect balance between receivables, payables, and capital requirements — or even short-term cash flow challenges may quickly transform a hoped-for boom into a catastrophic bust.

Bridge & Term Loans

Bridge and term loans are capital mechanisms that can be perfectly suited to construction companies seeking to access the untapped equity from their asset base. While both of these loans are typically paid back in monthly installments, they may be customized and structured to meet the needs of the borrower.

Bridge loans can be an effective tool for companies seeking short-term capital, wishing to repay with no penalties in less than a year. Term loans can be effective for providing a company with committed term capital with manageable cash flows for a longer horizon.

Both can be useful for solving a variety of common capital challenges for a construction company:

• Purchasing capital equipment
• Capital for upfront project costs or growth initiatives
• Equity transactions, such as shareholder or partner buyouts
• Acquisition financing, including leveraged buyouts or financing mergers and acquisitions (M&A)
• Distress recovery including short term liquidity, debt consolidation, and restructuring

Asset-Based Loans From Alternative Lenders

Alternative capital refers to financing from institutions or companies outside of federally regulated traditional banks. Asset-based loans offered by alternative lenders are underwritten based on the equity of a company’s asset collateral rather than focusing on the company’s cash flow and historic financials.

This is a great advantage for construction companies which may have “lumpy” or seasonal cash flows yet are asset-rich in the sense that they own heavy equipment or real estate that can be used as collateral.

Asset-based loans from alternative lenders are ideal for construction companies that need faster or easier access to capital than what traditional banks can offer. As the Fed has raised the prime interest rate in recent years, banks have been compelled to tighten their underwriting criteria, making the application process increasingly rigorous and time-consuming.

In contrast, alternative lending faces fewer government mandates, offering a simpler and faster application process. Even if a bank has rejected a company’s loan application due to poor financial ratios, historical performance, or lack of profitability, financing may be readily available from alternative lenders that can underwrite loans based on off-balance-sheet equity in capital assets like heavy equipment or real estate.

Furthermore, many bank loans include rigid financial and reporting covenants, adding tedious and time-consuming financial reporting requirements for borrowers each month during repayment to maintain good standing. Because asset-based loans are not underwritten based on the borrower’s financials, covenants are usually simpler or not required at all. Asset-based alternative loans are also typically non-dilutive, with no impact on the owners’ shareholdings.

Alternative lending is not a new trend; it is proven and safe and has been growing in popularity since major consolidation in the banking industry began in the 1990s. As consolidated large banks focused increasingly on lending to large enterprises, a need emerged for small and midsized businesses — and alternative lenders filled that gap.

By 2000, alternative lenders had overtaken traditional banks in corporate loans. Following the 2007 global financial crisis, federal regulations increased bank lending criteria, further reducing the appetites of banks for small- and mid-sized business lending.

The acceptance of alternative lending has skyrocketed over the past 30 years. For example, banks in 1994 were responsible for over 70% of primary market business loans. But since then, non-bank lending has become the primary source (Exhibit 1).  

Exhibit 1: Business Loans Are Now Primarily Provided by Alternative Lenders

Conclusion

Asset-based alternative financing is a valuable tool for construction companies that need reliable, expedient access to capital. These funding mechanisms can address various capital challenges, including short-term liquidity, balance sheet restructuring, M&A financing, and rapid growth investments.

Construction companies should collaborate with proven alternative financing providers who understand their industry, assets, and balance sheets to expedite funding access — especially when traditional bank loans are too inflexible and slow. With a nuanced capital strategy, construction companies can navigate the ebbs and flows of even the roughest economy, and nimbly pursue growth opportunities on the horizon.