No matter how big or how small your construction company is, cash is the lifeblood of your business. There are several options for procuring funding to get started, enhance growth and invest in your company’s future. Each option has its own advantages and disadvantages so be sure to compare the different financing alternatives available to you before signing on the dotted line.
The following are some of the most common financing options available:
- Equipment financing
- This option would be suitable for newer companies when obtaining equipment. The loan will finance equipment purchases with the equipment being collateral for the loan. Equipment financing is often easier to obtain than unsecured loans.
- Regular repayments will be made on a monthly basis, similar to any term loan.
- Operating line of credit
- Good for growing companies and can help to alleviate cash flow strains due to seasonality. You can access a fixed amount of capital and only pay interest on the amount of funds you draw out. You only need to repay the funds you’ve borrowed and can keep borrowing as needed up to the maximum fixed amount available. Operating lines of credit may be secured or unsecured. Interest rates on lines of credit are lower than credit cards and term loans. It’s better to secure a line of credit before you need it. You won’t pay anything until you draw from the line of credit when you need it.
- Term loan
- Usually used to finance a large project or investment.
- A commercial loan obtained from a bank for a sum of money with a payback term ranging from 1 year to 25 years.
- Regular repayments will be made monthly and will consist of principal and interest.
- Alternative financing/private lending
- Financing obtained from a non-bank financial institution (for example, a credit union).
- These loans are usually easier to qualify for than bank term loans.
- The amount of the loan will generally be lower than what you can obtain from a bank and the term will be short (ranging from 1 month to 5 years).
Things to Consider Before Applying for Financing
- Cash flow needs
- With cyclicality in the construction industry, cash flow needs are an important factor to consider when determining which financing option is best for your company
- A line of credit may help to alleviate cash flow worries in slower months of the year to help cover overhead costs
- Reporting requirements
- Some bank loans will require annual, quarterly or even monthly financial reporting depending on the amount of financing obtained
- Some will require an audit or review of your financial statements on an annual basis
- This reporting can be time consuming and costly, so it is an important factor to consider
- Credit history
- A higher credit score will help to ensure you are able to obtain the financing your company needs
- It can also lead to lower interest rates
- Interest and financing costs
- Professional fees paid to obtain financing are not 100% deductible in the year the cost is incurred. For tax purposes, the cost is deductible over 5 years.
- Interest incurred is a tax-deductible expense.
- Secured vs. unsecured debt
- Secured debt is backed by assets that are held as collateral, in the case that the borrower defaults on the loan
- Collateral mitigates the lender’s risk; therefore, secured debt is often easier to qualify for than an unsecured loan. With less risk, lenders may also offer better terms and lower interest rates on secured loans.
- You won’t have to put your assets up as collateral and more of the risk will lie with the lender, so unsecured debt may be tougher to qualify for. Creditors will be looking to lend to companies who are low risk and have higher credit scores.
- Personal guarantees
- Financial institutions may require a signed personal guarantee. If the company is unable to repay the debt, then you as the owner would be personally responsible for the repayment of the loan.
- Covenant requirements
- Financial institutions want to ensure that your company as a borrower will continue to be able to repay your debt obligations in order to maintain the level of risk attached to the loan they’ve given you. Therefore, some credit agreements will include financial covenants that must be satisfied. Some covenants can restrict or limit the actions of your company as the borrower. For example, a covenant may state that the borrower cannot borrow more debt or cannot pay dividends over a certain threshold. If a covenant is not met, this is a breach of your contract. When a covenant is violated, depending on the severity, the lender may be able to demand immediate repayment of the loan.
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