The construction industry is competitive, with thousands of entrepreneurs competing for the same market share of communities from coast to coast. Of course, there’s a lot of work to be done, but if you want to win business and grow toward your full potential, you’ll have to ensure you’re consistently operating at your highest capacity.
Cash flow problems at the wrong time can make it difficult to see work through to completion or, more severely, disqualify you from a contract and halt your growth. Whether your lack of liquidity is from a late-paying client or for another reason, the bottom line is that you’ll need to fix the problem quickly to ensure you can stay profitable and take advantage of opportunities.
You might have cash reserves you can tap into, but taking from your emergency fund leaves you less prepared for sudden downturns or unforeseen expenses. Fortunately, numerous capital sources are available for you to leverage as you drive success in your business, like term loans, business lines of credit, equipment financing, and more. Each option has its own benefits and drawbacks, so how do you choose the right one for your specific circumstances?
The only way to ensure you’re making the right decision for your business is to understand all the options available to you. Let’s explore the top 5 financing options for construction businesses in 2023 and, more importantly, how to secure terms that fit your business, not just your budget.
Financing Options for Construction Businesses
Construction businesses can leverage almost every type of financing solution, with the exception of specialized programs, like farm loans. Here’s a breakdown of the most common construction financing options.
Business Line of Credit
Business lines of credit are advantageous in almost any industry, but they’re especially helpful for construction entrepreneurs. Basically, it’s an open line of credit that you can draw physical cash from on an as-needed basis, up to a certain limit. Once you repay the borrowed amount, you can take the same funds again, allowing you to always have liquidity for opportunities, challenges, and expenses that come your way.
This is one of the most flexible options available to entrepreneurs. You only pay interest on the amount you draw, and you don’t need to speak with your lender every time you want to leverage your line for a business expense. However, some lenders introduce fees and stipulations that can detract from the usefulness of your financing. For the best results, make sure to carefully review your contract before signing on the dotted line.
| Term length | Interest rates | Ideal for |
| Revolving | Starting at the prime rate | Ongoing purchases or investments, flexibility, when you don’t know the exact cost of a project, long-term financing |
Equipment Financing
Construction equipment is expensive, with the price of excavators ranging from $100,000 to $500,000. Even if you have the cash to afford an expense of this caliber, shelling out the entire cost of the equipment can strain your cash flow and limit your ability to complete contracts, qualify for new ones, and manage the operational costs of your business.
Equipment financing is a way for construction companies to break down an expensive equipment purchase into a more manageable schedule. The lender essentially pays for the equipment you’re looking to purchase, and you repay the cost to the lender on a set schedule, with interest factored in. Once you pay off both the principal and interest, you’ll have full ownership of the asset and can do with it as you please.
| Term length | Interest rates | Ideal for |
| Medium length, but it depends on your needs – two to ten years on average | Between 2% and 20% | Breaking down sizeable equipment purchases into manageable payments |
SBA Loans
SBA loans feature low interest rates and favorable terms, but the eligibility requirements are strict. This is because SBA loans are partially backed by the government, meaning that they agree to pick up some of the cost if the borrower defaults on payments. The added layer of security makes them more attractive to lenders, who will offer lower interest rates, more favorable terms, and higher funding amounts because of the added layer of security.
SBA loans come in many shapes and sizes. The three flagship programs are microloans, 7(a) loans, and 504 loans. Microloans are the smallest of the bunch, with funding amounts of up to $50,000. 504 and 7(a) loans both come with funding amounts of up to $5 million, but 504 loans are designed specifically for “major fixed assets that promote business growth and job creation,” according to the SBA.
SBA loan interest rates start at the Federal Reserve’s prime rate, but this number changes based on the FED’s behavior. For more information on SBA Loan Rates, click here for our resource.
| Term length | Interest rates | Ideal for |
| Can be short-term or long-term; less than one year or up to 25 years | Starting at the prime rate | Borrowers with good credit |
Term Loans
Term loans are the most basic business loan, where funds are provided in a one-time, lump-sum payment you’ll repay throughout the term agreed upon with your lender. You may need to offer collateral as a method of “securing” the financing, but there are ways around this requirement, especially if you have a high credit score and substantial annual revenue.
The lender you’re working with may need to see a detailed business plan of how you intend to use the funds as well. Even if they don’t require this, it’s a good idea to have one, so you can fully understand where you’ll invest your money to drive success in your business.
| Term length | Interest rates | Ideal for |
| Can be short-term of long-term; less than one year or up to 25 years | Starting at the prime rate | One-off purchases or investments, when you know exactly how much a project will cost, long-term financing needs |
Revenue-Based Financing
Revenue-based financing is essentially the opposite of asset-based lending. Rather than leverage your physical assets in exchange for funds, you’ll use your future revenue projections to secure cash in the short term. The amount you’ll receive will depend on your business’s revenue projections, so you shouldn’t expect to receive more than you’re capable of making within a given time frame.
This method of accessing capital is a bit ambiguous compared to other forms of financing because your revenue projections don’t come with a physical receipt. It’s also a more advanced form of the notorious merchant cash advance, so make sure to review your terms and research the lender you’re working with thoroughly.
| Term length | Interest rates | Ideal for |
| Medium length, but it depends on your needs – two to ten years on average | 6% to 30% | Short to medium-length projects, highly profitable businesses, when you know exactly how much a project will cost, long-term financing needs |
How to Choose the Right Option for Your Business
Each of the construction financing options mentioned above is advantageous for certain circumstances. For example, an entrepreneur that wants the most flexibility will likely benefit the most from a business line of credit. But, on the other hand, someone that needs a large amount of money for a one-time purchase may benefit more from a term loan or revenue based-financing option—it all depends on you, your business, and your goals.
Here are a few steps to follow before you come to a final decision.
1. Determine Your Needs
First, you’ll need to ask yourself some important questions, otherwise known as the “what, when, where, how, and why” questions.
- What am I using the funds for?
- When do I need the money?
- Where will I apply the funds in my business?
- How will using the funds in this way grow my business?
- Why am I taking out financing in the first place?
This might seem like an unnecessary step, but with a little forethought, you can avoid “throwing money” at a problem or opportunity and see a greater return on your investment. You should also identify the type and amount of loan needed, as well as the terms that you are looking for in a lender.
You should also consider the flexibility of each product. If you need funds on a consistent basis or don’t want to be contained by the structure of a term loan, you may want to explore other types of construction financing, like business lines of credit.
2. Research Lenders
Once you’ve fully planned out your financing, you’ll start to search for lenders that fit your business and goals. You should compare rates from
- Banks
- Credit unions
- Direct lenders
- Online lenders
- Angel investors (if possible)
Each of the capital sources above can help you secure the funds you need to accomplish your goals, but they all have unique advantages and disadvantages. Banks and credit unions tend to have lower interest rates and more restrictive eligibility requirements, whereas direct and online lenders are essentially the opposite. Angel investors are much different from the other types of lenders, as these individuals/groups offer capital in exchange for ownership in the borrower’s business.
3. Analyze Your Eligibility
After you’ve researched lenders and found a few that match your needs, you should review the eligibility criteria of each organization and ensure you meet the qualifications to apply successfully. Taking this step can save you the time and frustration associated with waiting weeks for a denied application, so make sure not to neglect this stage as you go through the process.
Consider Collateral Requirements
Some lenders may enforce collateral requirements on certain loan products. Tangible assets, like real estate and vehicles, and intangible assets, like your accounts receivable, all qualify as collateral, but some lenders may prefer one type of asset over another.
Well-established businesses, with solid credit scores, high profitability, and lengthy times in business, may not have to worry about collateral. Newer businesses and those with less than favorable financial backgrounds may not have an avenue around offering collateral, so make sure to factor this into your search if you can’t/don’t want to offer collateral of any kind.
4. Understand Terms & Conditions
You’ll want to make sure you fully understand the terms of your financing, regardless of the type you’ve chosen. In some cases, lenders that don’t have their client’s best interests in mind have snuck hidden fees and contingencies into contracts that borrowers won’t know of until it’s too late. This can include early repayment penalties on term loans or 0 balance fees on business lines of credit, but the possibilities are endless.
For the best results, review your contract with a trusted financial advisor and ask as many questions as you can throughout the process.
5. Calculate Costs
This might seem obvious, but you should run through the numbers on your contract and ensure that the payments are within your business’s financial capability. You don’t want to find yourself in a situation where you’re struggling to pay back your financing or unable to do so entirely. By taking this step seriously, you can potentially save yourself from future stress and financial hardship.
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