Securing mainstream construction finance was never a simple enterprise, but it’s actually getting harder. This is especially true in the UK, where scrutiny from lenders has intensified over recent years, making it trickier and more time-consuming than ever for construction firms – even those with a healthy order book and a history of sound financial conduct – to secure the finance they need to grow.
In fact, some company directors are stepping in to provide finance to their own construction firms as banks refuse.
Mike Chappell, global corporates managing director for construction at Lloyds Bank Commercial Banking, told The Guardian in July 2017, that the uncertain political situation in the UK is making the situation even tougher for construction firms looking for mainstream finance.
“The headwinds prompted by the EU referendum a year ago continue to challenge the sector. Input price inflation is still an issue and there remain concerns about how the UK’s exit from the EU will affect construction firms, given their reliance on European labour.”
Without support from mainstream lenders, how can construction firms be expected to fund growth, manage cash flow, acquire materials for new projects, and plan for the future?
Funding challenges for construction firms
The construction sector is heavily influenced by domestic economic cycles, macroeconomics, commodity prices and a whole host of other factors outwith the control of the sector. These factors make lending to construction firms relatively risky for mainstream institutions like banks.
There’s also the big, inescapable fact that funding a construction project isn’t cheap. You can’t bootstrap an apartment block. Materials, labour, insurance, dispute resolution and the very fact that projects starting now will be at the whims of the economy in two or three years time, which could provide a very different commercial environment, meaning that for any significant construction project to get off the ground, the firms involved need liquidity and capital.
Other forms of construction finance to explore
But it’s not all doom and gloom. Just because mainstream lenders aren’t being as supportive as they might, it doesn’t mean all avenues are closed to construction businesses looking to generate funds. Here are the three dominant forms of alternative finance for your construction firm to consider.
Asset finance for the construction industry
There are two main types of asset finance; leasing and hire purchase.
Leasing – how it works
Leasing enables your construction firm to acquire new equipment, without having to find the entire capital sum upfront. This can often be the difference between expanding and growing or having to make do with old or out-of-date equipment. You may also need to acquire multiple of the same type of equipment in order to fulfil multiple contracts at the same time, so leasing is very useful.
Leasing is a fairly straightforward arrangement. The leasing company, typically underwritten by a larger financial institution and regulated by the Financial Conduct Authority, will purchase the equipment on behalf of the construction firm. The construction firm then pays a rental to the leasing company, over a pre-agreed time period, plus interest.
Leases are typically most suitable when the construction firm doesn’t require the equipment on a permanent basis. So instead of buying expensive plant assets that then sit idle for parts of the year, depreciating in value, the construction firm pays a premium in the form of interest to the leasing company, in return for the benefit of being able to return the equipment when it’s no longer required, relieving the firm of the liability of fully acquiring and owning the equipment.
This is widely accepted as a more affordable means of acquiring expensive equipment.
Hire purchase – how it works
If you plan to use the asset regularly and over a long period of time, hire purchase is probably the more suitable form of asset finance.
Hire purchase is similar to leasing in that you make smaller regular payments rather than having to find a lump sum at the beginning, but there is a key difference in the structure of the arrangement.
As with leasing, the hire purchase company purchases the asset on behalf of the construction company. The construction company then makes regular payment instalments over an agreed period of time. These instalments typically include interest repayments.
During the hire purchase agreement, the hire purchase company retains ownership of the asset, so it does not count as a company asset and will not impact on any profit or loss projections.
Once the construction firm has made the final instalment, they have the option to pay a balance, or ‘balloon payment’ to purchase the asset outright. If they take up that option, they then own the asset.
The hire purchase company may also offer a new hire purchase contract for a newer asset, enabling the construction company to acquire for their use more modern equipment.
Benefits and drawbacks of asset finance
Leasing and hire purchase offer two key benefits to construction companies. Firstly, they provide access to assets that would otherwise be unaffordable or at least put a squeeze on cash flow.
Secondly, in most cases, the responsibility for maintenance and repairs lies with the owner – the lease or hire purchase company – so that’s one less thing for the construction company to worry about or pay for.
Unsecured business loans for the construction industry
Unsecured business loans represent a fairly straightforward route to finance, provided your business’s application is accepted.
This form of construction finance is targeted toward SMEs and smaller businesses, who typically aren’t going to require huge sums and are less exposed to the volatilities of global economics, commodities and labour markets.
Companies looking for funding in the region of £25,000 to £100,000 can access unsecured debt products far easier than larger firms looking to fund a larger-scale project in the millions.
The main challenge facing construction firms looking for unsecured business loans is in achieving acceptance. Lenders aren’t able to secure the debt against an asset, so need to exercise caution when agreeing to lend.
To that end, unsecured business loans for construction require an unblemished business credit history and the business needs to demonstrate its ability to repay the loan comfortably. Failure on any of these two criteria is quite likely to see the application declined.
Benefits and drawbacks of unsecured business loans for construction
As with unsecured personal loans, the benefits and drawbacks of unsecured business loans are fairly simple to deduce.
On the one hand, the loan is unsecured, so the lender is not able to repossess your assets if you default on the debt. But you’re going to pay for the privilege in the form of higher interest rates and fees.
One other characteristic of unsecured business loans is that they are relatively easy to apply for and decisions are fairly quick. This can either be a benefit or a drawback, depending on your situation. Quick applications and approvals are great if you’ve got a good credit history and can demonstrate your ability to repay, but if you can’t – and would like to discuss extenuating circumstances – the rigid approval algorithm that ensures the application and approval process is quick will most probably prevent this. The speed and ease of the application process may work against any firm that doesn’t have a straightforward application to make.
Bridging loans for the construction industry
Bridging loans are typically short-term finance options that enable a construction business to operate between two financial milestones. For example, a construction firm may sign a contract for a large project but may need to acquire finance quickly to purchase property on behalf of the client. In this case, a bridging loan could be useful for funding the property purchase until the construction firm can raise their first invoice and clear the loan.
Bridging loans are almost always secured against an asset, such as equipment, property or land. The main operational difference between a bridging loan and a mainstream secured loan is the speed with which a business can expect to receive the funds.
Most business loans take weeks to approve and the transfer of money isn’t always immediate upon approval. Bridging loans are generally designed to be approved and released within days, or sometimes hours, of application.
Due to their short-term nature, bridging loans typically have higher interest rates, but cost less overall because the interest is applied over a shorter time period. So, assuming the business can make the repayment at the agreed time, the cost of the loan is relatively low.
However, failure to make a timely repayment can lead to high costs in a very short period of time.
Bridging loans also differ from longer-term loans in that they can be converted into other types of debt. For example, a construction firm may take on a bridging loan to fund the purchase of property. That bridging loan may then be converted into a mortgage against the property after development or renovation work has started and the property has increased in value.
Benefits and drawbacks of bridging business loans for construction
Under the right circumstances, bridging loans are the perfect product for securing short-term finance to get a construction project up and running. But the risks are significantly higher than taking out an unsecured business loan.
In the fast-moving property market, bridging loans can prove invaluable in providing quick access to significant finance that can often be the difference between getting a project off the ground and not doing it at all.
However, failure to meet the terms of the loan can be very expensive.
To find out which finance solution is right for your construction business, get in touch with Funding Guru today.
