Construction subcontractors face a tough challenge from the industry’s traditional financial processes: they are effectively financing the projects they work on, despite perhaps being the least able to bear that burden. Subcontractors’ expenses, such as payroll and materials, are outlaid long before payment is received – while the general contractor waits for the owner to pay – creating the potential for serious drain on working capital. Without adequate working capital, subcontractors face fundamental business challenges, not the least of which is difficulty taking on new work, and growing and expanding.
Changes in the financing landscape are adding to subcontractors’ business challenges. Traditionally, banks have been the main option for subcontractors in need of working capital, but borrowing has become more expensive and difficult. In the years following the global financial crisis, banks have become increasingly risk averse. Today, credit standards remain tight, and new regulations require banks to keep more capital on hand, which may both curtail their ability to lend and limit their appetite to provide financing to smaller organizations. To fill the working capital gap left by the changes to traditional banking, alternative financing tools have emerged in recent years. One such tool, called supply chain finance, offers subcontractors an innovative and cost-effective way to access vital working capital.
Supply Chain Finance Explained
In simple terms, supply chain finance (SCF) enables buyers of goods and services to maintain or enhance their own working capital while also improving the working capital position and cash flow of their suppliers through accelerated payment. The other key players in this process are third-party funding sources, which provide the early payments, and a technology platform to facilitate the transactions.
Also known as approved payables finance, SCF has been successfully used by blue chip companies across multiple industries for more than a decade. Some estimate as many as 3,000 programs are currently in use by companies ranging from Procter & Gamble to Rolls-Royce.
In response to difficult credit market conditions, the use of supply chain finance has grown in many industries in recent years, yet it still is not particularly well understood by the businesses that could benefit the most: the smaller suppliers who can take advantage of the earlier payments. In the construction industry, alternative financing has the potential to expand the options available to subcontractors, addressing the structural challenges of the traditional payment process and mitigating the impact of both slow payments and constrained conditions in the credit market.
New School Tools
By changing the flow of funds in subcontractor payments, construction supply chain finance programs can enable general contractors to dramatically shorten payment times for their subcontractors.
In such an arrangement, a general contractor works with an SCF program provider to arrange third-party funding of subcontractor payments. Subcontractors are offered the option of participating in the program at a modest cost, often in the form of a fee or discount. Rather than waiting weeks or even months for payment under traditional processes, participating subcontractors can be paid soon after invoices are approved, as there is no need to wait for the project owner to supply funding for payments. In essence, because such programs leverage the strength of the general contractor’s balance sheet, subcontractors potentially can get access to working capital at more favorable rates that they would be able to obtain on their own.
Critical to the success of SCF programs is the use of a technology platform that ensures that the construction industry’s complex payment transactions are handled in a way that provides the needed level of confidence to the funding entities. Indeed, third-party funders in many cases have historically shied away from participating in construction industry SCF programs due to the nature of the payment process and the industry’s litigious nature, among other factors. But robust construction payment management technology has made supply chain funding a viable and attractive option for general contractors and their subcontractors.
Such tools automate and simplify the invoicing and payment process – routing, data entry, exception handling, approvals, etc. – and can reduce risk by boosting transparency, bolstering compliance and even handling lien waivers. More than recouping the valuable time and energy spent on each stage of the process, automation creates invoices that a SCF financing partner can be confident are “clean” and free of liens – key factors for invoices eligible for accelerated payment through supply chain finance. The right payment management applications eliminate the barriers, including risk and compliance concerns, that have kept third-party SCF funders from investing in the construction industry. In addition, these tools can make program enrollment fast and easy for subcontractors, compared with the protracted and involved paperwork involved with traditional financing applications.
With construction supply chain finance programs, subcontractors gain access to much-needed working capital that is cost-prohibitive or unavailable in current credit markets. This new source of non-debt working capital can improve cash flow, strengthening subcontractors’ balance sheets, mitigating business risk, giving them new competitive advantages and providing the capital they need to grow. Indeed, subcontractors participating in early payment programs welcome the option and report that they are being paid much faster than they are on projects with no such program.
Major players in the construction industry have begun to recognize the power of supply chain finance to strengthen general contractor/subcontractor relationships. Turner Construction, the largest commercial builder in the North America, launched a supply chain finance program this year that is supported by technology from Textura Corporation, a construction collaboration solution provider.
A technology-driven approach to supply chain finance unlocks funds tied up in the construction supply chain, providing faster, more predictable payments for subcontractors, as well as improved working capital and stronger partnerships industrywide. That’s a genuine win-win proposition for the entire industry.
Mike Antis is Executive Vice President of Client Services for Textura Corporation, a leading provider of online collaboration solutions that improve outcomes across the construction project lifecycle. Textura’s Early Payment Program (EPP™), which was launched in 2015 in partnership with supply chain finance experts at Greensill Capital, is the first broadly available construction supply chain finance program.