For many construction businesses, at some point the old adage “you have to spend money to make money” applies. Whether to fund a start-up, expand or invest, the need for cash arises.
Large, well-established construction companies are well versed in borrowing to earn, says Andrew Latham of SuperMoney.com, a financial products and services comparison website. “Such construction companies understand that ‘good debt’ promotes growth and helps manage risk,” Latham notes.
Latham says the same principle applies to smaller construction firms. “View business loans as an investment opportunity,” he advises. But he says to proceed with caution. “If borrowing money won’t eventually make you money—or makes a bad situation worse—a loan is not a good idea.”
Why you might need a business loan
Some valid reasons to get a business loan include investing in equipment that allows you to accept larger jobs or reduces the expense of leasing equipment. Other viable reasons include recruiting new talent, modernizing your facilities, or opening a new office in an up-and-coming location.
Paige NeJame has owned the CertaPro Painters of the South Shore & Boston franchise since 1998. She’s currently applying for a Small Business Administration (SBA) loan to finance a building she’s buying.
“I have an SBA-backed credit line that’s been imperative to the growth of my business,” says NeJame. “I only use the credit line to float my accounts receivable in order to be able to cash-flow large commercial painting projects. My rule of thumb is that whatever is used on my credit line has to be equal to or less than my accounts receivables.”
Types of business loans to consider
Several business loan sources exist. These include small and large banks, many of which service SBA loans. Other options include online lenders and community development financial institutions (CDFIs).
According to the 2016 Federal Reserve Small Business Credit Survey published in 2017, the lenders who most often approve loans for firms with annual revenues of less than $1 million are CDFIs (77 percent), small banks (60 percent), and alternative online lenders (59 percent).
Companies with annual revenues of more than $1 million are more likely to get approved with a large bank (84 percent) or online lender (77 percent) than the lower-profiting companies are.
“When it comes to loan types, secured loans that use property as collateral, like auto and equipment loans, have the highest approval rates, at 79 percent,” says SuperMoney.com’s Latham. “SBA loans have lower approval rates and typically a slower funding timeline.”
If you can qualify for an SBA loan, NeJame has found that the terms are business-friendly. “With the mortgage I’m applying for now, a few commercial lenders offered 25 percent down and a 6 percent interest rate, but the SBA loan is only asking for 10 percent down and a 5 percent interest rate.” She also says getting an SBA loan is easier than it was a few years ago. “In the old days, a business owner had to work with the SBA directly, but my bank has facilitated the process.The approval takes much less time.”
Tips for getting a business loan
Putting your best financial foot forward is the key to getting a business loan. Latham offers the following tips for helping to ensure funding:
- Write a business plan. “Some lenders require businesses to provide a detailed business plan. Even if the lender doesn’t require a formal business plan, having one helps you run a smarter and leaner company,” says Latham. “In the plan, explain what you’ll use the money for and a realistic expected return on investment.”
- Calculate your debt service coverage ratio. “To determine if you can afford a loan, divide how much cash-on-hand your company typically has at the end of the month by the monthly payment of the business loan,” recommends Latham. “The result is your debt service coverage ratio. Although lenders will consider lower ratios, aim for 1.5 or higher. The higher the ratio, the less likely you are to miss monthly payments, which is something lenders like to see.”
- Compare rates and terms of several lenders. Latham advises using loan comparison tools to see which lender offers the lowest rates and the best terms. “The eligibility criteria, fees, funding timeline and rates of business loans vary widely.”
Securing funding is a necessary part of running a profitable construction company. Borrow responsibly, and you can use the funds to take your company to the next level.