The Fading Access to Affordable Capital
Prime lending rates have exploded beyond pre-pandemic averages, reaching a 15-year high in February 2023. Compared to March of last year, the prime lending rate increased over 75%, and increased 82% compared to the March 2020-Feb 2022 period.
Access to capital is fundamental in construction as trade contractors effectively fund the startup costs of a project by paying for materials and labor long before they are paid for their work. The average trade contractor profit margin before interest is typically around 10-12%, meaning they need to borrow below that rate to maintain a sustainable operation. As the prime lending rate has soared above 7.5%, many trade contractors don’t have the balance sheet required to access capital within the narrowing target range required to maintain their operations.
The Bottom Line
Construction activity is comparable to pre-pandemic levels, but borrowing is nearly 50% more expensive compared to the same 3-year pre-COVID period. As a result, trade contractors are now faced with a difficult choice: scale back, or borrow at unsustainable rates that will serve only to seal a prolonged inevitable downfall.
Lack of capital undoubtedly causes trade contractors' businesses to suffer, but the problem has quickly become endemic, causing severe consequences for General Contractors:
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General Contractors are in desperate need of reliable, well-funded Trade Partners to maintain project stability, keep project costs in check, and mitigate the risk of subcontractor default.
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An untold number of active Trade Partners may have already found themselves in a high-risk financial situation that could affect project performance and lead to default.
An Unexplored Opportunity for GCs:
Invoice Financing
In order to accelerate payments, some General Contractors leverage their own balance sheet to offer accelerated payments or pay for materials on a case-by-case basis. At a larger scale, some may offer their own invoice financing program, like Turner’s Accelerated Payment Program, which launched in 2014 to alleviate some financial burden for their trade partners, reduce project risk, and lower costs. With over $15 billion of annual revenues, Turner may have the cash necessary to support an invoice financing program at this scale, but it isn’t a viable option for most General Contractors due to development resources and capital constraints.
"Simple" solutions sometimes require complex processes. Paying approved invoices sooner, paying upfront for materials, supplies, or equipment all put strain on a General Contractor's balance sheet and require internal systems and processes to support. While traditional invoice factoring has faced a contentious reputation in the construction industry, the underlying financial mechanics place little burden on the General Contractors' finances when applied in appropriate circumstances.
A New Approach to Invoice Financing:
Early Pay Program
Constrafor’s Early Pay Program (EPP) was developed to help both General Contractors and Trade Partners with a mutually beneficial partnership that aims to improve the financial health of trade contractors and reduce risk for all parties involved.
With EPP, General Contractors can now leverage their collective bargaining power to negotiate a favorable invoice financing rate for their Trade Partners. In other words, General Contractors utilize their scale and superior balance sheet to negotiate a lower financing rate than their Trade Partners could obtain independently. Constrafor then pays their Trade Partner in as little as 24 hours after the invoice is approved, less the negotiated fee.
When a General Contractor opts into the program and negotiates a rate, they agree to pay Constrafor for the value of their approved invoices regardless of any offsets. In return, Constrafor funds the invoice and rebates the General Contractor for SDI premiums, closing the loop on the subcontractor default risk.