Raising finance and ensuring good cash flow for the smooth running of your construction business is tough. Financing new projects can be even tougher.
According to the EU construction sector observatory 2018, the construction of buildings, in Denmark, grew by 17.2% between 2010 and 2016. And the number of new buildings in the housing market has grown by 15.6% over that same six year period.
There are many opportunities.
Seasonality, competition and new opportunities for growth make having access to capital very important. In the past, accessing cash has been a minefield. But today, new products are entering the market. Products that are fair and sustainable.
This guide will explore your options, old and new, to give you clarity on what you’ll need for your current, or future projects.
There are four main reasons to get finance for your construction project:
- To purchase equipment and materials.
- Paying subcontractors on time.
- Hiring and training employees.
- To pay for any damage caused to a property
But I’m sure you already knew that. So let’s dig into some deeper questions.
What do I need to watch out for?
Expect a large deposit
You’ll need to put up a deposit of around 25% before anyone will consider lending you the money.
A lengthy application process
Be prepared to engage in a long and thorough application process. A lender will want to see a detailed plan. Information about your subcontractors, to ensure they’re qualified. A detailed timeline. Floor plans, architectural drawings, cost of materials, surveyor and legal fees, planning permission and more.
Paperwork, paperwork, paperwork
Getting a loan of this size isn’t going to happen online. That means you’ll be visiting the bank again. The good news is that lenders will help you fill out the application forms to increase your chances of getting finance.
So what do I need to get started?
Lenders consider construction finance to be very risky. You’re going to face tough requirements. Before you start looking for lenders, we recommend that you’re aware of the below and can confirm that you meet all of the requirements.
It’s worth mentioning again; you’ll need a deposit of 25%, at least.
Strong personal credit
With a loan of this size, many lenders will want access to your personal credit information. Sadly, the advantages of a limited company being detached from your personal information, diminish here. You (and your family) will be personally liable if anything goes wrong.
A lender will want to see your current and past debt and payment history. They’ll want to know what loans you already have on the property, too. You’ll be asked for financial statements, tax returns and proof of other assets.
On top of having a great personal credit rating you and your business should have a great reputation for completing complex building projects and paying back money owed in a timely fashion.
A lender will want detailed plans of the project you want to take on. This means working with other professionals, surveyors, architects, structural engineers, before being suitable for construction finance.
Lenders of construction finance work with professional appraisers. These appraisers will analyse your project before giving you the money. They compare your project to other, similar, existing construction projects. This gives them an idea of how much your construction will be worth in the future.
A good appraisal will improve your chances.
A construction loan is a short-term loan used by construction companies, home builders and buyers, used to finance the build of real-estate projects. Unlike a mortgage that’s used to buy a house.
These loans are often used to cover the costs of a project before obtaining a mortgage or long-term finance (for the construction companies).
These loans are often risky, so expect high interest rates.
These short-term (often one year) construction loans are very important for contractors and subcontractors because, often, the lender will pay funds directly to them, rather than the borrower.
It’s also likely that the payments will come in installments as your project flows from one stage of development to the next.
How does this work in the real world?
You come across a great plot of land for development but you don’t have the funds available. It’s going to cost 6M DKK. So you contact the bank for a loan. You estimate the project will take one year to complete. The bank agrees and secures a one year construction loan for you.
But you don’t need all of that money right now.
So the bank gives you what you need to cover costs for the first month. Let’s say 500.000 DKK.
Like a line of credit, you now only pay interest on what you’ve used. Great, you save some money.
This continues throughout the project. You take what you need to complete each phase and then you move on.
Until you get the end of the year.
This sounds pretty good but what are the downsides?
What happens if the project runs over? The loan is only secured for one year. After that you’re going to have to seek longer term finance.
Plus, Many lenders require a large deposit payment before giving you access to this. Often 25%.
So if you’re cash poor, or have a limited credit history, expect to find this option difficult. Collateral will have to come from elsewhere as, currently, the construction isn’t built. You will also have to give the lender a comprehensive plan and proof that your building team is qualified to take on this project.
Some lenders may lend to you even with a lower credit rating and collateral. However, expect to pay a lot more.
What influences the price of the loan?
There are many factors that influence how much you might end up paying for your construction finance. Some of these are, broadly speaking, “fixed” and there may be little you can realistically do to influence them.
They might include:
- the inherent risks associated with your proposition. By definition, some construction projects are likely to be deemed higher risk than others and that might affect pricing;
- the policies of a potential lender/investor. Some such entities may have very rigid lending practices that may demand a certain minimum level of pricing;
- background economic and financial market forces;
- the overall objective status of your business (funding may inevitably cost more if your business is in poor health);
- government policies, laws and the regulatory framework.
Project financing is made for large construction and infrastructure projects.
Lenders tend to rely on the project’s cash flow for repayment. It’s likely that you’ll be required to put up the projects assets, rights and interests and collateral, too.
If you’re working on a major project, this type of funding could be right for you.
Project finance for large scale projects often includes a special purpose vehicle.
According to Investopedia [a] special purpose vehicle, also called a special purpose entity (SPE), is a subsidiary created by a parent company to isolate financial risk. Its legal status as a separate company makes its obligations secure even if the parent company goes bankrupt.
This new entity, the SPV, then carries out the project through subcontractors.
At this stage, there is no revenue. So you’re taking massive risks during construction. Unfortunately, this means you’re typically liable up to the total amount of your shareholdings.
Great. But what about if you’re already working on a project but you don’t have enough cash to pay subcontractors, hire additional equipment and materials? A construction loan is out of the question and project financing, for your requirements, is just too expensive.
You could try an alternative, like Fellow Pay.
Fellow Pay: an alternative to expensive project financing
If you’re an SME owner that’s been denied funding or doesn’t have the time to go through the process of borrowing money to pay subcontractors, Fellow Pay could be a great fit for you.
Let me explain with a short customer story.
Freddy is a subcontractor who needs to get paid fast for work he’s done for his contractor, Vts Montage ApS.
But there’s a problem.
This multi-phase project isn’t finished and Vts Montage won’t get paid until later. What can Freddy do?
The banks are expensive, slow and complicated. Freddy doesn’t have a good enough credit rating, but Vts Montage, his larger customer, does.
So, unlike the other lenders, Fellow Pay can help him.
Freddy and Vts Montage make a credit stretch together. Freddy gets paid instantly and Vts Montage gets 90 days of credit, for just 1%.
A credit stretch allows you to be paid immediately and gives your buyers 60 days to pay us back without interest.
If your customer chooses to, they can extend that payment term to 90 days for just 1% of the invoice amount (between you and them).
Unlike bank loans, a line of credit, invoice financing and factoring; a credit stretch benefits both the buyer and the seller (the invoice issuer and the invoice receiver).
Invoice issuers are suffocating under the pressure of long payment terms. In many cases acting as a lender to their larger and more liquid customers. They need money now.
Invoice receivers want to reduce the risk of long production cycles and minimize the need for expensive project financing. They want to extend credit for free.
A credit stretch is also very fast. Less than 5 minutes to set up an account. Once set up on the system, getting the money from a credit stretch happens immediately after you and your customer sign the agreement.
So you won’t be waiting six months (bank loan), a few months (line of credit), or even days (invoice finance and factoring). With a credit stretch, you’ll get your money instantly.
A credit stretch avoids the issue of harming your customer relationships, like factoring, by offering great value (in the form of free credit) to your customers.
If your client doesn’t pay their invoice it doesn’t affect your credit rating or ability to borrow money again.
There’s no physical meeting, no financial interrogation and no paperwork.
Uniquely to Fellow Pay, you will get finance even if you’re not deemed creditworthy. We’re only interested in the creditworthiness of your customer.
And it costs just 3.75% of the invoice amount as a one time fee. That’s it. No hidden costs. No unexpected additional fees. Instant invoice payments, credit rating, bank transfer fee and invoice insurance all included in one set fee.
Still wondering whether a construction loan, Fellow Pay, or another option is the best choice for your construction project? We’d be happy to help. Get in touch.