Top Reasons Why Contractors Can’t Get Loans

Commercial and residential building contractors and sub-contractors have historically been considered high risk borrowers. As such, contractors have found it difficult to get financing from commercial banks. The following will summarize the reasons for concern that commercial lenders have when underwriting these customers. Hopefully, this insight will allow contractors looking for financing the ability to position themselves in a way that can mitigate the concerns of the lenders. Furthermore, this article should give an bank lender without experience in the industry some ideas as to the possible critical issues that these credits face.

 construction contractors at work

Some background

The construction industry is the ultimate example in diversification. Not only do we have different types of contractors {General, Electrical, Roofing, Plumbing, etc.}, most of the contractors within each segment are typically small firms. Take for example the electrical contracting industry, which is one of the largest subcontracting sectors in the United States. As of 2012, about 900,000 people in an estimated 200,000 firms are employed in the electrical contracting industry. However, most electrical contracting firms are small with more than 55% of the electrical contractors employing fewer than five individuals. At the same time, less than 1.0% of electrical contractors employ more than 250 people. Similar distributions can be found in most types of contractors.

Financing needs of contractors

Typically, a contractor will need three main types of financing:

a)      Working capital lines of credit.

b)      Equipment loans

c)      Owner occupied real estate

From time to time a contractor would decide to build for himself with the intention to sell the property. That type of financing is not considered a loan to a contractor, that financing is considered a loan to a developer and should be looked at cautiously as there are additional risks associated with being the developer that a contractor might not be experienced enough to meet.

Why are contractors considered high risk borrowers?

When the economy catches a cold, contractors catch pneumonia. The industry is particularly impacted by cyclical and seasonal fluctuations, as well as labor problems, and the failure of subcontractors to perform or deliver. The following is a list of specific risks associated with lending to contractors that I have encountered during my years as an underwriter:

The bonding issue. Most contractors are required to be bonded in order to be eligible for sizeable contracts. The bond is a commitment by a third-party {the bonding company} that a particular contract obligations will be fulfilled. The bonding company essentially takes over the contractor’s obligations. The problem from the point of view of a lender is that in most cases the bonding company will have a priority lien on accounts receivable. This means that in case of liquidation, receivables due from bonded contracts will be paid to the bonding company and not the bank.

The other bonding issue. A lot of times a contractor will approach a bank asking for a line of credit for bonding purposes. These lines are usually never utilized. However, it should be understood by the lender that these types of lines present a risk of their own as advances would only be requested at a time where the contractor has met with difficulty completing a bonded job. This does not mean that lines of credit for bonding are necessarily a bad idea. It only means that they should be recognized for what they are “A requirement by a third-party so that the ability is there for them to be made whole and avoid having to take over a project from the contractor”.

A successful contractor requires the mastery of several skills, which might not be present in a small firm. As mentioned earlier, most contractors are small. In fact, they are usually born from the desire of a tradesman to create his own firm. While the firm’s founder might be very skilled at the trade, he might lack the ability to do the following:

  1. Accurately bid on projects.
  2. Manage the books in a way that meets contractor accounting methods such as “percentage of completion”.
  3. Manage the billing process so that projects are not seriously overbilled or under bill creating cash flow problems.
  4. Ability to leverage connections to keep a stable and growing pipeline of business.


For more information about contracting financing and small business lending, you can buy the following books at Amazon:

Construction Business Management: What Every Construction Contractor, Builder & Subcontractor Needs to Know
or The SBA Loan Book: The Complete Guide to Getting Financial Help Through the Small Business Administration

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