Contractor Financing

A Financing Primer for Government Contractors© When Significant Capital Needs Precede Customer Payments on Government Contracts Richard W. Lewis, Numero Uno, Financial EngineeringCounselors, Ltd.

The Good News: Your Company has landed a new Government contract, one that will result in a significant increase in revenues.

The Challenge: In order to fulfill this contract, you must immediately commit to additional people (payroll), training, materials, and related costs. This commitment must be made in advance of receiving payments from your customer (the US Government). Unfortunately, the amount of capital needed to cover your commitments exceeds the balance available on your existing line of credit or your credit card. It also exceeds the amount of cash that could be made available by delaying payments to selected vendors. The nature of this contract might justify issuing new equity or debt, but raising capital generally is an expensive, complex task that ultimately may take too long to meet your short-term contract specific capital requirements.“

While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second. Whether you are starting a business or expanding one, sufficient ready capital is essential. However, it is not enough to simply have sufficient financing; knowledge and planning are required to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the amount required, or underestimating the cost of borrowing money.”

Solution – Planning!

In order to minimize the risk of your company having to scramble to raise enough capital to ramp up for future major contracts, your internal business development forecasting process should identify and signal situations early to senior management. This will allow for a pro-active review of any significant operational, personnel, and financial impacts. Specific terms may be negotiated into the customer’s agreement to dampen these impacts. Such terms may include extended delivery dates, partial payment upon order placement, or progress payments based upon specific performance criteria.

Existing Bank or Lender

If your company has an existing line of credit or borrowing arrangement with a bank or other lender, try to negotiate an increase with them. A responsive lender may provide all of the short-term capital needed until the Government agency begins payment. You should be aware that trade-offs of a significantly higher level of credit might involve committing to a new long term deal, additional loan covenants, greater reporting requirements, and/or higher interest rates. In addition, your credit agreement may constrain your ability to take on other types of debt or lease obligations.

In any event, it is best to discuss the situation as far in advance as possible and have a full financing/business plan and presentation available. Remember, LENDERS HATE SURPRISES. If your company does not have an accommodating lender, the following alternatives should be considered:


This is the sale of your invoices, accounts receivable, to a bank or finance company (the “Factor”), as opposed to using them as borrowing collateral. The Factor will advance a percentage, usually between 75% and 90%,of the invoice amount to the customer; the balance is refundable upon receipt of payment, less interest and transaction costs. Some Factors may also provide weekly or mid-month, funding of unbilled accounts receivable, mobilization financing for new contracts, and/or “term loans” for multi-year contracts. The Factor will, through the Federal Assignment of Claims provisions, notify the Federal Government agency customer that the invoice has been financed and is payable directly to them. There are several advantages to factoring; most of the A/R bookkeeping, customer credit worthiness, collections, and credit risk become a shared responsibility with the Factor, and the initial approval process can usually be a matter of days. In addition, because the primary credit criteria is based on your government customer, the federal, state, or municipality, a Factor will generally provide financing for start-ups, 8a,minority, Native American, disabled veteran, woman owned contractors, or other companies that may have a questionable credit history.

Although sometimes more costly, it is a viable alternative to traditional bank financing because of its increased flexibility. In addition, many Factors will provide a “financial support” letter, submitted with the proposal, to the Government agency insuring that their institution’s financial strength is behind the client. Contract Financing/Purchase Order Financing- You may be able to negotiate financing based upon your Federal Government customer Purchase Order(s). Some lenders provide Purchase Order financing based upon the credit worthiness of your customer (in this case the US Federal Government). PO financing is easiest when your products or services are well established. If your products are new, services are non-standard and/or unproven, PO financing is more difficult to obtain. The effectiveness of contract/PO financing in a pre-revenue ramp up situation will be determined by how soon your company can invoice the customer.

Commercial Financing-Asset Based Lending

This is a common type of financing provided by most banks and commercial financial companies. The primary asset used in this type of lending is your company’s accounts receivable, although inventory, fixed assets, and in some instances, intellectual properties may be used to collateralize additional long term financing requirements. With asset based lending your, as well as your customers’ creditworthiness will determine the percentage of the receivables that will be advanced, usually between 75% and 90%. Inventory and fixed assets advance rates are most often significantly lower because these are less liquid assets. This financing is almost always provided on a revolving or an on-going basis, thus the term “revolving credit.”

Leasing and/or Sale and Leaseback

These financing alternatives can be used to generate capital from fixed assets that are to be obtained or currently owned by your company, such as computers, equipment, furniture and fixtures, vehicles, and real estate. Banks, financing companies, dealers, and manufacturers provide these more specialized services. Your company’s credit standing and the quality of the assets involved will determine the amount of cash that can be raised and the terms under which it is provided. The specifics of the agreement will determine if these leases have to be reported on your company’s balance sheet or if they can be treated as “off balance sheet” items.

SBA Loan

The SBA offers numerous loan programs to assist small businesses. It is important to note, however, that the SBA is primarily a guarantor of loans made by private and other institutions. The Basic 7(a) Loan Guaranty serves as the SBA’s primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. It is also the agency’s most flexible business loan program, since financing under this program can be guaranteed for a variety of general business purposes. Loan proceeds can be used for most sound business purposes including working capital, machinery and equipment, furniture and fixtures, land and building(including purchase, renovation and new construction), leasehold improvements, and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.

SBIR and Grants: SBIR (Small Business Innovation Research) is a federal government program administered by 10 federal agencies for the purpose of helping to provide early-stage Research and Development funding to small technology companies (or individual entrepreneurs who form a company). Solicitations are released periodically from each of the agencies and present technical topics of R&D, which the agency is interested in funding. Companies are invited to compete for funding by submitting proposals answering the technical topic needs of the agency’s solicitation. Each agency has various needs and flavors of the SBIR program and you can learn more about them by visiting their sites.

Here are the addresses for the:


None of the alternatives mentioned above are mutually exclusive. In many cases, combinations can be very effective. However, there are significant legal and operational differences in these financing arrangements. The terms of some borrowing agreements may limit your ability to take on additional debt and they should be entered into only as part of a coherent financing strategy. Do not be alarmed when the lender asks for your personal guaranty. Personal guarantees are virtually standard for all but the most credit worthy and/or public companies.

Richard W. Lewis, Numero Uno, Financial EngineeringCounselors

K-WAM Financial Solutions can help you with mobilization funding and with factoring.

Learn more about receivables factoring in this article written by Marco Terry about how construction companies can finance their companies.

Most small and midsize construction subcontractors don’t have access to business financing. Sure, they need it and could use it. But, it’s simply not an option. The main reason is that most subs are not well prepared to meet bank financing requirements – such as providing business plans, balance sheets, forecasts, etc.

To complicate matters, most banks are not comfortable lending to construction companies in general because of industry risk. Those that that do lend to construction subcontractors, will only provide financing to companies that have sizable assets, solid collateral, and a long track record of profitable operations. Realistically, this is not an option for most subcontractors.

As a subcontractor, you do have some alternatives. Here are three common reasons why subcontractors look for financing and how to finance them.

Reason #1: You are just starting out

Unfortunately, there are few financing options for brand new companies. This doesn’t just apply to the construction industry – it applies to every industry. Getting startup financing is close to impossible. Realistically, your only bet is to use your own money to get started.

It’s really up to you. You will need to raise the capital privately, which often means from friends and family. This article provides some startup financing alternatives. But often, they boil down to one option – your savings. This is one of the reasons why many subcontractors start small and grow slowly.

Reason #2: You need mobilization capital

This is a common situation in the industry, where the subcontractor needs funds to get the project started. They need funding to cover some expenses, to move equipment, place initial orders, and hire subcontractors, etc.

Getting a project funded at this stage is possible, at times, but very difficult. The problem lies on the fact that the project has just started and no services have been provided. Lenders are concerned about the worst case scenario – they pay for mobilization expenses and the construction contract is cancelled. That leaves them out of their money, and everyone involved in a difficult position.

Companies that do provide this type of funding tend to work on local projects. Because of this, making a specific recommendation is difficult. One alternative is to talk to local factoring companies – especially those that specialize in construction. Many of them get requests for mobilization capital and should be able to refer you to a provider.

Reason #3: You can’t afford to wait up to 60 days to get paid by General Contractors or commercial clients

Cash flow problems can be very common for construction subcontractors. They usually happen because your general contractors (or commercial clients) can take 30 to 90 days to pay your invoices. However, you need to pay your own company expenses quickly – especially employees, suppliers and subs. Most subcontractors are not prepared to handle this common situation. Fortunately, there are a couple of ways to fix this problem.

If you need less than $30,000, you should consider a Micro-loan from the SBA. I’ve talked about them in this article, where you can get more details.

Another alternative is to use construction receivables factoring. This type of financing provides you with an advance, using your invoices from commercial clients as collateral. Instead of waiting for payment, you can use the financing proceeds to run your business. You can settle with the finance company when the final payment is made.

The financing transaction is usually divided into two installments. The first installment, called the advance, follows the flow of this diagram. The advance can range from 60% to 75% of the net receivable.

Value: The transaction settles once the invoice is paid in full by the general contractor or commercial client. At that time, the factor remits the remaining funds – less the fee. This diagram shows the settlement part of the transaction:

An advantage of construction factoring is that it’s easier to get than conventional financing solutions. However, factoring transaction only work if your customer – the company paying the invoices – has good commercial credit. Most factors check commercial credit by using one of the well-known credit bureaus. By the way, these are Dun and Bradstreet, Experian, and Cortera.

Also, this transaction will require the cooperation of your clients and General Contractors. They will need to approve the invoices and verify that the work was completed according to the contract. Obviously, this will only work if you have a good relationship with your client.