Understanding Why Construction Contractors Fail
Looking for a risky career? Try being a real estate contractor—it’s one of the riskiest businesses around.
Contractors will be the first to tell you about the large number of ways their businesses can fail. Some are obvious; others lurk beneath the surface and only reveal themselves after it’s too late. At Marcum, our Real Estate and Construction Group has seen large contracting firms fail, and we’ve seen small firms go by the wayside as well.
While the size and scope of the failings may vary, oftentimes, the reasons behind them fall into one of three broad categories.
Failure #1: Overextension. Contracting firms are always hungry for work; after all, it’s the lifeblood of their business. Accordingly, a tendency is to take on too much work, and not have the requisite resources to complete it.
Firms also can take on projects outside their scope of experience. Entering new specialty areas is both difficult and risky; it can expose contracting firms to a number of potential liabilities that may ultimately be their undoing.
There are several warning signs that point to overextension:
- A shortage of working capital
- A high degree of under-billings
- An increase of bank debt
- A significant increase in job backlog
If you’re a contractor, how can you address overextension issues? Consider these solutions:
- Faster collections and slower disbursements – Hire someone who can help collect accounts receivables, and ensure that accountants are billing in a timely fashion. You should also ensure that your subcontractor terms are the same as those you have with your client or customer. You shouldn’t have to pay your subcontractor until you are paid by your client or customer.
- Try to set up your contracts so that they front-load cash
- Invest excess cash prudently
- Identify disputes early. This should entail regular conversations with project managers and your management team to understand how jobs are proceeding – i.e., timing, budgets, contingencies and issues.
- Make sure to document everything and get change orders signed. If conflicts end up in court, whomever has better and more thorough documentation usually wins.
- Schedule and budget for billings and collections, including projecting the billing amounts by month.
Failure #2: Operational Deficiencies. These types of problems generally manifest themselves in one of two ways:
- Project performance – One bad job – i.e., one job that goes wrong for any number of reasons – can cause a resource shortage on other jobs, potentially necessitate taking on additional debt, and affect firm performance and capabilities relatively quickly.
- Accounting / budgeting issues – If the firm lacks personnel with experience in a project’s specific market sector (e.g., educational, industrial, health care), then estimated and real costs could be unrealistic, which in turn, can cause major cash flow issues.
Managing cash is critical, for any business, and contracting firms in particular. If possible, contractors should strive for contractor-friendly billing contracts that allow them to bill work early. This means the client’s or customer’s financing pays for the work to be done—not the contractor.
Additionally, performing job costing correctly is essential. When it’s not done properly, it can be difficult to identify poorly performing jobs and being able to consistently bid work correctly. For example, when the project manager doesn’t get accurate costs into the job, the result can be missing costs and the evaluation of results based on bad data.
So, how can contractors address operational challenges?
- Implement a better change order management process – Keep proper documentation for all work performed, and utilize qualified legal counsel who understands real estate and construction. They can provide invaluable help with regard to claims and potential litigation.
- Have the right project manager or managers who understand specific job contracts—and specifically, what’s in-scope and out-of-scope. Any and all project managers should ensure that job-related information is shared in a timely manner with other identified personnel in the firm.
Failure #3: Lack of succession planning. Fewer than 33 percent of businesses survive a second generation. So often, this is because they did not devise and implement a proper succession plan that ensures the firm is in good hands when a transition ultimately occurs.
When it comes to proper succession planning, there’s a multitude of questions and issues to consider, including what type of succession plan to use (e.g., Employee Stock Ownership Program (ESOP), sale of stock, new company, buy-in).
Some go-forward strategies for contractors to consider when it comes to succession planning:
- Work with a qualified professional succession advisor to research and discuss various plan options.
- Develop a process to select the proper successor (or succession team).
- Start developing that person (or team’s) knowledge base and abilities as soon as they are identified.
Set key milestone dates for implementation of a succession plan (e.g., research exit strategies, identify potential successor, set up training for successor, meet with advisors) and communicate with stakeholders regularly.