Contractors need different types of capital to run their businesses. They use long-term capital to finance equipment purchases and short-term capital to smooth out temporary fluctuations in cash flow. Here are the best loans for contractors with descriptions of their collateral requirements, application procedures and repayment terms.
Line of Credit
A business line of credit is a valuable and flexible source of funds for a contractor. It allows you to make “draws” as needed against the maximum approved line of credit. You will only pay interest on the amount of loan drawn down. If you repay the loan, you can come back later and borrow again. These types of loans are known as “revolving” lines of credit.
Lines of credit help smooth out short-term fluctuations in cash flow. They can be used to meet payroll expenses, pay suppliers and provide cash during slow periods. They can be drawn down at any time.
Lines of credit are usually secured by the contractor’s assets, such as accounts receivable, inventory and equipment. The amount of the loan is based on the lender’s appraisal of the worth of the company’s assets and its financial leverage. For example, a lender might advance 80% of the value of accounts receivable but only advance 50% of the book value of inventory and equipment. The maximum line of credit would be the sum of these appraisals.
The application and approval process for a line of credit is usually very quick.
From vehicles to high-priced heavy equipment, contractors need all types of equipment to perform their work. Equipment purchases for large amounts should align with the useful life of the asset. Equipment purchase loans are payable over several years, usually up to five years with monthly payments.
Lenders will require down payments of 10% to 20% but will finance the rest of the purchase price. This enables contractors to buy big-ticket items that may have otherwise been out of reach.
The collateral for an equipment loan is typically the equipment itself. This leaves the contractor’s other assets, such as receivables and inventory, available for collateral for other loans.
Small Business Administration Loan
Because of their long repayment terms and low interest rates, SBA loans are highly desirable. Lenders guarantee up to 85% of loans to contractors. This way, they have solid security in case the borrower defaults.
To finance long-term working capital needs and businesses with seasonal fluctuations, you can use funds from an SBA loan.
The hard part is that SBA loans are difficult to get. Only the most creditworthy applicants receive approval. Borrowers must have several years in business with good revenues and a strong credit history.
SBA loan applications require a considerable amount of paperwork and can take several months to get approved. SBA loans are highly desirable if you have the credentials and time to wait.
Accounts Receivable Financing
Under an accounts receivable financing agreement, the lender agrees to make advances up to a certain percentage, say 80%, of the contractor’s total accounts receivable outstanding. Repayment terms are either weekly or monthly. The contractor retains ownership of the receivables and assumes the risk of non-payment from the customer.
To make up short-term deficits in cash flow as needed, use funds from an accounts receivable agreement.
Invoice financing, also known as factoring, lets a contractor receive an advance against the company’s receivables. The factor typically will make an advance to the contractor of up to 80% of the invoice amount and collect the balance from the client at due date. Funds from factored invoices normally go into the contractor’s bank account the next business day.
In a factoring agreement, the lender, known as the “Factor”, purchases invoices from the contractor. They assume the responsibility of collecting the debt. Factoring fees can range from 2% to 4% of invoice value.
Approval for this type of invoice financing is based more on the creditworthiness of the contractor’s customers than the credit rating of the contractors themselves.
Loans for contractors range from lines of credit and receivables financing to meet short-term cash needs to equipment loans and SBA loans for long-term purposes.