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When Banks Won't Lend: Alternative Sources of Financing for Construction Firms

If it's true that the construction industry is a key part of the engine that powers the U.S. economy, then it only stands to reason that access to financing serves as the motor oil that keeps all the engine parts in good condition and running smoothly.

There are numerous ways to secure financing; methods run from the traditional to the extremely creative. But the one universal challenge that any construction firm faces - at almost any stage of growth - is to find the method (or combination of methods) that fits its own unique set of goals and circumstances at a particular point in time.

Factors like company size and maturity, market niche, credit history, potential for growth and local market conditions all inevitably play into the equation. Also important is the cost of borrowing those funds, because rates vary widely from source to source.

Traditional bank loans have been the go-to method of financing for hundreds of years, and they remain the first resource that most firms turn to for either a short-term line of credit or a longer-term loan.

But although the recession may be winding down, banks remain in a stubborn mood. A recent survey conducted by Pepperdine University showed that even though banks report an increase in the volume and quality of loan applications, they continue to turn down the vast majority of them (74 percent).

To increase your chances of success, it's best to build a business relationship with a bank well before you need to ask them for funds. Let the bank get to know your business, and get to know you as a credit-worthy customer.

If your bank is unwilling to help, borrowing from family and friends is often the easiest way to obtain funds, particularly for start-up entities. Often, the costs of borrowing the money are less than with other methods.

But intermingling business with personal relationships has its potential drawbacks, which is why we advise clients who choose this method to set up the transaction in a formal, business-like manner.

Give your lenders paperwork that acknowledges their loan, and the terms of repayment. Make sure their rate of return is reasonable (this includes loaning funds to yourself). And give lenders an "out clause" that allows them to ask for their money back at any time.

Home equity loans and credit card financing are two other methods of self-funding. But they also come with a level of personal risk to the borrower that is often beyond the tolerance of all but the most seasoned entrepreneurs.

Another alternative to traditional bank funding is government-sponsored grants or loans that are designed to assist companies with seed capital or to enhance an existing operation. The federal government and most states offer financing geared to growing specific areas of the economy that policymakers believe require nurturing. In most cases, the interest rates are especially favorable if the funding leads to job creation.

Unlike a loan, a grant typically does not have to be repaid. However, there is a significant amount of research and paperwork involved. Grant programs can be highly competitive, with specific, detailed formats that need to be followed carefully when applying.

There are a number of creative methods of financing for larger, stable firms, including asset-based financing, receivables financing, and factoring. While each technique comes with its own benefits, drawbacks and costs, what ties them together generally is the use of an existing, tangible asset of the enterprise as collateral for the loan.

Supplier or vendor financing is also a creative alternative in certain situations where funds are needed to acquire expensive capital equipment. Manufacturers and leasing companies will almost always offer financing, and at interest rates that are relatively attractive.

Perhaps the most difficult financing path for owners to take is working with outside investors. There are many options for accessing funds in this way, but all of them involve giving up some measure of control of the business. We advise owners to tread carefully when considering these types of arrangements.

Equity financing may be the simplest of these options. Equity is defined as the value of the enterprise, minus what is owed. An owner can raise funds by selling a portion of this equity, but the buyer will then be a "partner," and will have partial control of the enterprise. This arrangement can work well between businesses that complement each other.

When the full equity of a business is sold, it is considered a merger in which the enterprise becomes part of the company that purchased it.

Individual angel investors provide financing to early-stage companies that demonstrate the potential to offer a better rate of return on the angel's money than more traditional investments would. These individuals may also offer their experience and contacts to the operation in addition to funding.

But expect to give up some control in return, in the form of a board position, a formal consulting role or an ownership stake. The same holds true of a venture capital firm, which is essentially a group of investors who have pooled their funds to finance early-stage, high-risk enterprises with the expectation of a potentially large return on their investment.

Of course, the specific goals and circumstances of your construction business will dictate whether any one of the techniques above makes sense. Be sure to seek the guidance of trusted advisors as you consider the options.

Bill Rucci is a partner with the Boston area accounting and business advisory firm Rucci, Bardaro & Barrett (www.rb-b.com), where he heads the firm's Construction Business Services Group. For specific questions on financing methods and strategies, contact Mr. Rucci at (781) 321-6065 or billr@rb-b.com.

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