It's now been almost 15 years since the Great Recession, and the construction industry has been on an incredible run of expansion and growth. Many economists are predicting the next construction recession to take place in the next six to 18 months. It’s important to remember the lessons of the last recession so that contractors can be better prepared to handle the next one. Here are five lessons I learned as a Surety Bond professional from the Great Recession that contractors can use to prepare for the next one.
Be Careful on Federal Contracts
When the Great Recession hit and work dried up, many contractors went scrambling into the federal project market to fill their backlogs. Many of those contractors found out how different and challenging federal contracting can be. The paperwork can be daunting, the guidelines rigid and the expectations vary by office. Many contractors who were not familiar with federal work and jumped in, lost large amounts of money on these projects. Even if work becomes less plentiful, contractors should really evaluate whether getting into this space makes sense.
Watch Your Revolving Debt
Revolving lines of credit are important to contractors and surety bond companies alike. Having the ability to finance cash shortfalls can be critical while a contractor is waiting to get paid. Unfortunately, many lines of credit have a “demand clause” in them. A demand clause means the lender can call the line of credit at any time and the contractor will need to pay this back.
Most contractors feel that their lender would never do this, but The Great Recession showed the opposite. Many lenders got into trouble of their own, were purchased, or taken over by the FDIC. When this happened, lenders called lines of credit from contractors that needed the borrowing the most. Contractors may want to consider converting some revolving debt into a term loan that cannot be called as easily.
Carefully Scrutinize Contingent Payment Clauses
The validity of pay-if-paid, and pay-when-pay varies by states. Pay-when-paid assumes that a contractor will be paid at some point. However, waiting on payment can certainly cause cash flow problems and take a contractor out of business.
Pay-if-paid pushes all the financial risk to the contractor. When the Great Recession hit, many contractors were under Pay-If-Paid contracts. In one famous example, the lender pulled the financing on the development and the project developed problems. Even though the General Contractor on the project had a Payment Bond in place, they were able to get out of paying subcontractors because of a Pay-if-Paid clause in the contract. The court sided with the General Contractor and Surety Bond Company because the General Contractor had not been paid for the work by the Owner.
Contractors should always carefully scrutinize Contingent Payment Clauses. This is especially true entering a recession, when General Contractors may also run into payment troubles.
Trim Overhead Quickly
Overhead is easy to acquire when times are good. Unfortunately, it's also difficult to reduce in challenging times. Nobody wants to get rid of key staff, especially in what has been a challenging labor market. However, if a recession does occur, nobody can be sure how long it will last. Many contractors believed the Great Recession would be short lived and did not cut overhead fast enough. This caused large losses for some companies that were difficult to recover from. This time around, contractors need to make cuts quickly and find a way to maintain profitability.
Monitor Account Receivables
When account receivables get older, they get even more difficult to collect. This becomes even more true in challenging times. Although there are some legitimate reasons for older receivables, it is often caused by financial challenges. Contractors should refuse to do work for parties that do not pay them on time or according to the contract. Of course, it can be more difficult to cut off an account when work is more scarce. Still, it is never a good idea to incur more costs for a party that is struggling to pay you. Often, this leads to an even bigger loss. In a recession, contractors should demand to get paid, or cease work until they do.
Hopefully, a construction recession will be avoided all together. Should a recession occur, contractors should take these and other precautions to successfully make it back to more profitable times.
