Project Financing: Ask Your Clients How They Plan to Do It
When we first interact with homeowners, we ask them many questions in our quest to qualify them and hopefully turn them into paying clients. We want to know all about their vision for their project, the type of work they want to do, their timeline, and their budget.
But there's one question that many general contractors do not ask potential clients, and it's perhaps the most important one of all: "How are you funding this project, and can you provide proof?"
If reading that last question made you slightly terrified, you're not alone. Many remodelers and custom builders balk at the idea of asking homeowners this question because it's an uncomfortable and offputting question when you're trying to close a sale, particularly for larger projects.
But you absolutely have the right to ask this question—and you should be asking it. Going into home improvement projects without knowing if the clients have proper funding in place to meet your payout milestones can have negative effects on their projects and on your company's overall profitability.
Why You Need To Ask Clients About Project Funding
When homeowners buy a house without paying cash, they must first prove to the seller that they have financing in place. But when they undertake a home renovation project or build a custom house, they are under no obligation to prove to you that they can afford the job.
However, how a client chooses to pay for their remodel or custom-built house can have significant impacts on your ability to maintain healthy cash flow across all your projects.
In any industry, a company's cash flow is measured by how much money is coming into the business vs. how much is flowing out - and at what intervals. In the residential construction industry, managing cash flow carefully is critical because not having funds available to purchase materials or pay for labor impacts your ability to make progress on a job. More often than not, client payments are tied to that progress, especially if a project is being funded by a bank loan and subject to the bank's payment schedules.
You're A Construction Company, Not A Bank
At a very high level, the above statement is true: you're not a bank. But when it comes to remodeling or custom-building a client's home, you are essentially taking on the same risk as a bank would for providing a customer with a construction loan.
In fact, to qualify for a remodeling loan, homeowners would have to provide a bank with several key pieces of information:
Two years worth of tax returns
A credit check
Proof of title for the property in question
Proof of employment and pay stubs
Proof of savings via bank or investment statements
Proof of some liquidity via bank or investment statements
A list of current debt obligations, potentially with a request to be paid off or aggregated into one loan
That's a lot more information than you're asking a client to provide—either that they are liquid enough to fund their remodel or that they have proper bank funding in place. And unlike a bank, which often secures loans with collateral, you have nothing to fall back on if the client runs out of money mid-way through the project.
Overall, understanding a homeowner's funding source helps contractors gauge the project's financial stability and reduce the risk of any red flags that could signal project delays or cancellations due to financial issues.
Bank Funded Payouts Don't Always Align With Your Schedule
Aside from ensuring a potential client has the funds available to complete their home remodeling or custom-build, knowing how they are funding it is critical to understanding how cash will flow throughout the job.
If a client is self-funding their residential construction work, then they should have funds on hand to meet the established billing schedule that you've shared with them at the onset of the project. Learn more about billing schedules and managing cash flow in your residential construction business here.
Banks, however, use a "percentage payout to milestones" approach. This means they determine what completion milestones in the project will trigger what percentage of funds to be released for payment. That approach can vary from bank to bank and often doesn't align with the sequence of how you'll incur those costs in the project.
If you're in a position where you're waiting on a bank appraiser to determine whether you're at a certain stage of completion to release funds, you might need to take float money from another project to keep it from being over-extended. Multiply that by two or three projects, and you could easily find yourself over-extended and headed toward a dire financial situation.
Work With the Bank
In many cases, banks are open to negotiation about shifting the percentages and timing of payouts to align with a properly built project financial schedule. Don't assume that because the bank has sent you this schedule of milestone payment terms, it's set in stone.
Start by establishing a relationship with the banker and then review the documentation they send along. Next, create a Gantt chart for your project and assign financial amounts to each stage of the project, making sure to capture:
Internal team hours and incurred labor costs
Material deposits, full purchases, and future balances due
Trade partner deposits, progress draws, and final completion amounts
Present this to the banker in a meeting, and shift around the percentages until the project financing aligns with your time-to-schedule approach.
The "Scope and Budget Alignment" Conversation
Asking about funding up front gives you significant clues into how the project will flow overall and helps establish honest conversations about scope alignment. By knowing how your client is funding their remodel or custom build, you can better align the project scope with the available budget and anticipate or adjust situations where potential costs could increase and cause incomplete work due to cost overruns.
It also opens the door for broader conversations about client expectations of what is feasible given their budget and avoids misunderstandings or frustration with the final results.
It Helps Determine Overall Risk Assessment and Compliance
Understanding where your clients are drawing from to fund their remodeling projects helps determine the risk of non-payment or default. A homeowner using bank funds to complete their residential construction project might be less likely to default because the bank determines when payout funds are released.
Homeowners using their own funds aren't necessarily more likely to default, but it's harder to gauge their other debt obligations and how much of their liquid assets can be devoted to this project. When push comes to shove, they will naturally divert funds toward their own interests over yours. This is why not only asking how they are financing it but also asking for proof is critical.
Additionally, certain types of loans may require specific documentation or compliance with regulations. Knowing the funding source helps contractors prepare the necessary paperwork and ensure compliance.
How to Ask Clients the Funding Question
The initial series of meetings with potential clients can be nerve-wracking. Everyone is trying to determine whether the other person is a good fit for them and for the project. Homeowners are worried about what the project will cost, and contractors are trying to capture the full scope in an accurate estimate that ensures the job is profitable and the clients are happy and not sticker-shocked by the price tag.
As a business owner, you always worry about keeping your schedule full and your teams busy. So it's understandable that you'd be concerned about asking clients upfront whether they can afford the project. They could take it the wrong way and choose another contractor who doesn't seem as concerned about where the money is coming from.
But putting in the time to perfect asking this question early on in the sales process is a much safer option than waiting until it's midway through and learning that the money has run out.
Solidify Your Sales and Pre-Construction Processes
I spend a lot of time talking with remodelers about their upfront processes, like sales and pre-construction, because they are critical to ensuring a successful outcome for all stakeholders. The best contractors are those who master this process.
It's these initial processes that show clients that you're not just building their house but that you're building a relationship with them and guiding them in understanding why they should want to work with you, the right contractor, and not just the "cheapest quote."
A solid upfront sales process demonstrates that you understand their unique situation and will work to offer solutions that meet their specific needs, as well as the value that your years of experience bring to their project.
Part of that value is understanding how important it is to have the full financial picture prior to starting the project so they will achieve the end result with minimal change orders that can impact the total cost. This is why adding a discussion about funding early on in that process is in the best interest of both you and your potential client.
Make it a Standard Question
Discussions about money are always awkward, and the dance that homeowners and potential contractors do when they're in the upfront sales portion of a relationship is complicated.
The last thing you want to do is make a client feel defensive, so try explaining it to them like this:
"If I don't ensure that each client has the appropriate funding in place, I am putting other clients' projects at risk because I would eventually run out of working capital to continue all projects."
This helps the client see the bigger-picture perspective and put themselves in another project's viewpoint. It also helps to establish the "Like, Know, and Trust" that we talk about when we educate clients about how we approach work as a valued partner with experience and not just a fly-by-night unethical contractors who will disappear when the money runs out.
Include Standard Language in Your Contract
Every residential construction project starts with a contract that outlines all the terms and conditions for the work. Including language in the contract about providing reasonable proof of funding sources helps ensure that you are not taking on any additional risk and that you have a leg to stand on should work need to stop because of funding issues.
It also clarifies the payout schedule that you've worked with the banker to align to the project's timeline so you don't have to "Steal from Peter to pay Paul."
The Bottom Line on Funding Projects
Discussing funding is a crucial step in your pre-construction phase because it ensures that both you and the homeowner are on the same page regarding the financial aspects of the renovation or new home build.
Accepting projects without understanding where the money is coming from and how it's flowing can adversely affect your draw payouts and cash flow and leave you at risk of jeopardizing other projects if you need to float money from one job to another.
Getting in front of this question early with homeowners by asking them to provide proof of liquidity or a copy of their bank funding agreement not only builds confidence in the project's financial feasibility but also helps show prospective clients that your investment as a builder is to ensure a smooth project completion and successful outcome.
At the end of the day, you're a construction company, not a bank, and you shouldn't be responsible for covering the costs for any part of the project.
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