How do contractors refinance stacked merchant cash advances?

How a contractor runs out of cash on a profitable job

Follow one commercial job from award to final payment. The contractor mobilizes, orders materials, and puts a crew on site. Materials are paid on supplier terms, or on delivery if the contractor has fallen behind with the supplier. The crew is paid every week. At the end of the first month the contractor submits a progress bill, which the general contractor or owner reviews, approves and pays, often only after being paid itself. A share of every bill is held back as retainage until the job is finished and accepted, sometimes longer.

The job earns 100. To earn it, the contractor has to finance nearly 300 at the worst point, for months. Run three or four jobs like that at once, add a change order the owner has not approved, a general contractor who slows payment, or a winter shutdown in a weather-exposed trade, and the trough is deeper than the contractor's cash. An advance fills it in a week.

Then the advance's daily debit keeps running through the months when no progress payment arrives, and through the winter. The next trough is filled with a second advance. Contractors also take advances after a bad job, one bid too thin or one that ran into site conditions nobody priced, and that version of the stack is harder to refinance, because the lender has to be persuaded the loss was confined to that job. For the general mechanics, see refinancing cash advances into term debt.

Why lenders read the WIP before the P&L

Most contractors of any size recognize revenue on the percentage of completion. The profit on the P&L therefore rests on estimates: how complete each job is, and what it will cost to finish. An optimistic estimate pulls profit forward into this year and leaves the loss for next. The work-in-progress schedule shows the estimates job by job, and it is where an experienced lender starts.

• Margin fade. The lender compares each job's estimated margin now with its margin at bid. Jobs whose margin has fallen, and keeps falling, are the most common hidden cause of a contractor's advances.
• Under-billings. Work performed but not yet billed. It is an asset on the balance sheet, but lenders discount it heavily, because an under-billing is often a cost overrun the contractor has not admitted yet.
• Over-billings. Amounts billed ahead of the work. The cash is real but it is owed back in work. A contractor living on over-billings is funding itself with its customers' money, and that stops the moment backlog shrinks.
• Backlog. Signed work not yet performed, and its expected margin. Backlog does not size the loan, but a thin backlog makes a lender doubt this year's earnings will repeat.
• Closed jobs. For the last full year or two, how each finished job's actual margin compared with its bid. This is the lender's best evidence of whether the estimating can be trusted.

Contractors who file taxes on a cash or completed-contract basis may need an accrual view prepared for the lender; see cash-basis vs accrual financials. Earnings are then rebuilt without the advance costs, with add-backs for anything documented and one-time, and tested against the new payment.

If the advances began when one job went wrong, the file has to show the jobs since then earning their bid margins. That is the evidence the problem was one job, not the business.

The surety, the general contractor and the advances

A contractor that bonds its work has a third party watching its balance sheet. Sureties set bonding capacity largely on working capital and net worth, and they read the same financial statements a lender does. Stacked advances damage both: they drain cash, and because they are short-term, the whole balance sits in current liabilities. A refinance into a term loan moves most of that balance into long-term debt, which improves the working capital the surety measures even before a dollar of cash is saved. For a bonded contractor that is often as important as the lower payment.

The surety also has rights. Under the indemnity agreement every bonded contractor signs, a surety that has to complete a job or pay its subcontractors and suppliers can claim the contract proceeds from that job. A lender taking the contractor's receivables as collateral needs to know which are from bonded work, and on a larger facility may want an agreement with the surety setting out who has first claim on what. See intercreditor agreements. Keep the surety informed before a refinance closes; a surety that learns about a stack of advances from a lien search reacts badly.

General contractors matter too. A contractor behind with its suppliers may find the general contractor paying by joint check, or withholding payment until lien waivers arrive. Past-due suppliers can also file liens on the project, which puts the contractor's relationship with its best customers at risk. If supplier balances are part of the problem, see terming out past-due payables.

Which refinance fits which contractor

Heavy trades often have the most room. An excavation or site-work contractor with owned equipment can sometimes retire most of its advances through an equipment refinance alone; see refinancing equipment loans and machinery and equipment in an asset-based loan. Specialty subcontractors with little equipment and a receivables book full of retainage have the least, and depend on earnings. Asset-based lenders typically advance 80% to 90% of eligible receivables, but on a contractor's book the eligible share can be much smaller than the total; see eligible vs ineligible receivables and borrowing against a signed contract.

Residential and service contractors are a different file. A remodeler, or a heating, plumbing or electrical company doing service calls, takes deposits from homeowners and is paid at completion, often by card or through a consumer financing company. There are few receivables to lend against, and the advances look more like a retailer's. The route is usually a term loan against earnings, with equipment and vehicles alongside. See refinancing advances for HVAC and plumbing companies and the lines of credit for general contractors and remodelers, electrical contractors and roofing contractors.

Preparing the file

A contractor's refinance file is thicker than most, because the lender has to test the estimates as well as the results:

• The WIP schedule as of last month-end and as of the last fiscal year-end.
• A closed-job report for the last full year or two, bid margin against actual.
• A backlog list with each job's contract value, remaining work and expected margin.
• An AR aging by customer with days outstanding, retainage shown separately, and an AP aging with any past-due supplier marked.
• The P&L and balance sheet for the last full year, a year-to-date P&L through last month-end, and business tax returns for two to three years.
• An equipment list with year, serial number, lienholder and payoff for each unit.
• A letter from the surety or bonding agent confirming the bonding line and the contractor's standing, if the work is bonded.
• Every advance agreement, a current payoff letter from each funder, and bank statements for every month the advances have been debiting.
• A debt schedule and a short written account of what caused the advances and what has changed.

Disclose any unpaid payroll tax or supplier lien up front; both change what the lender can do and in what order. Transparent builds the lender package for these files (financing model, lender presentation, blind teaser and underwriting memo) in a day once the documents are in, and writes it to lead with the jobs, the margins and the backlog rather than with the advances. The broader approach is on MCA refinancing.