The recent wave of bank failures has put a new focus on the security and stability of financial institutions. Most small businesses face little risk of a failed bank, but even with protections in place, a bank’s failure can be disruptive, causing delays and confusion regarding access to funds — not to mention the potential impact on the funding necessary to every general contractor, subcontractor and supplier.
The Federal Deposit Insurance Corporation (FDIC) insures deposits of up to $250,000, an amount far less than the $12,100 balance for most small businesses revealed in a recent JPMorgan Chase Institute survey. The potential risk increases for construction businesses with employees.
The Payroll Exception
Payroll costs are among the biggest expenses for most in the construction industry. Gusto, a payroll and benefits provider for small and midsize businesses, reported that half of businesses with 50-99 employees had monthly payrolls above $250,000. However, the U.S. Small Business Administration (SBA) shows that fewer than 20% of all small businesses have employees. That means few businesses have significant payroll costs that can push their deposits above $250,000.
Avoiding Possible Bank Failures
Now that the panic from the recent banking collapses appears to be diminishing, small businesses should examine their accounts to determine their level of risk. When protecting deposits from potential future bank failures, diversifying accounts is usually a good idea.
As mentioned, the FDIC insures each depositor at each institution — not separate accounts at one institution. Having a second banking relationship makes it easier to quickly wire funds to safety when worries develop about one being unstable.
Since these protections usually come into play only after the fact (i.e., after the failure of a bank), it is critical that construction business owners and managers take the necessary precautions to avoid needing those protections. The safest course of action is to do your own due diligence and distribute your risk.
A due diligence checklist might include:
- Assessing the overall health of the operation’s bank
- Reviewing the bank’s investments
- Ensuring the bank participates in so-called “stress tests”
- Regularly monitoring the bank for material changes
- Protecting deposits beyond FDIC depositor protection such as with accounts in more than one institution
Mitigating the Risk
Surprisingly, it is banks that may offer the most protection from failure. The IntraFi Network, a system that can split a customer’s large deposits into small chunks that are below the $250,000 cap, sends those chunks to other banks in the system. The result? Customers have multiple FDIC-insured accounts without having to open each account.
The first option involves the bank chopping a customer’s money into certificates of deposits (CDs) of less than $250,000 before placing those accounts in other institutions. While the CDs earn interest, the money can’t be withdrawn before the CDs mature.
A second option involves a “sweep account” where a customer’s balance in excess of $250,000 is “swept out” to other banks periodically in smaller blocks. With both options, deposits are protected by the FDIC because, technically, they are sitting elsewhere.
Although free, banks usually limit the service to only businesses with uninsured deposits. Even if eligible, however, a construction business owner may not want to utilize either option, leading to copying bigger operations by creating a treasury strategy.
Profits From Treasury-Related Actions
All contractors know how difficult managing the operation’s finances can be. Tracking profits and losses, planning future expenditures and securing expansion capital can be challenging. One answer involves utilizing treasury management, those back-office, behind-the-scenes services that enable small businesses to make and receive payments electronically, in-house or through a financial services provider.
Accounting software can usually handle day-to-day cash flow management; treasury management usually involves more. Treasury management, both in-house and via outside providers, includes managing the operation’s holdings with the ultimate goals of managing its liquidity and minimizing potential risk.
A simple switch to electronic deposits wherever possible could improve cash management, keep deposits safer and save time. Plus, there is faster notification of attempts to deposit checks where there might be a lack of funds.
For some construction businesses, in-house treasury management might incorporate the clearing network for electronic payments, the Automated Clearing House (ACH). ACH is an efficient — and economical — way of making and receiving payments.
ACH payments are made by directly transferring funds from one bank to another without paper checks. While it costs an average of $1.22 to process a paper check, the same payment can be processed for pennies using ACH.
Funding in Today’s Financial Arena
In a recent National Small Business Association (NSBA) poll on the current state of lending, more than half the respondents said they were unable to obtain adequate funding even prior to the Silicon Valley Bank (SVB) collapse, with a third claiming terms have become less favorable.
It’s not that banks are reluctant to lend to small businesses, but traditional financial institutions have outdated, labor-intensive lending processes and regulations that are often unfavorable to smaller businesses and organizations. When credit dries up and liabilities become harder to roll over, construction business owners may need to explore alternative financing.
Alternative financing refers to any method through which business owners can acquire needed capital without the assistance of traditional banks.
Generally, if a funding option is based entirely online, it is considered an alternative financing method. By this definition, options such as crowdfunding, online loan providers and cryptocurrency qualify as alternative financing.
Among the reasons why a contractor might turn to alternative financing are:
- Lower credit requirements — Traditional banks are almost certain to decline loans to borrowers with poor credit.
- Faster approval — Traditional bank loans can take weeks to be approved, whereas some business loan alternatives provide access to funding in as little as one week.
- Easier qualification — Not all small business owners meet the additional requirements to apply and be approved for traditional loans. In these cases, business loan alternatives are helpful.
Online vs. Brick & Mortar
Small-business lending is becoming a big business, with hundreds of millions of dollars raised from unique platforms such as crowdfunding, peer-to-peer lending and marketplace lending. The entire lending marketplace is an emerging segment of the financial services industry that increasingly uses online platforms to lend directly or indirectly to consumers and small businesses.
As the needs of investors and financial services customers become more complex, there is a demand for effective tools to simplify the process. So-called “digital transactions” involve constantly evolving methods where financial technology (fintech) companies collaborate with various sectors of the economy to take advantage of new lending and capital raising opportunities.
Financial institutions are increasing the digitized services they offer while the financial marketplace competes with offerings such as peer-to-peer lending, alternative online financing and crowdfunding. How can any construction business owner take advantage of these speedy financing options while avoiding the risks associated with borrowing from so-called “shadow banks”?
While the newer “marketplace” funding remains largely undefined, it encompasses lenders that make loans to higher-risk, lower-income borrowers; microfinance; and larger-scale lenders that market their products to traditional consumers and small businesses. Online marketplace lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend directly to small businesses and consumers.
While the volume is tiny in comparison with traditional bank lending, marketplace lending has experienced rapid growth. In fact, some online lenders purportedly rely on “big data” not evaluated as part of traditional bank underwriting processes.
The Path to Coping With Potential Bank Failures
Although in the short term bank accounts remain safe because regulators have shown a willingness to step in when needed, the experts advise it’s probably a good idea for small businesses to diversify funds while cementing their relationship with the construction operation’s banker or bankers.
Coping with the potential of a bank failure is something that should be done today. In addition to preparedness, the strategies that reduce the risk of exposure to a bank’s failure can be quite profitable for every construction business — and its owner.