Before expanding into a new market, prepare yourself for financial and tax issues.

With this stagnant economy relentlessly pounding down the construction industry, many firms have expanded geographically to get more work. While it sounds relatively simple, working in a new geographic area comes with a set of challenges.

In fact, the more experience a construction firm has in one market, the more difficult it can be to learn the performance and compliance issues in a new territory. Many have done this successfully, but many others have actually lost money on out-of-state projects.
Some of the challenges businesses face include workforce and labor practices and issues related to finances and taxes.  If you are considering bidding on out-of-state projects or have just begun the process, first examine your goals, and ask yourself some key questions.  Can your firm afford to lose money on this project? Is your management team prepared for the greater risks that come with working in a different area?

Labor Considerations

The No. 1 challenge with out-of-state projects is finding the right workers and quality subcontractors. Out-of-state contractors tend to find less experienced workers and subcontractors.  And given the economy, this is an even greater problem.  Some believe that the workers will be less likely to work hard for out-of-state contractors since they may never work for them again.

To alleviate this issue, construction firms should do their homework before entering a contract in another state.  Get to know the local powers and subcontractors.

Financial Concerns

Labor and subcontractor issues inevitably lead to financial issues. On any out-of-state project bid, construction businesses should add an extra cushion of profitability. The cost of inexperience or a potentially unmotivated workforce can mean the difference between profit, loss and disaster on a project. A New York firm that wins a project in North Carolina should budget for one or more full-time employees relocating temporarily while the project is in progress. A work location must be found and rented as well.

In general, contractors optimistically believe they can recover any lost profit through efficiencies. This may be true for jobs in a firm’s core territory since they know the ins and outs of that particular job and market better than others and can likely create efficiencies. But it is not wise to underbid a project outside of your home market.

Tax Issues

Sales and use taxes and business taxes are nuisance taxes that cause compliance issues and affect any project’s profit margins. States differ in the way they treat sales and use taxes—who they are charged to, when they are charged and what exemptions are granted. It is vital to understand the rules before bidding on an out-of-state contract.

Georgia, for example, hit subcontractors with sales and use taxes, and if subcontractors do not pay, contractors or owners will be expected to pay. Another example is the Transaction Privilege Tax in Arizona. This tax, which applies to non-resident contractors who work in the state, can take a significant amount from a builder’s bottom line. In New York, new construction (capital improvements) is not taxable, while maintenance-type construction is taxable. On projects that include both maintenance and new construction, the entire job could be taxable if an invoice does not separate the two.

In most states, construction firms do not have to collect sales taxes if their work is deemed a capital improvement. However, when purchasing supplies and materials for construction projects, they must pay sales or use taxes. Some states may provide exemptions to this general rule. Qualifying for the exemptions depends on the types of contracts negotiated, the contract terms and the clients. Other issues that affect tax liability include whether your business resells property and which state you should pay taxes to for out-of-state jobs.

In some states, the type of contract—lump sum or time-and-materials—may have an effect on when you will have to pay sales taxes on materials and supplies purchased. For example, in Florida, under a lump-sum contract, a construction firm pays sales or use taxes when purchasing supplies and material. This can be an advantage because any markup charge on the materials, supplies and labor will not be subject to sales tax. Alternatively, if a firm itemizes the materials, supplies and labor in a time-and-materials contract, it is considered a reseller and only bills the sales tax to the customer and incurs the sales tax liability when the customer finally pays.

Local tax authorities collect unpaid taxes and impose penalties and interest charges to contractors. Seek guidance from your professional tax adviser, and at a minimum, work with the local chamber of commerce to learn the law.

Compliance Issues

Licensing and regulatory requirements can differ from state to state. Do not expect authorities to be flexible with these rules. Although they cannot stop out-of-state businesses from bidding on work, they may have a perceived bias against companies trying to compete with locals for projects.

Joint Ventures or Partnerships

Creating a joint venture or partnership with a firm or organization in states that you may be targeting is an alternate solution. This often means sharing revenue, but it also means sharing risks as well. The major benefit is having an in-state presence that knows the lay of the land and can help navigate code requirements, workforce issues and tax and other compliance issues.

Do You Have What It Takes?

Construction businesses that consistently win and are profitable on out-of-state jobs typically have a lot in common.  Those successful at expanding geographically share these characteristics:

  • A competitive edge gained through a specific niche or skill set
  • A strong management team capable of monitoring performance and making changes in real time
  • A willingness to properly staff an in-state office and work with the local workforce, unions and officials
  • The ability to redesign the project or portions to produce the desired end result for the client while reducing the labor requirements
  • A strong accounting or back office with people dedicated to ensuring that differences in taxes, regulations and workforces are accounted for and built into the bid estimate and implementation of a project
  • Ample use of outside professionals, such as CPAs and attorneys who are familiar with the tax and legal issues in specific states and localities

Expanding geographically to work in different states can either be a lifeline for construction firms or a giant money pit.  If you are only looking for a quick revenue bump and are not prepared for the challenges, you might want to stay in your territory. Be realistic about the opportunities and increased work that come with these jobs. The good news is that these jobs become easier the more you do them.

Learn From Another Firm’s Mistake

One New York-based construction firm looked outside its home market to bid on a $15 million job for an entertainment venue in Pennsylvania.  This firm won the job, but managing the workforce was much tougher than expected, resulting in a loss.
Problems arose from the beginning when the firm did not research the market and costs. While it was a job the firm had done many times before, they had never worked in Pennsylvania.

Their first major mistake was coming in with the best price, which means that the profitability margins were already tight.  Well-versed in the New York market, this construction firm knew how to create profitable margins there but not in Pennsylvania. 
The second mistake was not realizing the employees on this job were not of the quality and experience the firm was used to. There were quality issues, missed deadlines and labor cost overruns.
Also, issues from sales and use taxes and payroll needed to be handled.  These were minor problems, but combined with the larger issues, they created a complicated situation for the construction firm.

Construction Business Owner, May 2011