The current sub-prime mortgage situation has dealt a serious blow to small and large homebuilders alike. Like all downturns, this too shall pass, but experts predict it may take quite a while for this housing market to stabilize. However, all is not lost: Commercial construction continues to thrive, and you can move your organization right into it.
Start by writing a business plan. Think of this as a skull session. Aside from its use in acquiring bank loans, a business plan forces you to think about what you want to do with your business, what the requirements are and how you will meet those requirements. You very likely have a positive outlook, or you wouldn’t be in construction, but you must be honest with yourself about your potential and your abilities and be willing to make changes if the business plan reveals weaknesses. Writing a useful business plan requires a bit of work but help is available on the Internet at little or no cost. (Editor’s note: Check out Roadmap for Success: How to Write a Business Plan from CBO’s January 2007 issue and on www.constructionbusinessowner.com.)
Meet with a reputable business lawyer who can help you decide on your business structure, most likely an “S” corporation or a “C” corporation. Operating instead as a sole proprietorship or partnership is risky because everything you own personally is at risk, and in a partnership, each partner may be liable for the total debts and obligations of the company. Your business lawyer will instruct you on how to maintain separation of your personal and business assets—this is important because failure to keep them separate may make your personal assets available to creditors regardless of the protection the corporation would otherwise provide. Although I don’t recommend it, you can set up your own corporation and save a few hundred dollars, but you’ll still need to learn how to safely maintain your corporate structure. While no contractor plans to go broke, good business practice requires that you prepare for every contingency in setting up your company.
If you set up a new corporate entity, you’ll need to establish banking relationships, including a line of credit, if possible, for intermittent use in managing your cash flow, and set up vendor accounts at places like Home Depot, Lowe’s and others as needed—all in the name of your new corporation. Paying bills when due should be a top priority to maintain and grow your credit lines.
Because construction insurance is unique, you should seek out a reputable insurance agent who specializes in construction. He will be able to explain the risks you face, the contractual requirements for a given project and the types of coverage available to meet them. It is practically impossible for anyone other than an insurance agent or attorney whose specialty is construction insurance to keep current in the field because of continually changing interpretations of policies by the courts.
It is not economically practical to cover every risk with insurance, but at least you know where uninsured exposures lie and then can consider ways to mitigate them. You should be certain that the risk inherent in any given construction project is fairly allocated between you and the project owner by way of terms and conditions written into the construction agreement. Your insurance agent and construction attorney are key players in sorting this out.
Accounting and Costing
The certified public accountant (CPA) you consider should have construction accounting experience and provide references. In speaking with the references, you should be able to determine not only his competence, but also how accessible the accountant will be to you. If reaching him requires your having to go through layers of assistants or wait interminably for returned phone calls, try a different CPA.
The accountant you ultimately choose will meet with you and your in-house bookkeeper to help you understand the elements of a good bookkeeping system, including recommendations for construction accounting software and assistance in setting it up. Your CPA will also help you understand the reports required by various government agencies and the records you must maintain for filing taxes and preparing your financial statements.
Your CPA can help you create a chart of accounts, establish billing and payment policies and procedures, and set up filing and retrieval systems. Once your startup systems are in place, you or your bookkeeper should consult with your CPA a few times per year.
Before you cut the first payroll check, you should know how, when and where to remit your employees' payroll withholdings to the federal and state governments. Remit these payments on time to avoid penalties, interest and unwanted letters and visits from the IRS.
You should sign all checks yourself. In many years as a general contractor, I relinquished this responsibility only briefly. Not only does your review and approval of checks let you know where your money is going, but it also gives you a sense of the subcontractors and vendors who are working with you and the activity on your jobs. Rarely did I go through a stack of payroll and vendor checks that I didn’t have a question on one or two that I wanted answered before I signed, even though the checks had been through the normal approval process before coming to me. If your direct involvement in this procedure does nothing else, it will result in everyone in the approval chain being a little more diligent in this crucial area.
Whether you pay bills with paper checks or electronically, your bank will provide means for you to confirm that your money has gone where you intended. It is good practice to have a duplicate paper bank statement sent to you at your home, and you also can observe daily account activity online. Small business firms can easily lessen the possibility of financial loss due to oversight or even dishonesty by implementing these and other simple common-sense measures.
Small contractors may take advantage of the Small Construction Contracts Exception in the IRS code. For contractors whose average annual gross receipts for the three most recent years do not exceed a certain annual limit (currently $10 million), the IRS allows the profit on each job to be reported in the year the contract is substantially completed. This means that qualifying contractors may defer the profit on jobs that are open at fiscal year-end, the obvious benefit being deferment of income tax on the open projects. This exception requires that the contract be completed within a two-year period. It is legitimate to report income on uncompleted contracts in your company financial statements while deferring it for income tax purposes.
Track general expenses (payroll, rent, vehicle expense, insurance, etc.), bank balances, job costs, contract amounts, income, payables and receivables from the first day forward.
Hire only employees you have reason to believe will excel in all respects. Qualities to look for include honesty, strong sense of responsibility, enthusiasm, ability to think “outside the box,” the drive to do whatever is required to accomplish the task at hand and stable employment history. It is false economy to hire solely on the basis of cost. Only by surrounding yourself with superior key people can you manage your business to greater opportunities and profits for the long term.
Every contractor faces the great temptation to hire workers as “independent contractors” instead of as payroll employees. Because this is a hot area for the IRS, you must ensure that a worker meets independent contractor criteria if you hire him as such. Otherwise you may be subject to serious penalties. Here are only a few of the conditions the IRS claims it looks for in determining the status of a worker. The answers following the questions favor independent contractor status.
- Is there an agreement in writing between you and the worker? (Yes)
- Does the worker have the opportunity for profit and loss in his business? (Yes)
- Can the worker provide services to others in addition to you? (Yes)
- Do you pay the worker’s travel or other business expenses? (No)
- Are your firm’s employee benefits available to the worker? (No)
- Does the worker provide his own tools and equipment? (Yes)
- Does the worker have his own place of business and provide his own vehicles? (Yes)
Failure of any one of these tests alone does not necessarily disqualify independent contractor status, but the IRS is the IRS, and it may apply these or any other criteria it chooses. Get additional information on independent contractors at www.irs.gov.
You’ll need to apply for an employee identification number (EIN) for your corporation at www.irs.gov. You will need this number for filing all federal income and employee withholding tax returns. Sole proprietorships may use the owner’s Social Security number instead of an EIN.
Your corporation is registered with your home state’s secretary of state along with the corporation’s creation, but there may be other state and local agencies with which you must register. If you do business in other states, you’ll need to register with the secretary of state in each of them. Failure to register with secretaries of state can have serious legal and financial consequences. The attorney who incorporates or registers your company in other states should be able to inform you of all required registrations.
In addition to state corporation registration, most states and some local governments require contractors to prove their professional and financial qualifications in order to obtain a professional contractor’s license. If you fail to become properly licensed, you may be subject to fines and penalties and exclusion from the state’s court system. The professional licensing process can take several weeks, and in some states your contractor’s license may be required to have been issued even before you submit a bid on a project in that state.
A simple business license is usually required by the town or county.
Your long-term success as a contractor is going to depend to no small degree on the terms and conditions of the contracts you enter into with the customers you work for and the subcontractors who work for you. When possible, use forms published by the Associated General Contractors of America (AGC) or the American Institute of Architects (AIA), and modify them as required to meet the conditions of the project and to fairly allocate risk between the project owner and yourself. Many project owners create and require use of their own contract forms that are written in their own interest. Be aware that both what is and is not stated in the contract may distribute risk away from the project owner and onto to you. Hire an attorney who specializes in construction to review all contracts before you sign them unless you’re certain you know what to look for in contract terms and provisions.
You can improve your chances of getting paid for the work you do by following a few simple rules. Here is a sample of the practical questions to which you should get satisfactory answers before entering into a construction agreement.
Where is the project owner’s money coming from that he will use to pay you? He should be willing to answer this question to your, or your attorney’s, complete satisfaction.
Will the owner’s construction lender agree to reserve loan funds adequate to pay the full amount of the contract plus a reasonable contingent amount for change orders?
What is the owner’s track record for dealing with and paying contractors?
The project owner’s lender may request, prior to your starting construction, that you agree to complete the owner’s project for the lender in the event the owner defaults on the loan. You should require within the lender’s agreement that, in that event, you first be paid in full for work completed to date.
Your contract should state when and to what address and individual you can apply for progress payments, what supporting documentation is required, the amount of retainage to be withheld and the number of days the owner is given to make payment to you after he receives the required documentation.
If receipt of your payment is in doubt, you should be prepared to file a lien on the property the project is located on. Placement of liens is very technical and almost always requires an attorney, but before starting any project, you should at least be aware of any pre-construction notice requirements and the time limits pertaining to filing liens as prescribed by law. Lien laws vary from state-to-state. The AGC’s State Law Matrix provides state-by-state lien law details (as well as information on contractor prequalification requirements and other information important to contractors.) Consult your construction attorney well in advance of the deadline to file any liens.
The Pre-Startup Checklist below includes a number of responsibilities applicable to a typical construction project. This becomes a valuable tool when specific project requirements are added.
Construction Project Pre-Startup Checklist
Legal & Administrative
- Owner-contractor agreement signed
- Owner financing verified
- Written notice to proceed from the owner
- Cost codes/schedule of values to bookkeeping
- Construction schedule to all parties
- Pre-construction lien rights notice to owner
- All contracts distributed in-house and to others
- Owner's billing requirements and forms
- Supplier/vendor purchase orders issued
- Business insurance in place (CGL, WC, etc.)
- Job-specific coverages in place
- If Builders Risk by Owner, is policy received?
- If Builders Risk by GC, is policy received?
- Subrogation waiver by all parties
Plans & Specifications
- Contract dwgs./revision nbrs. verified
Licenses & Permits
- Secretary of State registration
- State/local general contractor license
- Business license
- Building permit/inspection card in hand
- Permit dwgs. received
- Demolition permit
- Environmental permit
- Other permits: ________________________
- Municipal bonds
- Contact info for all subs and vendors
- Subcontracts signed by both parties and delivered
- Billing requirements to subs
- Subs' original Cert. of Insurance per spec
- Subcontractor bonds
- Pre-construction meeting with subs and vendors
- Temporary Facilities and Utilities
- Office trailer
- Storage trailer
- Electric (temp. power pole installed/inspected)
- Broadband Internet service
- Undrgrnd util. located (Call Before You Dig)
- Soils report
- Erosion control
- Property corner pins placed by owner
- Corner pins verified by contractor
- Elevation benchmark established by owner
- Benchmark verified by contractor
- Site/grading plan verified to existing conditions
- Testing firm hired
Local Accounts Established
- Building materials/lumber
- Tool rental
- Temporary labor
This is not an exhaustive list. Revise according to requirements of the project at hand.
Moving into commercial construction can be very rewarding, but like any other transition, it must be done with due planning and attention to detail.
Disclaimer: This article offers general guidelines for use in the complex and risky business of construction. Consult the appropriate professional regarding their use in any specific situation.
Construction Business Owner, January 2008