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In our last issue (July/August) we looked at a powerful, new way to look at your renovation business and why you should think seriously about financing its growth. If you missed that article, you can find it at under Contractor U. This month, let’s get specific about four ways to find the necessary funds to grow your company. By Mike Draper


unding growth is a big challenge in the renovation industry, as most banks are leery of financing smaller residential construction businesses. There has been a long history of shoddy contractors borrowing money from banks and then defaulting on the loans. The owners would just close up shop, open up under a different name and the financial institutions would be hung


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out to dry. This history is unfortunate, as it has made it more difficult for legitimate business owners to secure bank funding for their growth. The other major financial challenge for renovation contractors is that this is an industry with very large cash flow demands and, typically, thin profit margins. Most renovation contractors have little or no cash reserves in the business. Just look at your own bank


account. Is there very much ‘extra’ money in there that you won’t need in the short term? In Part 1, we talked about how crucial it is to have a vision of what you want your business to look like three years from now. This vision should then form the basis of a business plan. That plan should describe, in detail, what will you need to add to your business – especially in terms of people – to reach the amount of work that you want to be doing. If you haven’t read Part 1 you should do so now. If you don’t have a solid business plan, raising money will be almost impossible. Anyone that is going to lend you money is going to want to know how likely it is that they will receive their monthly payments from you. Let’s look at what are some of the financing sources available for home renovation firms and the pros and cons associated with each. There are basically four ways to find the money to finance your growth. Let’s start with the people who are closest to you.

Friends and Family


Friends and family are typically the easiest-toaccess sources of financing for most small business owners. They know you and, hopefully in most cases, believe in your capabilities and integrity. They have generally seen some of the work you have done in the past and they know your strengths and weaknesses. They may feel, because of their personal relationship with you, that there is a relatively low risk of their not getting paid back. They may not ask you for a written business plan and may make their decision based on your verbal assurances. This last point is, in fact, the major downside of obtaining financing from family and friends. Bypassing an objective, third party review of your business plan exposes both parties to considerable risk. We have all heard stories of contractors accepting money from family and friends, only to have their businesses die within a very short period of time. If this happens, the owner is unlikely

to be able to repay the lost money for a long time, if ever. Needless to say, friendships and family relationships can be permanently destroyed by this unfortunate, but sometimes predictable, sequence of events.

Financial Institutions As sticky as they can be about lending money to start-up renovation businesses, banks do offer a wide variety of ways to fund growth. The longer you have been in business and the more stable your revenues and profits are, the more likely you will be to obtain financing from a bank. Here’s a look at how lenders generally structure loans, with common variations. Line-of-credit loans: The most useful type of loan for the small business is the line-of-credit loan. This is a short-term loan that extends the cash available in your business’s checking account. You pay interest on the actual amount advanced from the time it is advanced until it is paid back. Line-of-credit loans are intended for purchases of inventory and payment of operating costs for working capital and business cycle needs. They are not intended for purchases of equipment or real estate. Installment loans: These loans are paid back with equal monthly payments covering both principal and interest. Installment loans may be written to meet all types of business needs. You receive the full amount when the contract is signed, and interest is calculated from that date to the final day of the loan. If you repay an installment loan before its final date, there will be no penalty and an appropriate adjustment of interest. Balloon loans: These loans require only the interest to be paid off during the life of the loan, with the final “balloon” payment of the principal due on the last day. Balloon loans are often used in situations when a business has to wait until a specific date before receiving payment from a client for its product or services. Interim loans: Interim financing is often used


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by contractors building new facilities. When the building is finished, a mortgage on the property will be used to pay off the interim loan. Secured and unsecured loans: Loans can be secured or unsecured. An unsecured loan has no collateral pledged as a secondary payment source should you default on the loan. The lender provides you with an unsecured loan because it considers you a low risk. A secured loan requires some kind of collateral, but generally has a lower interest rate than an unsecured loan. Loans secured with receivables are often used to finance growth, with the banker lending up to 75 percent of the amount due. Inventory used to secure a loan is usually valued at up to 50 percent of its sale price. Mortgage financing: Mortgaging your house or other personal property is much less expensive than obtaining a business loan. While banks are in the business of loaning money, their top priority is ensuring that they get paid back with interest. Real estate offers secure collateral for a business loan. Insurance financing: If a contractor currently has a life insurance policy with a cash value built up or an over-funded universal life insurance plan, they are able to borrow against these values in a few different ways to fund future growth of their contracting business. Contractors are able to use the cash value as collateral for a third party loan. Alternately, you could cancel your insurance policy and take the cash value instead of taking out a loan. This last option would be the worst case scenario as a business owner should have some type of insurance plan in place in the event of premature death or disability. Most life insurance products in Canada come with premiums and a face amount that is guaranteed for life. Using a permanent insurance plan has many advantages to a contractor, not only from a lending scenario but to protect their insurance needs in the future. The information in this insurance section was graciously provided by Alana Guthro, Guthro Financial (


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Business Partners/Investors The majority of renovation companies have sole owners. Only a very small percentage of contractors have business partners. While I can only speculate as to why that is, I suspect that most contractors started off running their own small contracting business after working for another contractor. It’s rare that two or more people get together and say, “Let’s start a renovation company.” Having a business partner can be very helpful in many ways, not just as an extra source of cash for the business. It also means that you have someone else on the same team as you, giving you another pair of eyes on your business and someone you can bounce ideas off. It also means that you can get to a much higher level before you hit a revenue ceiling, since there is extra help in handling the workload. If you have someone who is interested in buying into our business but who doesn’t have enough cash or borrowing power, “sweat equity” is a way for them to purchase shares in your business. For example, let’s say you have a project manager who wants to become your partner, and the competitive salary for his job is $70,000 per year. If he agrees to work for $50,000 per year, he would earn $20,000 in sweat equity that could then be used to purchase shares. Now that he owns some shares, next year he is entitled to a proportionate share of the profits. The obvious downside is that you now have to pay the salaries of two business owners instead of one. Your firm might need to perform up to twice the amount of work you were doing as a sole entrepreneur. You also need to be able to deal with different personalities, potentially different work ethics and different visions on where the company is going.

Financing From Cash Flow


Cash flow is critically important in running your business. Unfortunately, too many contractors struggle to make their day-to-day operations cash flow positive, never mind trying to fund growth from cash flow. However, it’s important to


remember that it is possible to generate significant, positive cash flow from performing professional renovation services and that funding growth this way is one of the least expensive and safest ways to grow. You could leave the extra money in the bank, but with interest rates so low, it won’t earn much interest anyway. Reinvest that money in your own success! The keys to positive cash flow are easy to understand. Execution is largely a matter of self-discipline. 1. Build in sufficient profit for all proposals. If your projects are profitable, you won’t have cash flow problems. 2. Prepare a reasonable and fair contract that outlines when milestone payments are due. Terms should be due on receipt. You are not in the business of financing your client’s renovation project. You should always get paid before you have to pay your vendors. Clients should give you deposits before you provide them to suppliers. 3. Use trade credit to purchase all supplies. This will give you 30 days to pay in most cases. As you do more business with a supplier, you build up trust and will have the opportunity to get even better credit terms from them. Using trade credit allows you to slow down the flow of money out of your company so that you can use incoming money to fund legitimate expansion. Trade credit also helps you to reduce the time spent on administration. But there’s a downside to trade credit, too. You can quickly find your business in a cash flow crunch should you abuse this type of credit. Just like in the family and friends section, trade credit will get extended to you based on supplier’s histories with you, not because they have reviewed your business plan or done any other type of due diligence. Use trade credit wisely.


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4. Complete your milestones and projects on time. Delays in project completion cause payments to be delayed. Delayed payments increase both financing and operational costs. Financing your business from internal cash flow is the “old school” way of building a firm. Most of us have met or heard about the great entrepreneurs of our grandparents’ or great-grandparents’ generation who would build substantial enterprises without taking bank loans. They expanded when they had the cash to expand, not before. Nevertheless, if you take too much money out of your bottom line and start to invest in expansion too early, you can easily starve your business for cash and create more trouble than if you had prudently financed with a more costly source of money.

Summing up When you look at the various methods of funding discussed here, you need to decide which method of funding best suits your needs, your goals and your tolerance for risk. Loans from financial institutions, from outside investors, or even from family and friends come with the additional responsibility that you will constantly be asked – in one form or another – to account for how your business is progressing. If you don’t like this idea, or have a very low risk tolerance, financing your growth out of existing cash flow is probably your best bet. You will grow more slowly, but you will sleep at night. Each business is unique, as is the personality of every entrepreneur, as are the business conditions in different areas of the country. Just don’t act impulsively. Take your time, have a vision, write a business plan, and be rigorously honest with yourself at all times. cc Mike Draper is a business coach for Renovantage ( and a frequent contributor to Canadian Contractor.

Financing Growth Part II  

Canadian Contractor September/October 2013