Construction finance is actually different from other forms of business finance especially when it has to do with small businesses. In reality, it is a bit more complicated than equipment finance, working capital finance, and others.
This is because it involves funding two distinct loan periods with each having its own level of risk. It is a common practice for most owners to secure two different loans—possibly from two different lenders—to finance each period. The first period for which construction finance is usually obtained is the period of construction when the physical structure is being set up. The form of finance obtained during this period is what is commonly referred to as a construction loan. The second period for which financing is required is the period after the construction when the physical building has been completed.
During this post-construction period, another loan called a permanent loan is obtained to pay off the construction loan. It is possible for a business to obtain both the construction and the permanent loans at the same time, in which case it is called a combination loan if it is from the same lender. But if business owners opt for alternative lenders that offer merchant cash advance instead of commercial banks, all the complication is removed and the advance is given once and for all while the business then embarks on payment until the advance has been fully repaid.
Challenges in Obtaining Construction Finance
The financial market at the present moment is very tight and lenders now consider providing for construction finance to be riskier than ever before. There are many pitfalls that lie in the way of small business owners, especially startups when it comes to obtaining adequate construction finance. In order to avoid several of those pitfalls, it is necessary for the business to have an ownership group having a defined plan for finished facilities. There has to be a highly skilled project team whose task will be to ensure that the project is completed on time.
It is also the responsibility of this project team to ensure that the construction is done according to the budget while the high-quality standard is maintained throughout. All this is necessary because financial institutions that provide the construction finance do not want to have even the slightest doubt that the project would succeed; that being the case, having a strong team could help allay their fears.
At the present moment, it is not uncommon to find that lenders would not finance a project one hundred percent. In most cases, funding is limited to about 75 percent of the entire project cost, although this is not what takes place with merchant cash advance where a business can get an advance for construction provided it does not exceed 250 percent of its monthly revenue. In all cases of obtaining from traditional sources, however, collateral and even additional personal guarantees are usually required. A personal guarantee is provided by the owners of the business in order to assure the banks that they would be personally responsible for paying a bank loan.
When collateral is required it is the finished facility that is usually offered. So if business owners default on the loan the lender gets ownership of the facility-one only needs to recall that the facility at this point is already worth more than the value of the loan. Land could also serve as collateral for construction finance especially when the lender judges that a facility might be very difficult to sell. For example an office complex can be rented out more easily; on the other hand, a gas station might not be so easy to sell. In the case of personal guarantees, the lenders typically evaluate the net worth of all the borrowers in order to determine whether or not it is equal to the loan amount when combined. All of this makes it very difficult for small businesses to obtain construction finance. Let us now take a look at some of the most popular sources of funding for construction projects.
Commercial banks as a source of construction finance and why business owners are looking for alternative sources nowadays
Prior to this time, the most popular source of construction financing had been the commercial banks which provide construction loans to small businesses. Banks have always been the most popular source of all of the forms of business finance and not only construction finance because of the low-interest rates they offer. It is also very much easier for local banks to evaluate projects within the region operate than say a distant merchant cash advance provider. Moreover, bank loans are especially suited for small projects costing less than 5 million dollars, an amount small businesses will hardly exceed.
There are also constructions lending banks which specialize in construction projects and which can sometimes provide expert advice to businesses embarking on construction projects of whatever nature. In spite of the advantages of commercial bank loans, a major drawback is that the approval rates are very low.
In addition, small businesses are often unable to meet the stringent requirements of collateral, personal guarantee, credit score and a host of other requirements. As a result business owners have had to resort to nontraditional sources of funding such as merchant cash advance which eliminates most of the problems associated with bank loans.
What is Merchant Cash Advance and can be it be used to finance construction?
A merchant cash advance is one unique source of funding which can be used to obtain construction finance much more quickly than can be obtained through commercial banks. The essence of a merchant cash advance has utilized the revenue of a business as a sort of collateral to obtain a cash.
What this means is that a business in urgent need of funding for construction, and which does not meet the requirements for a commercial bank loan, can sell its future revenue to merchant cash advance providers in exchange for cash which can be made available almost immediately. So a merchant cash advance is essentially a sale involving a business in need of construction finance in this case and a merchant vendor that is ready to provide the finance.
In view that a merchant cash advance is structured as a sale, it is not governed by regulations that normally apply to loans. This not suggesting that the entire merchant cash advance industry is a chaotic one because it is definitely not. Such laws as the uniform commercial code of each state as well as the fair credit reporting act are applicable to merchant cash advance transactions although laws which govern business to customer transactions do not apply. This is because a merchant cash advance transaction is seen as one involving two businesses.
Merchant cash advance can be used to obtain equipment finance, working capital finance, as well as construction finance as has already been suggested. When a merchant is in need of construction finding and approaches a merchant cash advance provider it is usually only a matter of days before the advance is fully processed.
As long as the business seeking the advance has been in operation for a minimum of about 6 months, and as long as it meets the requirement of monthly revenue of at least $10,000 it can obtain construction funding. However, because the amount involved in construction could be ranging in hundreds of thousands, a business must have sufficiently high revenue in order to be eligible for merchant cash advance.
How a merchant cash advance works
A merchant cash transaction begins once the merchant cash agreement has been signed. The agreement outlines the terms of the offer, including all such things as factor rate which determines how much the business pays back in total.
The other thing which the merchant cash advance agreement captures is the withholding percentage. It is very important that the business is clear on this as it is what determines the fraction of the daily credit sales that goes into debt repayment. In this regard, the business has an option of choosing between fixed percentage and fixed amount payment options.
The fixed percentage implies that the amount that is paid would depend on the total sales for each day; while the fixed amount option ensures that the same amount is paid regardless of business conditions. Expectedly, merchants who have obtained construction finance generally prefer the fixed percentage option. Whatever option the business adopts, it continues to make daily payments until the entire advance has been repaid.
Benefits of Merchant Cash Advance
One of the major benefits of opting for merchant cash advance is that because payments are structured in such way that should not exceed 18 months, a business would not be indebted for long. There is something not too pleasant about a business having to pay interests for several years even though might appear to be more convenient.
One cannot also talk about the usefulness of merchant cash advance without mentioning the fact that it is an unsecured form of business credit, meaning that the business bears no risk, while the business owners do not stand to lose their personal belongings as no personal guarantees are offered.
Moreover, a business with a low credit score can also be offered construction finance, provided other requirements have been met. Finally, there is no better option when what is required is a quick business loan that can be obtained as easily as possible. From all indications, the merchant cash advance industry is growing and this growth is expected to continue.