Key points
- Subcontractors are paid in monthly stages, with a retention held back until long after the work is finished.
- Many standard invoice finance providers will not fund construction contracts; specialist products exist for this reason.
- Plant and vehicles can be financed on hire purchase or lease, and sometimes refinanced to release cash.
- Expensive short-term borrowing taken to bridge a late payment is how construction debt most often gets out of hand.
How construction businesses are paid
Most construction work is paid in stages. The subcontractor submits an application for payment, usually monthly, for work done to date. The contractor above assesses it, may reduce it, and pays a certified amount on an agreed date, often 30 to 60 days later. Work done in January may be paid in March.
A retention is a percentage of each certified payment, often 3 to 5 per cent, held back as security for defects. Half is typically released at practical completion and the rest after the defects period, which can be 12 months or more. A firm with several live contracts can have a large sum in retentions it cannot touch.
The Construction Act, formally the Housing Grants, Construction and Regeneration Act 1996 as amended, sets payment rules in plain terms: longer contracts must provide for stage payments, the payer must issue a payment notice saying what it will pay, it must issue a pay less notice in time if it intends to pay less, and disputes can go to adjudication, a fast decision process, without court. Pay-when-paid clauses are generally unenforceable unless the party above is insolvent. Knowing these rules matters more than any loan when an application goes unpaid.
Under the Construction Industry Scheme, CIS, the contractor deducts tax at source, usually 20 per cent, from the labour element of each payment. It is set against the subcontractor's tax bill later, but it cuts the cash received now.
Where the cash-flow pressure comes from
- Labour and materials are paid first. Wages, merchant accounts and plant hire fall due whether or not your application has been certified.
- Plant and vehicles. Diggers, telehandlers and vans are expensive, and a firm often carries several hire purchase agreements on different terms.
- Concentration. Many subcontractors depend on two or three main contractors for most of their turnover.
- Insolvency up the chain. If a main contractor fails, unpaid applications become unsecured claims and retentions are usually lost, while the subcontractor still owes its own suppliers and workers.
- Weather. External trades lose days in winter while fixed costs continue.
Finance options that fit the sector
Asset finance and asset-based lending for plant
Plant and vehicles are the obvious security. New equipment can be bought on hire purchase or lease, spreading the cost over its useful life. Equipment owned outright, or with equity in it, can sometimes be refinanced through a sale and hire-purchase-back arrangement that releases cash while you keep using the machine. The asset is at risk if repayments stop.
Construction-specific invoice finance
Standard invoice finance advances money against an invoice for goods or services delivered and accepted. Applications for payment are different: they can be reduced by a pay less notice, retentions are held back, and the contract may allow set-off for defects. Many mainstream invoice financiers therefore will not fund contractual debt. A smaller number of specialist providers do, usually advancing a lower percentage, often against certified amounts only. The cost reflects the risk, but it can be far cheaper than the alternatives below.
Working capital and cash flow facilities
A working capital facility can cover the gap between paying a gang on Friday and receiving a certified payment six weeks later. It should be sized to the actual timing gap and repaid as applications are paid, not left to drift into permanent borrowing.
Consolidating equipment loans
A firm with several hire purchase agreements, a van loan and a short-term loan may find that consolidating business debt into one facility simplifies the outgoings and may lower the monthly figure. A longer term increases the total repaid, HP settlement figures may include interest that is not fully rebated, and cheap secured agreements are often best left in place.
Refinancing against property
A firm that owns its yard or workshop can consider a secured business loan against it, which typically costs less than unsecured borrowing. The premises are at risk if the loan is not repaid, and valuation and legal fees add to the cost.
The sector's most common mistake
A certified payment is late and wages are due Friday. The firm takes a high-cost short-term loan or merchant cash advance, meaning to repay it when the application is paid. The application is then reduced or paid a month late, the expensive facility is still running, and a second one is taken to cover the first. Within months the business is servicing debt that was never meant to last. If this is already happening, our cash flow problems page sets out practical steps, and Business Debtline offers free, impartial help.
Risks specific to construction borrowing
- Borrowing against an application that may be reduced. Until the payment notice arrives, the amount you will receive is not certain.
- Counting retentions as cash. They are released late, sometimes disputed, and lost if the payer becomes insolvent.
- Cross-collateralisation. Several HP agreements with one provider may be linked, so a default on one can affect the others.
- Personal guarantees. Unsecured borrowing by a limited company contractor will almost always need a director's guarantee; see our personal guarantees page.
- CIS and HMRC. Losing gross payment status tightens cash further. A Time to Pay arrangement for arrears may be possible via GOV.UK.
Questions to ask before borrowing
- Is this a timing gap that will close, or a loss-making contract that borrowing will only disguise?
- Has the payment notice been issued, and what date does the contract actually say I will be paid?
- Will the invoice finance provider fund applications, certified amounts only, or neither?
- Which assets and personal guarantees would be at risk if a main contractor failed next month?
Our guide on how to compare business finance offers shows how to put products side by side on total cost.
Frequently asked questions
Can a construction subcontractor use invoice finance?
Sometimes. Many general providers exclude contractual debt because applications can be reduced and retentions held back. Specialist construction finance providers do fund applications and certified payments, usually at a lower advance rate and higher cost.
Can I borrow against retentions?
Rarely as a standalone product. Some specialist providers include certified retentions in a wider facility, but most treat them as too uncertain. Plan cash flow as though retentions will arrive late.
Can I refinance plant I already own?
Often, yes. Equipment with clear title and resale value can be sold to a finance provider and hired back, releasing cash while you keep using it. The machine becomes security for the new agreement.
What happens to my debts if a main contractor goes into administration?
Your own debts to suppliers, finance providers and HMRC remain payable. Money the contractor owed you becomes a claim in its insolvency, and recovery is often small and slow. If that leaves your business unable to pay its debts, speak to a licensed insolvency practitioner or Business Debtline before borrowing more.