It would be easy to blame the COVID-19 pandemic for the rising number of construction companies experiencing financial troubles — even if these hardships were delayed due to federal initiatives focused on employee retention such as the Paycheck Protection Program (PPP), Employee Retention Credit (ERC), and other relief programs designed to give qualifying companies an influx of cash. But, while there have not been many construction companies completely shuttering, it is imperative to recognize the red flags that a failed construction company displays, especially during times of economic uncertainty.
What Is Contractor Failure?
Generally, contractor failure is defined by a series of events that ultimately lead to a shutdown of operations. The contractor cannot successfully complete a project, meet its financial obligations, and sustain operations due to cash flow constraints.
While the economy and local market conditions impact businesses in all industries, the construction sector has additional unique factors to contend with, including:
- Labor shortages
- Contract language
- Exorbitant insurance costs
- Changes in jobsite conditions
- Unexpected increases in materials pricing
- Inclement weather
- Slow investment in new technologies
These factors have been compounded during the pandemic by additional expenses (e.g., personal protective equipment (PPE), sanitizing stations, and medical personnel), decreased productivity due to staggered shifts, and sharp rises in material prices.
According to Grassi’s 2021 Construction Industry Survey Results,1 more than half of general contractors and subcontractors surveyed experienced decreased revenues in 2020. And more than 80% were affected by delayed, closed, or canceled projects. The costs of pandemic-related protocols, the aforementioned volatile material prices, deteriorating backlogs, and a crowded bidding field can be added to these issues. These obstacles are not easy for any contractor to survive, let alone profitably. But the true reasons for why contractors fail in this environment lie deeper than the surface.
Even as jobsites are fully remobilized, the challenges continue as new work is not appearing as quickly as backlogs are being burned off and credit availability is shrinking.
Who Pays the Price?
When a contractor fails, the company is not the only impacted party — failure has far-reaching consequences on employees, credit providers, vendors, and subcontractors; even CPAs and advisors may face reputational damage.
As contractors continue to face COVID-19 challenges, it is more important than ever to consider the common reasons why businesses fail and identify the solutions that can be employed to mitigate the associated risks.
Failure #1: Overextension
Ultimately, construction companies go out of business because they have no cash. Construction is a naturally risky business that embodies the concept of feast or famine; when an overextended contractor takes on too much work, it can lead to a shortage of working capital. Cash is tied up in projects while outstanding receivables age, underbillings are not realized, and/or operating liabilities and indebtedness increases.