Immediately prior to the COVID-19 pandemic, the construction industry was experiencing tremendous growth in nearly all market segments in all areas of the country. The pandemic has many contractors rethinking their growth plans for 2020 and beyond. Contractors in some states were required to stop work for months. Even those contractors that were permitted to work throughout the pandemic may be less optimistic than they were six months ago, in part due to concerns about whether they will have enough work to sustain them through these uncertain economic times.

The good news is that established contractors rarely go out of business because of a lack of work — they are far more likely to die of gluttony than starvation. Here are five (5) challenges that help explain why:

1. Shortage of qualified project management and labor. In bad economic times when there is less work, established contractors adjust by trimming their staffs to retain their best management and labor teams, which means a higher percentage of their projects are being handled by their best people. In good economic times when work is abundant, contractors are tempted to take all the work they can get, without considering whether they have enough qualified management and labor to perform that work, with the result that contractors find themselves using inexperienced managers and employees on complicated projects. When “C” project teams are being asked to perform “A” work, their projects can quickly become disasters — and one disaster can put even an established contractor out of business. Successful contractors have the discipline to honestly evaluate their available teams and to walk away from prospective work for which they lack qualified project teams.

2. Upstream contracting parties continue to push contract risks onto downstream parties. In an economic environment where the supply of capable subcontractors struggles to keep pace with demand, subcontractors have more leverage to negotiate favorable contract terms, but too many subcontractors do not take advantage. The result is that many risk-transfer (or risk-limiting) contract provisions are not as favorable to the subcontractor as they could be with negotiation. These include:

• Obligations to indemnify against others’ negligence without regard to whether the subcontractor was at fault.
• Unlimited liability for consequential damages.
• The subcontractor agreeing to be a “co-warrantor” that is obligated to perform manufacturer warranties when the manufacturer goes out of business.
• Provisions that do not clearly give the subcontractor written notice and an opportunity to cure before upstream parties can supplement the subcontractor’s workforce or terminate the subcontractor.

3. Failing to include more profit margin in their bids. When work is plentiful, contractors should include more profit margin in their bids, but many do not. Instead, they continue to prepare bids with razor-thin profit margins based on their belief that such margins are necessary to win the work. Often that belief is mistaken. If the belief is accurate, even in good economic times, the contractor should re-evaluate whether to pursue that work.

4. As contractors grow, providing project managers and executives with proper support. As the number, size, and complexity of a contractor’s projects increase, the contractor should add to its overhead staff to ensure that project managers get the required support, with regular reviews of project costs, schedule, manpower, and quality control. In the same vein, the contractor’s owners and executives should periodically review its team of advisors — e.g., CPAs, lawyers, bankers, and insurance and surety brokers — who can assist with anticipating issues and providing guidance through the contractor’s growth period.

5. Maintaining appropriate levels of working capital. As contractors grow, it is challenging to maintain adequate “working capital,” which is the difference between the contractor’s current assets and current liabilities. Bonding companies typically like to see their contractors maintain working capital between 5% to 10% of the amount of their total work programs, but the amount required can be more or less depending on the surety and the contractor’s circumstances.  Contractors who can maintain those levels of working capital through growth periods will be healthier financially and will impress prospective sureties when they need bonding.

In short, the COVID-19 pandemic may have clouded some contractors’ visions for growth in the near term, but that cloud comes with a silver lining: contractors can re-evaluate their business development, estimating, operations, and management teams so that, when the opportunity to grow comes again, they can grow for their benefit rather than at their peril.

© Riley Bennett Egloff LLP

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Posted on July 21, 2020, by Kevin N. Tharp