Negotiating a Downpayment or Early Payment
As a Contractor, you should always try hard to get a
downpayment or some form of an early payment for the work that you
perform for a Client.
By: Kit Werremeyer
President, Southernstar Consultants, LLC
Positive
cash flow from operations is a very important element of a
successful contracting business. Actually, it’s an important element
of any business, unless perhaps you are a charity.
But this
article is not written for charities. It is written for Contractors
who are in the business to make a profit from their construction
activities and want to make sure that they are getting paid in a
manner that keeps more cash coming in the door then is going out the
door.
Asking for a Downpayment
or an Early Payment
Just because a Client says his standard terms
of payment are paid-when-paid, or paid-if-paid, or paid at the end
of the job, or maybe you’ll get paid somewhere between 30 and 90
days after you submit an invoice, or some other form of delayed
payment, doesn’t mean you have to roll over and accept them.
Contractors have lots of upfront expenses associated with any new
contract, including sales and marketing and overhead costs
associated with negotiating the contract.
There are a number
of important business rules, but the most important one is: have
cash, and the sooner you receive it for your work the better.
During negotiations for the
contract with the Client or, better yet, in your proposal to the
Client for the work state that your terms of payment include for a
downpayment or some form of an early payment. Think of an early
payment as just a slightly delayed downpayment. In other words: just
ask for it!
Often, a Client will simply refuse to agree to a
downpayment, unless there exists certain special contract requirements,
like the purchase of a major piece of specialized equipment which
has a long lead time.
Sometimes Clients just say: “We don’t do
downpayments.” Some Clients even bristle at the suggestion that a
downpayment is part of the agreed upon terms of payment for the
contract. They say: “Good heavens. Pay that Contractor before he has
done any work for me. No way!”
Okay. Absent some special
contract requirement as mentioned above, if the request for a
downpayment is going to give the Client too much heartburn, then
fall back to asking for an early payment which, as noted earlier, is
just a slightly delayed downpayment.
A downpayment implies
that the Client will be given an invoice, payable within some short
timeframe, for typically some percentage portion of the contract
price at the time of signing the construction contract.
An
early payment is one that is tied to the Contractor performing some
actual scope of work activity that takes place very early on at the front
end of the contract.
Here are several common examples of events
or activities that can be used to trigger an early payment upon
their completion:
• Submission of Contractor’s evidence of
insurance certificates.
• Submission of Contractor’s
performance and other bonds or sureties.
• Placement by
Contractor of major material or equipment purchase orders.
•
Submission of first set of engineering drawings or similar documents
developed by Contractor.
• Mobilization by Contractor’s field
forces and/or equipment at the jobsite.
Try to find some
activity that takes place in the first few weeks of a new contract
and then negotiate to submit an invoice for that activity or
activities. The value of the invoice doesn’t need to represent only
the value of the activity but should include, for example, other
upfront costs like sales and marketing and overhead and other costs
associated with securing the contract.
Since an early payment
is tied to the submission of an invoice for contract required work,
then it’s likely that the invoice will fit into the Client’s
approved way of paying for work done by the Contractor. Clients say,
“you gotta’ do something before you get paid for it.”
Be
creative! Find scope of work that is done early and quickly bill for
it.
If an early payment is received several weeks later than
if a downpayment had been received, it’s just about as good as it
meets the goal of having cash coming in the door early.
The Size
of the Downpayment
Ever get a 50%
downpayment for a contract? That would get some serious cash coming
in the door. Read on.
Maybe, if you are lucky, the Client
will allow you to negotiate a 5%, or less, downpayment. What a nice
guy! A little miserly, though; but, better than 0%.
Often,
the Client seems to have a paradigm (preconceived notion) about the
size of a downpayment when he is at least receptive to negotiating
one with a Contractor. That paradigm seems to run in the 10% or less
range for a downpayment. A 10% downpayment is okay, still a little
miserly, but certainly better than 5%. There doesn’t seem to be
anything magic about 10%, except it being a negotiating tactic by
the Client to minimize the agreed upon downpayment.
20% seems
to be a good number for a downpayment. Do a cash flow on a
construction project to test this number. By the time you get the
cash for the downpayment, maybe 15 to 30 days after you invoice, you
will have been freely spending cash on other contract matters to use
it up. The argument here is that this downpayment percentage is
needed to start a terms of payment program which will result in a
positive cash flow for the Contractor. That’s just good business.
And fair, too.
Now, what about a 30% downpayment? How about
40%? Maybe 50%?
Being able to negotiate these sizes of
downpayments, if there are no significant major material purchases
required at the front end of the contract, will likely require an
incentive for the Client.
Incentives are wonderful
negotiating tools. The Contractor gets a sizeable downpayment and
the Client gets an incentive to agree in return. Something good and
valuable is received for everyone involved. Some examples to
consider are:
• For a 30% downpayment, Client receives a 1%
discount on the contract price.
• For a 40% downpayment,
Client receives a 2% discount on the contract price.
• For a
50% downpayment, Client receives a 3% discount on the contract
price.
Again, do the math through a cash flow analysis of the
construction project’s terms of payment with these large
downpayments. Does a 50% downpayment in return for a price reduction
of 3% keep the Contractor from borrowing or using his own funds to
finance the project?
Ask the Client how valuable that price
discount incentive is to him. He has funds available to build the
project. It might actually save him money to agree to a, for
example, 50% down payment in return for a 3% price discount.
Try to use an incentive program for the Client in order to encourage
him to agree to a
sizeable down payment. The percentages noted in the above examples
may not apply to every construction project, but will at least
demonstrate the idea of providing the Client with an incentive to
agree to a sizeable down payment. Be creative with the incentives.
With respect to down payments or early payments, try your best
to achieve the goal of keeping the cash coming in the door faster
than it is going out the door. Downpayments, especially large ones, and early payments
will clearly help achieve
that goal.
And remember the three most important rules for a business:
- Have Cash
- Have Cash
- Have Cash
Copyright ©2005 Kit Werremeyer, Southernstar
Consultants, LLC, Revised January, 2014.
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