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
• 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.”
creative! Find scope of work that is done early and quickly bill for
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.