Starting a Construction Contractor Business the Right Way

December 28, 2019
Posted in: Uncategorized

Table of Contents

 

 

You’ve been bitten by the entrepreneurial bug and have always been told that you’re “handy with your hands” so starting a construction contractor business seems like a logical move. Even if this is the perfect business idea for you, there’s a lot that goes into starting a construction contractor business. Construction is one of the top industries for startups but it also has one of the highest failure rates. According to data from BizMiner, building, heavy/highway, and specialty trade contractors have a failure rate of nearly 30%. You don’t have to be one of them. In this article, we’ll discuss how to plan your business, register it properly, operate legally, and become profitable.  We’ll also discuss the pitfalls that can cause your construction business to fail. 

 

construction hat

 

Reasons Why Construction Businesses Fail

Running a successful construction business isn’t easy. There are so many risks and challenges in the industry that can lead to failure. Here are some of the most common factors that cause construction businesses to go under. 

 

Inadequate Capital & Poor Cash Flow Management

Construction businesses require large amounts of capital to purchase fixed assets like tools, heavy equipment, and vehicles. If an adequate level of capital isn’t maintained, a construction business has a higher chance of failure. A business needs to have sufficient capital to weather the lean times and to handle unexpected expenditures. 

Overinvesting in underutilized fixed assets and tying up working capital and cash in ongoing projects are ways that some businesses dip into their reserves and wipe out all available capital. Construction businesses need to maintain adequate reserves to protect the business from unexpected capital needs that may arise. 

Another area of concern for a construction business is poor cash flow management. Not closely monitoring cash flow, the amount of cash coming in and going out, can lead to business failure. How can you ensure your business’s success if you aren’t billing for projects and getting paid in a timely manner? You also have to keep watch over your accounts payable and receivable and properly manage project budgets. 

When you maintain a positive cash flow, you can pay debts and expenses, reinvest in your business, and maintain reserves for emergencies. If you don’t keep an eye on cash flow and you find yourself in a situation where more money is going out than coming in, this can quickly lead to failure.

 

Poor Project Performance

Ensuring that you’re working on profitable projects is a process that should start well before any contracts are signed. You need to only agree to projects that are the right fit for your business. Do your due diligence and decide if a project is worth bidding on. If, after job costing, you find that the project will cost more to complete than you’ll be paid, you need to walk away. 

One unprofitable project won’t necessarily shut your business down, but if you bid on several money-losing projects within a short period, your business could be in serious trouble.

If, after job costing, a project promises to be profitable, you need to ensure that it’s managed properly. The work needs to be planned out so that it’s completed on time and within budget. To accomplish this, you need to have the right leadership, employees, and equipment in place to successfully complete the job. If the project isn’t properly managed, this can result in losses or very small margins. It could also hinder you from getting repeat business. 

 

Failure to Plan

The importance of a sound business plan can’t be stressed enough. It’s key to running a successful construction business. A sound business plan involves developing goals and objectives that are attainable and sustainable. Your business plan should include information about your business’s leadership, operations and marketing strategies, and financial projections. 

To be successful, you need to carefully map out plans for growth or expansion to avoid becoming overextended or straying too far from the goals and objectives that you originally set for your business. Be sure to communicate your goals and objectives to all team members. They’ll need to know what you’re trying to accomplish if they’re expected to help you get there. 

 

Growing Too Fast

Growing your business is a good thing. However, as mentioned above, plans for growth or expansion should be carefully mapped out so that they can be managed properly. If you try to grow your business too fast and without having the resources, manpower, and knowledge necessary for successfully executing that growth, you’ll be fighting an uphill battle.  

If you try to grow your business by taking on more work than you can handle (in volume and project size) or expanding into new geographic areas without thorough research, complications are sure to arise. Successful expansions require strategic and methodical planning. Manage your growth by building up to larger projects. If you’re currently working on $25,000 projects, try bidding on $40,000 projects before jumping to $150,000. Apply this reasoning to expansion into new geographic areas.  Test it with one or two projects in the new geographic areas. Successfully complete those projects before you consider taking on additional ones.

 

 Having the Wrong Team

To accomplish your goals, you need to have the right team in place. You can have a great product or business idea but, ultimately, you need qualified people to help execute that idea. Everyone, from your executive team to entry-level employees, should share your vision and have the required skill set to make a meaningful contribution to your business. 

Since turnover in the construction industry is high, it’s important that you offer a competitive salary and benefits. This will allow you to recruit and retain the best employees possible. You’ll also want to foster a company culture that makes employees feel valued and motivated. 

 

Failing to Innovate

Blockbuster Video was forced to file bankruptcy when services like Netflix and Redbox came on the scene. Failing to innovate and adapt to technological changes and changes in the marketplace has been the undoing of many businesses including Blockbuster, General Motors, Compaq, and Sears. These businesses went bankrupt or were forced to cease operations partly because they weren’t able to adapt fast enough to stay afloat. 

Technology is reshaping the construction industry and businesses that refuse to adapt to these changes will find themselves heading for bankruptcy. Drones, robots, and Building Information Modeling (BIM) are rapidly changing how the construction industry plans, designs, constructs, and manages buildings and infrastructure.  

As construction projects become more complex, the businesses that embrace the new technologies and incorporate digital tools into their businesses are very likely to experience success in the future. Those that refuse to innovate and insist on holding on to outdated practices will be left behind. 

 

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Preliminary Research

To determine if starting a construction contractor business in your area is a viable option, you need to conduct market research. If the construction market in your area is oversaturated and customers are satisfied with the current supply of local companies, it may be difficult to grab an amount of market share that makes your venture worthwhile. 

When conducting market research, you’ll first want to know how many construction companies are already operating in your planned service area.  You’ll also want to know what they specialize in (their niche), their rates, and what type of reputation they have. Along with this information, you need to gain an understanding of your potential customer base. How many are there? What is their median age and status, etc.?  Having this information will help you create a thorough business plan and give you a competitive advantage if market conditions are favorable and you proceed with starting a construction business in your area. 

 

Finding Construction Market Information

The Small Business Administration (SBA) offers a wide range of free resources that provide data on customers and markets. It’s probably one of the easiest places to start your market research. You can look up the demographics of your target market including age, gender, employment statistics, spending habits, and more. You can also find production and sales statistics for your market. 

If you want more specific information than the SBA can provide, local industry publications can help you beef up your research. By typing your city name + “construction industry publications” into Google, you can find most local publications. The search results should provide a list of publications or links to many of the construction magazines in your area. These magazines will be full of articles about local construction companies and the state of the local construction market.

 

Conducting Your Own Market Research

If you want to get an understanding of your potential customer base, one of the best ways to do that is to ask them what you want to know. Direct customer feedback can be obtained by using surveys or questionnaires, focus groups, or individual interviews. To make the most of these contacts (which can be both time-consuming and costly), have a good idea of what you want to ask beforehand.

Some questions to consider asking:

  • How often do you hire contractors in the _____ trade?
  • What’s most important to you when hiring a contractor?
  • What are the biggest issues you have with contractors?

The answers to these questions will help you develop your business plan and more specifically, your competitive advantage or unique value proposition (UVP). A UVP is a statement that describes the benefit of a company’s offer, how it solves customers’ needs, and what distinguishes the company from the competition.

 

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Writing Your Business Plan

The preliminary research should give you an idea of whether starting a construction contractor business in your area is feasible. You should also have a general understanding of the construction market for your area and of your potential customer base. Now it’s time to create a more detailed plan that maps out the specifics of your business. The purpose of this plan is to guide you in starting and managing your business.

Some concerns that your plan will address: 

  • Your startup and ongoing costs
  • Defining your target market
  • How much you will charge customers

 

Construction Contractor Business Startup Costs

Let’s face it. Starting a construction business will not be an inexpensive endeavor. You can start small and add on as you gain more clients but expect to spend somewhere in the neighborhood of $10,000 to $15,000 initially. 

You’ll need:

  • Professional-grade tools and equipment (Consider leasing or purchasing used equipment to reduce your initial investment.)
  • Office space
  • Business licenses and permits
  • Business insurance (including workers’ compensation)
  • Marketing/advertising campaign (to get the word out)
  • Reliable transportation
  • Trailer for hauling materials, tools, and equipment
  • Phone service
  • Website design

 

Ongoing Costs for a Construction Contractor Business

The ongoing expenses you’ll encounter as a construction contractor business operator will mostly be job-related. Here are the ongoing expenses that you can expect:

  • Raw materials 
  • Tools and equipment
  • Labor
  • Professional services (accounting, legal)
  • Renewal of licenses and permits
  • Rent and utilities
  • Phone service
  • Marketing/advertising
  • Business insurance premiums

 

Your Target Market

In your preliminary research, you gained a general understanding of your target market. You found out how many potential customers you have and the demographics of those customers. When defining the target market for your construction contractor business, one factor that’s highly important is financial stability. What is the annual income or net worth of your target market?

It’s important to have this information because you should focus your marketing efforts on individuals and families with sufficient financial resources. Clients with very tight budgets will be anxious about the amount of money being spent during the project. As a result, they may want to cut corners in order to spend less. They may also run out of money and need to put a project on hold, indefinitely. This lack of stability could spell trouble for your business. To keep the project moving forward, a client must have ample resources to supply funds throughout the project as needed.  
 

Income Projections

Construction contractors are paid up front to buy materials and hire workers to start the project. Clients are then billed at regular intervals throughout the project to cover the cost of materials and labor and again when the project is completed. As the owner, you’ll receive the portion that’s left after all other bills and workers are paid.

As part of your business plan, you need to estimate or forecast what your sales and expenses will be for the first 12 months, then annual forecasts for the following three to five years.
 
The financial projections to include in your business plan are:

  •  
  • Sales forecast Your sales forecast is your projection of how many projects you’ll complete over the next few years. Don’t worry about breaking it down into too much detail. If you offer multiple project types, you may want to break your forecast down by major project categories. You may also want to include a corresponding row for each project category to account for the direct costs associated with completing the project. Direct costs don’t include business expenses like rent, insurance, etc. Only the cost of raw materials or costs directly associated with completing the product should be included.
  • Profit and loss statementThe profit and loss statement (P&L), or income statement, lists the sales and direct costs figures taken from your sales forecast along with other ongoing business expenses. The focus of the P&L is net profit or the “bottom line” which will show whether your construction business expects to make a profit or experience a loss during a given reporting period.
  • Balance sheet — The balance sheet provides an overview of your business’s financial health. It lists your business’s assets, liabilities, and your (the owner’s) equity. Liabilities are subtracted from assets to determine net worth.
  • Cash flow statement The cash flow statement will show how much cash you have at a given point in time. The cash flow statement will highlight when you might be low on cash so you can consider options for raising or borrowing money to keep your construction business afloat.

 

How Much Will You Charge Clients?

In order to complete the sales forecast statement above, you need to determine how much you’ll charge for projects. Clients are typically charged based on specific project rates, meaning the scope of the project affects the pricing. Since it was recommended that you account for the direct costs associated with projects, you’ll also need to determine an hourly rate for your workers (labor). 

Your preliminary market research of the local construction industry (which hopefully included researching current construction businesses) should help you establish a baseline for costing your work. You want to make a healthy profit on projects but you don’t want to price yourself out of the market.  Charge a competitive price that still allows you to earn a decent profit.

 

Profit Expectations

A successful construction contractor business isn’t built overnight, so your first few years may show a meager net profit. Most of that profit will likely (hopefully) be invested back into your business to support its growth. However, once you become established, you could potentially gross between $100,000 and $1 million annually.

 

drill

 

Naming Your Construction Business

Naming your construction business may seem like an easy task but it’s not as simple as just picking something that sounds good. Choosing the right name is very important and requires thought and intention. The wrong name won’t resonate with your clients and could hinder your marketing and branding efforts.

Qualities you’ll find in a great business name:

 

  • It’s Consistent with your Branding – The name is consistent with your positioning in the marketplace.
  • It’s not Similar to Competitors – Choosing a name that’s close to a competitor’s could confuse clients.  
  • It’s Simple Short names and names without hyphens or special characters are easier to remember. 
  • It’s Easy to Spell –– Hard-to-spell names can confuse potential clients and make it difficult for them to find your business online.
  • It Can Grow With Your Business – Pick a name for your construction business that doesn’t limit you to a specific service or area. You may want to branch out to other services or geographic areas.
  • There’s Meaning Behind It – Business names that convey something meaningful or that conjure up pleasant thoughts have a lot of appeal.
  • Doesn’t Have Negative Connotations – Don’t use a name that you don’t know the meaning of. It could be offensive or put your business in a negative light.
  • It Hints at What You Offer – Pick a name that will give clients a good idea of what you provide when they see it.
  • It’s Easy to Pronounce & Sounds Good – You don’t want to pick the perfect name only to have others mispronounce it. It should sound good when said aloud.
  • It’s Catchy – Your business name should inspire potential clients and be memorable.

 

Choosing a Legal Structure

There are five legal structures you can operate your construction business under. The one you choose should offer the right balance of liability protection, tax benefits, and flexibility.  Because of the nature of the construction contractor industry, you’ll definitely want to ensure that you have adequate liability protection should your business be sued.

  • Sole Proprietorship – The sole proprietorship is the simplest and most straightforward of the legal structures. However, it offers no personal liability protection. For example, if a client sues you for negligence, your personal assets would be at risk.
  • General Partnership – All partners actively operate the business and equally assume responsibility. This structure offers no liability protection.
  • Limited Partnership – A limited partnership has both general and limited partners. The limited partners act as investors only and aren’t liable for any of the business’s obligations.
  • Corporations – Although, the corporate legal structure involves a great deal of paperwork, it provides excellent asset protection for its owners/shareholders. The C –corporation is taxed twice while the S-corporation is only taxed once.
  • Limited Liability Company (LLC) – An LLC combines the best features of a partnership with the asset protection of a corporation.

For most small construction contractor businesses, an LLC is a great option. It offers liability protection and it’s easier to form than a corporation. To protect your privacy and ensure that you receive all documentation from government agencies, you should consider using a registered agent
 

Getting Federal & State Tax ID Numbers

Before you can open for business, you’ll need to obtain an Employer Identification Number (EIN) which is another name for a Federal Tax ID number. The EIN is basically a social security number for your business. The IRS requires that it be listed on all of your business’s tax filings. If the state in which you plan to operate has an income tax, you may also be required to obtain a State Tax ID number.
 

Opening a Business Bank Account

A business bank account is essential for keeping personal and business expenses separate (which makes accounting and tax filing easier) and for personal asset protection. When you handle both personal and business transactions from the same account, your personal assets are at risk in the event your business is sued.  

A business credit card can also help separate personal and business expenses by having all of your business expenses in one place. A credit card can also help build your business credit history which will prove useful should you need funding in the future. 
 

Managing Finances

To ensure the financial health of your business, you need to implement a financial management system that tracks all sources of income and all expenditures. This will not only let you see where your business stands at any point in time, but it will simplify your tax filing. 

Cash flow management is a critical part of the financial management system.  It will help you foresee cash flow problems in time to take corrective action.
 

Obtaining Required Licenses & Permits

Depending on the state in which you operate, there are a number of licenses and/or permits you’ll be required to obtain. Failure to do so could result in hefty fines levied against your business or your business being shut down.  

Clients will also expect your construction business to be “licensed, bonded, and insured”. This shows that your business is credible and professional. Clients also prefer it for quality-assurance reasons and to limit their liability.  

Licenses are typically required for most contractors including:

  • Electricians
  • Roofers
  • HVAC installers
  • Drywall installers

Because it varies from state to state and city to city, check with your state or city to see which types of contractors must be licensed to legally operate. Also consult these agencies to see which permits you need to obtain. You may need to obtain an employee permit to hire employees or a building permit when working on certain projects. Don’t start work before knowing which permits you need. 

The SBA is an excellent resource for finding local licensing and permit requirements. On their website, you can enter your business location and industry to find the local requirements for your business.
 

Certificate of Occupancy

Construction contractor businesses are generally operated from storefronts or mobile trailers. Businesses that operate from a physical location typically need to obtain a Certificate of Occupancy (CO).   The CO confirms that the structure is fit for occupancy and that all building codes, zoning laws, and government regulations have been complied with. 

 

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Obtaining Surety Bonds

In addition to obtaining the required licenses and permits, some projects may require your construction business to carry a surety bond. Even if a project doesn’t require it, it’s in your best interest to obtain one for your business. Surety bonds may help you win contracts since clients will feel more secure knowing that the bond is a reassurance that the project will be performed and completed as expected.

Should an accident or mistake occur, a surety bond can reduce the amount you pay out-of-pocket to cover any damages. Surety bonds are worth considering as an alternative to more expensive insurance policies since they provide enough coverage to protect your business financially. However, unlike an insurance policy, you’ll have to repay any amount your bond issuer pays toward a client’s claim.

 

Getting Business Insurance

As the owner of a small construction contractor business, it’s highly recommended that you carry enough business insurance  to protect your assets in the event of harm or damage to clients, employees, or the general public. 

At a minimum, you should carry:

 

  • General Liability – This common construction liability insurance protects your business from financial ruin if you’re responsible for events such as property damage, bodily injury or faulty work. 
  • Commercial Auto – Protects vehicles used in your construction business including those that transport tools and equipment. 
  • Workers’ Compensation – Covers employee medical costs and a portion of wages if they’re injured on the job or become ill.

 
You may want to consider:

 

  • Business Owner’s Policy – This is a hybrid of general liability and commercial property insurance. 

 

As with surety bonds, some projects will require you to carry an adequate amount of insurance to limit the client’s liability.

 

Bidding on Construction Projects

Bidding is the process through which contractors are selected to work on construction projects. Sometimes, the contractor who presents the lowest price to the client wins the contract. In other cases, the contractor’s qualifications are the deciding factor. To have a successful construction business, you need to know how to bid on jobs. 

 

To select a contractor, the hiring client first engages an architectural firm to develop a design for the building or project. Once the design is completed and approved by the client, the architect then accepts bids for the design. To win a project, a contractor presents a formal bid on a construction bid template, or bid sheet. During the bidding process, the architect may request more information about a contractor other than price, but ultimately most bids are won based on price. 

 

Types of Bid Proposals 

There are two common bid proposal methods for commercial construction jobs:

  • Design-build method – In this method, the architect and contractor work as a unified team to present not only a price to build the project but also the cost of the architect’s design. Proponents of this method believe it’s more efficient and results in lower costs than with a traditional bidding process.
  • Construction manager at-risk (CM at-risk) – In this method, the contractor and architect operate separately, but the contractor is involved in the process from start to finish and acts as a liaison in dealing with the architect. The contractor’s bid involves a guaranteed maximum price which includes the cost of pre-construction services and the statement that the project itself won’t exceed a certain amount.

 

construction

 

Marketing Your Construction Business

Before devising a marketing plan, you need to determine how you’ll present your business to potential clients. Your brand is what your business stands for and how it’s perceived by the public. What benefits do you offer that competitors don’t? 

Promoting your construction business needs to be a continuous process if your business is to succeed. What methods will you use to let potential clients know about your business? 

Here are some effective promotional methods:

  • Word of mouth and personal referrals – Most powerful method
  • Social media – Inexpensive and effective
  • Business website – To showcase your work
  • Signage at job sites – So potential clients can associate your work with a company name
  • Business cards and flyers – Cards are great for initial meetings and when giving quotes. Some contractor supply stores will allow you to post a card or flyer where potential clients can see.
  • Join industry-related organizations – Contractor organizations like the Associated General Contractors and Associated Builders and Contractors, Inc can help potential clients find you or inquire about your reputation. Link to these organizations from your website to add credibility to your business.

 

Final Thoughts

There are a lot of “I’s to dot and T’s to cross” to get your construction contractor business off the ground. In the end, the effort will be worth it. By thoroughly mapping out your business plan at the start, you’ll create less work down the line. When you’re busy managing day-to-day business activities, you’ll be glad you put in the initial work.  

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