This information comes from a recent presentation titled “Top 10 Mistakes Contractors Make When Growing Too Fast”.  A board-certified construction lawyer the presentation at a recent construction industry event.  These are the notes we took at the presentation, plus we’ve added information from our own experience to give you additional insights. We want to help you grow your construction company while avoiding pitfalls with accounting, employees, insurance, and management.

  • # 1 Disorganized Accounting and Lack of Training in Claims Preservation.
  • # 2 Too Much Work with Too Little Staff.
  • # 3 Not Considering Effects on Insurance.
  • # 4 Poor Hiring and Slow Firing.
  • # 5 Not Considering Effect of Growth on Bonding.
  • # 6 Failure to Grow Tech Capabilities to Match Growth.
  • # 7 Rushed Project Mobilization.
  • # 8 Daily Crises Preventing Management from Long Run Planning.
  • # 9 Chasing Bad Jobs.
  • #10 Failure to Plan for Liability Mitigation.

# 1 Disorganized Accounting and Lack of Training in Claims Preservation.

Everyone knows a good builder or trade contractor who has stagnated or failed in business because they did not implement proper accounting and risk management systems for their growing business. 

  • Common problems revealed in a surety’s post-mortem on 10 recent contractor failures:
    • Cash flow management issues – 10/10 failed contractors;
    • Poor internal systems- 8/10 failed contractors;
    • Inadequate job cost updating- 8/10 failed contractors;
    • Overextension- 7/10 failed contractors;
    • Inadequate claims preservation- 5/10 failed contractors.
  • Accounting Systems
    • Does your accounting system and team provide you with an on-demand view of your overall financial condition and current job cost? 
    • Are changing conditions in the field reflected in your job costing system? 
    • Ideally you are regularly updating your cost to complete based on revised field estimates.
    • Are you automating your payment systems?  You can build supplier loyalty if you send out checks quickly and at predictable intervals.
    • Are you tracking use of your owned and rented equipment to ensure you are minimizing expenses and maximizing return on these investments?
  • Claims Preservation
    • Contractors are constantly asked to do additional work on the fly.  This can be costly if you don’t have systems in place to preserve your right to payment.
    • At the outset of a job, review the contract and highlight the notice procedures.
    • Note the deadlines for lien and bond claim preservation in the file, make calendar reminders to furnish notice to owner/contractor etc. 
    • Demand written change orders or written change directives before starting additional work, but if you are acting on an oral order, memorialize it in an email and ask for any disagreement to your email to be in writing.
    • Don’t accidentally sign a lien waiver without documenting your change order.
    • Put your insurance carrier on notice upon learning of claims, don’t delay because it can cost you coverage.

# 2 Too Much Work with Too Little Staff.

Many contractors in Florida are sitting on record backlogs and at the start of 2020 they are more opportunities than ever, but in a growing construction business, field and office staff alike are overstretched and the pipeline of talent isn’t flowing fast enough.  

Problems for overstretched contractors include: 

  • Declining quality of work product and limited resources for corrective work:
    • The speaker believes decline in quality is inevitable as volumes rise and you have less workhours available for each project.
  • Geographic Overreach- When contractors follow customers farther and farther from home:
    • Small inefficiencies become more obvious and painful at greater distances.
    • Equipment and personnel are harder to move from one job to the next.
    • Simple matters like weekly paycheck distribution get more complicated.
    • Knowledge of local labor pool, subsurface conditions, and other location specific information is more limited.
  • Staff Expectations- are overstretched contractors managing their people and their people’s expectations?
    • Staff might be getting used to overtime and bonuses, cutting back to regular hours will feel like a pay cut.
    • Manage expectations for the inevitable decrease in volume.
    • Are your people getting burnt out?  Know the signs in your employees.
  • No time for long-run thinking or strategic planning:
    • If you are spending all of your time putting out fires you cannot effectively lead your business.

Remember:

  • Volume isn’t leadership, the goal of your business is to produce the best bottom line results while reducing the risk of loss.  
  • To survive at higher volumes with too little staff, your team has to shift from a “work ethic” paradigm to more “results-oriented” and “efficiency” paradigms.  This can be painful for some of your team.
  • Know when to turn work away.  This is easier said than done, because turning away one job might cost you future opportunities.  Take an honest appraisal of your situation:
    • Do you have the staff to handle the new opportunity?
    • Does the new opportunity pose different or more difficult challenges compared to your other work?
    • Does the new opportunity fit with the rest of your backlog or could it create or exacerbate a cashflow crunch?

# 3 Not Considering Effects on Insurance.

As you expand your business and work program, do you have enough coverage on all your insurance lines? Are you actually covering the risks involved with the new work?

  • Commercial General Liability
    • Your CGL insurance is looking at your payroll, your revenue, and your risks.  If any of these start changing, you’ll probably be looking at rate changes at renewal.
      • For example, suppose you suddenly start working on condominium projects in the middle of your insurance year, your rates are going to go up. 
      • More importantly, you might not even have coverage for those jobs if they are an exclusion on your CGL policy.
      • When you are taking on a new project, make sure to check that project specific exclusions are removed from the policy and that you actually have coverage.
    • Beware starting work before signing a contract.
      • Some carriers require you to sign the contract before mobilizing or starting work, so if you were rushed to start a job before signing a contract you may not have coverage.
      • You might also lose your waiver of subrogation-this waiver protects you!
      • Even if you have a signed contract, you might not get payment from the owner or GC until you produce the certified policy and endorsements from your carrier.
  • Workers Compensation
  • Is your Worker’s Compensation being properly reported at project initiation? 
  • You can adjust reported/projected payroll at regular intervals and pay the upcharge as its incurred if your carrier allows for it. 
  • Even if you don’t pay the upcharge upfront, you’ll want to retain those funds in preparation for the year end audit.
  • Adjust payroll and Worker’s Comp at regular intervals in advance of an audit.
  • As your volume increases, you will want to get an umbrella policy if you don’t have one in place already.
  • Do you have professional liability exposures? Are you involved in discussions with the architects and engineers in a way that someone might blame you for design liability? Consider professional liability insurance.
  • Auto insurance costs are rising, and commercial auto claims are costly for insurers.  They are starting to look more closely at employee driving records, they may refuse to ensure poor driving new hires. What are you doing to figure out if your potential new employees are safe drivers?

# 4 Poor Hiring and Slow Firing.

Due diligence for new hires has been rushed and poor quality in the construction industry for the past few years.  The result is that contractors hire problematic employees that increase the risk of claims and undermine corporate culture.

  • Create a roadmap for hiring:
    • Start with Job Descriptions:
      • Broad enough to cover everything that might be required in the role
      • Specific enough to set expectations for performance.
    • Identify trusted referral sources and nurture referral relationships.
      • Pursue quality prospective employees and quality referral sources like you would pursue a long-term customer.  
    • Due Diligence, beyond interviewing:
      • Check litigation history via name search in state and federal courts.
      • Review social media- LinkedIn, Facebook, Instagram, Twitter
      • Personality testing can reveal good fits
      • Trust your gut
    • Probationary Periods
      • Legally, your employee is your employee regardless of probationary period, but the psychological effect of a probationary period still works.
      • Usually 90 days long.
      • Full benefits aren’t extended to employee.
      • If you see any red flags or problems in this period, you should cut bait.
      • Maybe no unemployment benefits if terminated during probation.
    • Track your current and upcoming needs
      • Knowing your backlog, job schedule, and pipeline is crucial to making sure you have the right staff on hand and you aren’t overstaffing or understaffing.
  • Reviews:
    • Hold regular in-person reviews.
    • Use the job descriptions to assess employee performance.
    • Encourage employees to provide honest feedback as well.
    • Identify the issues early and make a plan to resolve them.
  • Employee Manual:
    • If you decide to have a manual, you need to update it regularly to keep up with changes in law.
    • Review it annually.
  • Establish a disciplinary process and use it:
    • Consistent documentation will help you know if an employee needs to be terminated. 
    • Failure to address issues using your disciplinary process could leads to disgruntled employees of two types:
      • employees who feel targeted by uneven enforcement.
      • employees who carry the load for peers who aren’t performing.

# 5 Not Considering Effect of Growth on Bonding.

  • The aggregate size of your surety program is based on a mixture of metrics including working capital, net worth, debt, available bank credit, and cost to complete for your current work program. 
    • Most of the metrics are based on financial condition weeks or months prior to the current bond need.
    • When you are growing your work program rapidly, you can quickly exceed the surety’s underwriting guidelines.
    • You may want to utilize your bank line to scale up for your new work program, but surety underwriters are trained to view bank line usage as a potential red flag.  If you need to rely on your bank line, you’ll want to communicate about it in advance to mitigate against potential negative reaction. 
    • If your collections of receivables slow down as you scale up, receivables over 90 days may end up excluded from your current assets, reducing your bonding capacity. 
    • If your working capital and other underwriting metrics are not keeping up with your work program, the surety may require you to infuse cash into the company.
  • Local underwriters may have limited authority, you may find the approval process slows down if you haven’t communicated growth plans to your agent (and underwriter in annual meetings).
  • If your backlog is growing, you may find your working capital case becomes thin and the surety will want more detailed cash flow projections to get approvals. 
  • Your quarterly work in process reports are very important as you grow, if your internal reporting systems are not producing timely and accurate information about your work program, the bonds will not keep up.
  • As volume goes up, you are more likely to experience claims and are more likely to have to make claims against bonds as well. Claims against your bonds may not be well founded, but how you handle those claims has a lot of bearing on how the surety supports your future growth. 
  • Claims you make against other contractors bonds unfortunately may result in cash flow slowdowns on those jobs and may lower your overall working capital picture.
  • Talking with your surety agent regularly as you grow is crucial.

# 6 Failure to Grow Tech Capabilities to Match Growth.

  • You can lose a competitive advantage to other firms who are more flexible due to their use of new technology.
    • Technology makes it possible to handle higher volumes more efficiently.
  • Contractors make money by mitigating risk, how can you identify risks and track results without accurate and timely data?
    • If your accounting system doesn’t readily show you profit fade on jobs in progress, you are going to be flying blind and potentially misallocating your attention and resources.
    • Quickbooks may no longer be sufficient since you cannot track pending claims and change orders readily in that program.
  • Technology impacts your bond program:
    • If you can quickly deliver an accurate quarterly WIP and internal statements, you will likely stay in the surety’s good graces.
  • Other considerations:
    • Does your field staff have to come in to review AP invoices, or do you have a system in place to approve digitally and streamline the process saving time and cost?
    • Set calendar alarms for when you need to obtain subcontractor insurance certificates and prequal packages.

# 7 Rushed Project Mobilization.

  • Who is reviewing and negotiating all your contracts?
  • As your construction business grows, you have less time to review contracts and more contracts to be reviewed and negotiated. 
  • You are taking on risks by mobilizing and beginning work before formal construction contracts are signed. 
    •  A contract you’ve received but not signed may be binding on you if you begin performing work under the contract.
    • On the other hand if you order a subcontractor to begin work, but you don’t give them the subcontract or the prime contract incorporated in it, they might not be bound by the provisions of that subcontract.
  • At a certain point you will want to consider hiring a contract administrator.
    • This person needs to have great attention to detail.
    • They also need adequate training on:
      • what contract terms you are willing to accept;
      • what contract terms you prefer; and
      • what contract terms require escalation to a higher authority within your company.

# 8 Daily Crises Preventing Management from Long Run Planning.

  • Contractors who are growing too fast often spend their time just reacting to the issues that pop up each day.
  • When you are growing too fast, you don’t have the time to change your organization and embrace the painful process of implementing systems necessary to handle higher volumes.
  • When your workload goes back to prior normal levels, your organization hasn’t gained any of the efficiencies that best in class larger contractors have implemented during their growth cycles.
    • You have to find a way to make the changes necessary to handle higher volume if you want to be efficient when you plateau at a “new normal” volume or regress to previous normal volumes.
    • If you are suffering from inefficiencies during growth, go through the pain of addressing and solving the issues in your systems to meet the demands of being a larger contractor.
    • Those who put the processes in place will have more efficient systems that produce higher margins even in leaner times.
  • We find management at reactive contractors are making the following mistakes more often than contractors operating a comfortable volume levels:
    • Taking on projects they haven’t done before;
    • Making overly optimistic projections regarding cash, resources, and people;
    • Assuming profitability, but not planning for what would happen in the event of non-payment issues, stoppage or other problems on a job;
    • Failing to regularly review project status (which they should be doing at least monthly);
    • Failing to adequately review new contracts or put the proper team in place to review them;
    • Ignoring opportunities to upgrade procedures that would improve operations; and
    • Losing track of who are the prime employees who provide consistent results and instead focusing on the ones who are able to keep up with the daily crises.

# 9 Chasing Bad Jobs.

  • Many Contractors can get caught up in the intoxication of growth and momentum.
  • Revenue is Vanity, Profit is Sanity, and Cash is Reality. 
  • The numbers worth growing are at the very top of the balance sheet and very bottom of the P&L statement.
    • We all know of contractors who have chased volume only to make the same amount of net profit as a competitor who took on a fraction of the volume and risk and slept much better that year.  

# 10 Failure to Plan for Liability Mitigation.

  • Construction is a litigious business, contractors who are growing too fast tend to forget this.
  • Do you have the insurance coverage necessary to defend yourself against claims?
  • Do you have the resources necessary to perfect and pursue your own claims, or are you so stretched that you cannot enforce your agreements to get the value you bargained for?
  • One risk mitigation strategy:
    • You might be able to reduce some risk by creating subsidiaries for asset protection.
    • Make sure you follow the right licensure, corporate formation and corporate formalities to avoid risk of being considered one entity for liability purposes. 
    • You also need to be upfront and honest with your surety about subsidiaries and related entities.