SINCE RETENTION IS typically paid sometime after a construction project is completed, a contractor's place within the phases of a project can affect the firm's long-term debt and overall financial health.
If you are unclear about how this affects you and your competitor's debt, then the chart on this page should help. The chart, put together by Risk Management Associates, indicates different debt levels for different subtrades. As you may know, banks or other lenders' attitudes sometimes change, depending on the type of contractor with which they are working. In other words, different types of contractors experience different debt levels and that it is considered normal.
It should come as no surprise that specialty contractors who work in the early stages of a project carry more long-term debt. This is especially true for civil and structural contractors who pay large material and equipment costs at full invoice, and then wait for the owner to release their retention after later phases of the project have been completed. They wait in line with everyone else, but their wait is much longer.
What is interesting about the chart is the rise of overall debt percentage between 1980 and 2000. Contracting is more of a business than ever and retention practices are more demanding than they were 25 years ago. Construction firms have said it for years. Statistically, the table shows that they're right.
Many contractors wish that retention would be abolished by constitutional amendment. We already finance the construction with our own funds, never getting ahead of the client. Since no change is anticipated in our lifetimes, we'll have to manage it as best we can.
There are several variations on retention practices. Some owners offer partial releases of retention such as in the case of strip shopping centers or projects that can be completed in distinct, independent parts. Certainly, contractors should make it a topic of discussion during the contract formulation process.
Government officials and others have experimented with 5% retention and even no retention. Nevertheless, 10% retention policy remains the norm. Couple this with a 4% average net profit for a construction firm and you see why it will not change. The owners use it as an incentive to complete a project satisfactorily by this simple practice.
Sometimes the next best strategy, besides trying to reduce retention, is trying to gain acceptance of parts of the project such as individual floors on a high-rise where access can be controlled or given outright to an owner.
A number of construction firms have offered a slightly reduced price of some percentage to the client in exchange for no retention. The calculation of this percentage reduction is too lengthy to cover here and is a topic for another column. Furthermore, as clients negotiate hard for you to shave dollars off your bid, you can use elimination of retention as a worthy negotiating point.
We have observed many contractors using a punch-as-you-go method to en-sure fewer punch list items remain at the end of the job. Some contractors will discourage the client from using multiple punch lists. The contractor's goal is to receive only one punch list and focus on that to completion, so retention can be released more quickly.
We cannot predict any change to retention practices. It's powerful leverage in assuring a fast completion to a project. If we built for our own account, we would be foolish not to use it. After all, what better lever is there for ensuring satisfactory completion than holding back double the net profit?
Long-term debt as a percentage of total assets
Matt Stevens is a management consultant who works only with construction contractors. He has been in practice since 1994. McGraw-Hill will publish Stevens' book, "Managing a Construction Firm on Just 24 Hours a Day," this fall. He can be reached at [email protected]. More information on his firm, Stevens Construction Institute, is available at www.stevensci.com