The construction industry has done a good job of focusing on safety and quality. This mindset has been driven down to the smallest of contractors. They know safety and quality not only impact what work they can secure and for which owners and contractors they can work, but it also drives the cost of their insurance program. Prequalifying contractors based on their safety experience and program is the norm.
The prequalification process, however, should not be limited to safety. Financial prequalification should receive adequate attention as well.
The industry has seen failures and contractors who have shrunk, both in revenues and overhead. Smaller is not a bad thing, unless it was done too late – for example, the contractor who tried to keep good people on board for too long when not having good work for them to do. What we see sometimes is this now smaller contractor, who weathered the economic downturn, takes on too much work too quickly as the economy picks back up. The contractor has the mindset of having a deep bench of experienced resources, but the actual resources are either inexperienced or too few. This can turn into a tricky situation.
Financial prequalification is essential to protecting your business or your project. It might not be front of mind like safety is for your workforce, but it can have just as big, if not a bigger, impact. As either an owner or an upper-tier contractor, perhaps you have a financial prequalification process for your lower-tier contractors. If you don’t, you should consider developing one. Your surety and your risk management team will thank you!
A financial prequalification process does not have to be extensive. But it does need to be specific enough in the information requested. Also, the process needs to be run by someone within your organization that has the proper experience to understand and analyze the information provided. Information is great, but pointless if you don’t know what to do with it.
Most contractors hate to share any of their information. As such, all data should be kept confidential – you would hope for the same treatment by an owner or upper-tier contractor who has your sensitive information. Consider adding a nondisclosure agreement to the prequalification to show you are serious about confidentiality.
What about contractors with whom you have a long-term relationship? Do you require a prequalification or a regular update? Updates to an initial prequalification form for all contractors should be done on a routine basis. Old information is just that - old. Whether it is working capital, available line of credit, or backlog – all can change drastically in a matter of a month or two, if not weeks. Frequency should be dependent on the amount of risk involved – number of jobs outstanding with the given contractor, and the size and duration of these jobs. Applying a level of reasonableness is okay, yet it’s best to work within a set of standard operating procedures.
A contractor’s balance sheet tells a story, but that is the story on “picture day” – some date in the past. How are you ensuring that a contractor is not over extending himself today? Perhaps you are monitoring how much work you are giving this contractor, but what about the other work he is securing from others besides you? If you aren’t regularly monitoring the contractor - the work they perform, their financial status, word on the street about their performance, and payment of others, you could be at risk.
Along with a solid financial prequalification process, a supplemental risk mitigation technique is to consider requiring a surety bond of your contractor. Chances are you have been required to provide a bond to an owner or up-stream contractor before, and perhaps your surety has even required you to have a subcontractor “bond back” to you in the past. There is a cost involved, and it does not mean you should not be monitoring your contractor. But with a surety bond you have a surety guaranteeing completion and payment of suppliers, lower tier subcontractors, and laborers. Requiring “bonding back” is not just for the big boys.
So many considerations, so little time to manage your business. The potential cost of not actively managing the contractors working for you could be significant. Don’t cut corners and get lax in good business practices just because of a perceived comfort level with a contractor or the perceived savings of a few dollars. Get a solid prequalification process in place, ensure that it is utilized, and consider using surety bonds to supplement your risk mitigation techniques.
