Construction is a complicated business that faces ever-changing conditions, and contractors who are not prepared or capable of meeting these demands run the risk of failure. According to BizMiner, of the 853,372 building (non-single-family), heavy/highway, industrial buildings/warehouses, hotel/motel and multifamily home construction, and specialty trade contractors operating in 2002, only 610,357 were still in business in 2004 — a 28.5% failure rate.

Every year thousands of contractors, whether they have been in business for one year or 100, face bankruptcy and business failure. These firms leave behind unfinished private and public construction projects — and still worse, billions of dollars in losses to project owners and taxpayers.

Contractor failure is usually the result of multiple causes. Because preventing contractor default is a key component to the surety business, surety companies and surety bond producers are experts at spotting business practices and conditions that can lead to contractor failure. The Surety & Fidelity Association of America (SFAA) reviewed 86 claims cases and identified the top five factors related to contractor failure:

Unrealistic Growth
• Change in type of work performed
• Expansion into a new geographic area
• Significant increase in the size of individual projects
• Rapid or over-expansion

Performance Issues
• Inexperience with new scope or type of work
• Personnel do not have adequate training or experience
• Insufficient personnel

Character Issues
• Contractor retires, dies, or sells company, changing leadership or focus
• No ownership or management transition plan to ensure continuity in the event of death or disability

Accounting Issues
• Inadequate cost and project management systems
• Estimating or procurement problems
• Lack of adequate insurance
• Improper accounting practices (not adhering to the American Institute of Certified Public Accountants’ Audit Guide for Construction Contractors)

Management Issues
• Key staff leaves company
• Staff inadequately trained on company policy and operations
• Insufficient or incapable personnel at upper management or project level
• Failure to maintain solid accounting and management systems to track costs and billing

Other Factors
• Economic down-turn and high inflation
• Weather delays
• Poor site conditions and/or building plans
• Labor difficulties (lack of skilled labor)
• Material and equipment shortages
• Owner’s inability to pay
• Onerous contract terms

There are also warning signs that a contractor may be headed for trouble:

Ineffective Financial Management System
• Inability to forecast cash flow or cash flow is tight
• Receivables are turning over too slowly
• Vendors are demanding cash on delivery for supplies and materials

Bills are past due
• Profit fade
• Bank Lines of Credit Constantly Borrowed to Their Limits
• All credit fully secured
• Credit lines not being renewed

Poor Estimating and/or Job Cost Reporting
• Revenue and margins decrease over time
• Continued operating losses
• Loss or reduction of bonding capacity
• Bidding jobs too low

Poor Project Management
• Inadequate supervision
• Inability to administer and collect change orders
• Project(s) not completed on time
• One or more contracts have a claim
• Company is continually involved in litigation
• Increase in backlog without adequate project management resources
• Lead time to prepare bids too short

No Comprehensive Business Plan
• Contingency plans are not developed
• Company does not have a “road map,” goals, or objectives

Communication Problems
• Disputes between contractor and owner
• Poor communication from field to management

As a management consultant to the construction industry, Brian Moore, Senior Consultant, FMI Corporation, works with contractors on various strategic, financial, and operation issues. Through his experience, he has found several key problems that cause contractors to go broke.

“They grow too fast, they lose leadership or key people through retirement or to competitors, or someone at the top loses interest,” he said. “Another problem is they take on unfamiliar work or work in an unfamiliar market.”

Other key issues include having incompetent estimators, field managers, or top managers; following a flawed strategy for too long; or relying on bad information from a poor management information system.

“Contractors can also suffer bad luck in the form of weather, strikes, death, accidents, or bankrupt subcontractors or suppliers,” he added. “All of these problems are preventable, even, to some extent, bad luck.”

According to Moore, good contractors share these characteristics:

Organization
• Formal and on-the-job training for all levels of employees
• Logical, incentive-based compensation plan
• Tenure for proven field superintendents and internal promotion when possible
• Depth of personnel at all levels of the organization

Succession planning
• Up-to-date organization chart, distributed to all employees
• Culture of loyalty, ownership, and urgency
• Visionary, inspirational leadership
• Low turnover

Finance
• Solid management of cash flow and overhead
• Profit-focused company
• Timely payment of bills
• Management of debt and retainage
• Reasonable growth without overextending resources

Marketing
• Superior estimating skills and systems to manage costs
• Satisfied customers
• Well-defined market niche and 12- to 36-month growth plan
• Company culture where everyone is a great salesperson

Project Control
• Closely managed projects with early warning systems to catch potential problems
• Litigation avoidance
• Productive field managers trained to improve processes

Planning
• Disaster preparedness
• Continuity plan with:
• Adequate life insurance coverage
• Shareholders’ agreements detailing buy-sell agreement for multiple shareholders
• Only qualified and interested family members in management
• Detailed business plan
• Strengths, weaknesses, opportunities, and threats

A variety of successes make a good contractor, and one is being astute to the common events that lead to failure. Bonded contractors have the resources of professional surety bond producers and the backing of corporate surety companies to help them heed the warning signs of failure before the red flags go up. SLDT