Construction Draws

General contractors make extra profit at the expense of their subcontractors

construction draws

Construction draws have become an area for sharp-operating General contractors to earn extra profit - at the expense of their Subcontractors.

Major construction projects typically involve a General contractor and Subcontractors the various specialties such as electrical, mechanical, HVAC, etc.

The owners obtain a financing commitment from a lender and employ engineers/architects to plan and supervise the project and a General contractor to handle construction. Each period during construction, General contractor has Subs do appropriate work and bill the General contractor. General requests construction draws for payment of the portion of the work that engineer / architect certifies is completed during that period.

General receives the construction draws and disperses to each sub according to the work some performed and billed for that period. The contracts amongst the various parties specify how bills are rendered and paid.

Traditional Payment

If Subs had errors or deficiencies in their bills to General then General would notify them and correction or additional documentation would be produced. Construction draws payment might be delayed for a week pending corrections.

New General Contractor Practices

A General contractor could easily have a monthly turnaround of $5 million from owners and a $4 million consrruction draws payout to Subs.

Financial managers at General contractors noted that if they could delay the $4 million payments to Subs for, say, one month, they could earn a nice chunk of spending money. The $4 million payment doesn't affect their profit or even their financial position (since their balance sheet shows the $4 million extra cash offset by the $4 million unpaid liability). But, $4 million at 3% for 30 days...

... is approximately $120,000 per year or $10,000 per month. A nice addition to the bottom line if they can do it!

How to earn $10,000 per month with virtually no risk?

Simple!

Instead of sending the sub a complete list of all documentation deficiencies to correct before the construction draws check is cut, delay that list. No, if they just did not send the list the sub would scream to the owner. So, General issues each deficiency point, but does it one at a time. Each week, something else crops up and causes a delay. Soon four weeks have passed. Sub is screaming, and General caves in and pays.

The downside for General is that their reputation suffers amongst Subs. But that only hurts them if the market for Subs is tight. That's not usually the case. And if most General's do it, the Subs have to live with it.

One would think that the whole process wouldn't work all that often because Subs would simply submit proper documentation to support their draw request (as they are, in fact, required to do by their contracts with General.)

But it isn't a perfect world and it continually amazes me how sloppy Subs can be with their documentation and billing.

Lessons for the Family Business Sub Contractors

  1. Your Project Managers have to stay on top of the project and keep a close contact with the General's Project Manager and the engineer/architect.
  2. Find out exactly what form and procedure General expects you to follow. Ensure that your project and billing staff follow these to the letter. Dot the I's, cross the T's. Make sure your whole organization knows how important "billing time" is - the accounting clerk and Project Manager getting out that billing are your most important people right then - your whole cash flow and livelihood depends on them!
  3. We had our billing clerk go over to a new General's office to walk through their requirements. Occasionally, one would have a requirement that didn't fit with our normal procedures, so we'd work it out with them. The whole concept was "no surprises".
  4. Occasional CFO to CFO and CEO to CEO contact to confirm that things are working well and to reinforce the relationship.
  5. If you have a General that persists, threaten legal action. The fact that you have taken steps to perform your duties under the contract is a strong position. Involve the owners and lender as well as getting other sub contractors involved if they are also being harassed. No one really wants the distraction and cost of litigation.

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