The construction industry is volatile, faces high failure rates and works on slim-to-virtually-nonexistent margins. While an increase in construction projects is generally good for companies in the industry, even that good news can hide dangers.

The dangers in a growing construction economy are different, but no less serious than the dangers posed by an economic (or construction-specific) downturn. Construction professionals should take care to watch out for the unique risks that companies face when the overall outlook is looking up.

This article isn’t meant to be solely "doom and gloom," but it pays to know what dangers to look for, so they can be avoided.

Too many projects can cause a cash crunch

As noted above, a growing economy can create unique challenges and difficulties for parties in the construction industry. In fact, a subcontractor is three times more likely to fail in a recovering economy than it is during an economic downturn.

While this seems counterintuitive, it starts to make sense when viewed through the lens of the unique construction payment process. The construction industry is a credit-heavy market, so instead of a company requiring payment prior to delivering materials or performing work, almost all materials and labor are furnished on credit — even when that value is quite substantial.

This credit-based payment scheme extends throughout the payment chain on every project. Most companies both extend credit and need a line of credit of their own. In many situations, payment of their own bills must wait until payment is received from those higher in the contracting chain. The further down the chain a project participant is, the more opportunities there are to experience hiccups or abuses in the payment process.

Because of this structure, mid-tier parties are generally expected (or required) to float substantial project costs. For companies that are not flush with capital, these painful realities of construction payment can be deadly.

Waiting for payment from parties higher up on the payment chain and still being forced to pay the parties below can cause significant financial strain. Sometimes, if the projects are large or if the party is involved in multiple projects, the strain can be such that the company runs out of cash and becomes another casualty of the construction industry.

P3 projects are getting more popular

The landscape of certain large construction projects is rapidly changing. Public-private partnerships (P3 projects) are rapidly gaining popularity, and many construction companies will soon be faced with determining how to remain in a secure position on these projects if they haven't been forced to make that determination already.

While the underlying construction tasks performed on a P3 project are no different than those on any other project, the regulations, contractual obligations and legal rights available for protection can be different. P3 projects, while seemingly a new project type, are generally classified as either private or public in nature (for the purposes of remaining in a secured position).

This means that if the underlying project is determined to be private in nature, the security availability is generally the same as any other private project mechanics liens. Likewise, if the underlying project is determined to be public, a bond claim would generally be the proper avenue to obtain payment.

Unfortunately, as the law stands now, there is no easy way to provide a cheat sheet or even a reliable step-by-step method that determines which potential remedy (if any) applies. If the underlying property is public, a mechanics lien cannot attach to the underlying property, and the only way a mechanics lien may be the applicable remedy is if there is a private property right, such as a leasehold interest, to which the lien could attach.

However, if the underlying contract is public, the mechanics lien right may still not apply if there is no private property right sufficient for the attachment of a mechanics lien. Similarly, if the underlying contract is private, but the underlying property is public, the statutory bonding requirements may not apply.

This can be problematic for construction participants because they may be left with no applicable avenue to recover money owed. All it takes is one big project to not be paid to dramatically weaken a construction company. It's unfortunate, but the P3 project type can leave project participants with no ability to secure their extensions of credit, making the financially turbulent construction industry even more difficult.

Problems can be unpredictable

The previously mentioned difficulties can be predicted and planned for, at least to some extent. The construction industry as a whole, however, is not so predictable and can be drastically effected by outside forces.

Within the last couple of years, an exceptionally rough winter weather season put a substantial number of construction projects on pause. This type of problem is a fact of life, but is extremely difficult to predict. Pointing it out can seem like business 101, but companies can be strained and stressed by unpredictable problems that cause fluctuations of revenue, especially if costs like payroll (or rental or lease agreements) remain fixed.

Conclusion

The construction industry is difficult and full of risks. A little bit of planning and some examination of how the unique risks can apply to your company can save a lot of headaches in navigating the waters of a growing construction economy. In turn, this can enable you to make sure your company isn't another statistic in the pile of construction company failures.