• Louise Stewart, CEO and Founder at ProjectPay


• 11.10.2023 09:45 am
#banking #payments

In the construction world, where towering structures, mega projects, and awe-inspiring feats of engineering shape our cities, a financial nightmare remains hidden beneath the surface for the small businesses that make up 98% of the sector. It's an industry that breathes life into our urban landscapes yet hides a dirty truth. 

Silently navigating this financial landmine are small businesses. These businesses shoulder an immense financial burden, expected to carry the cost of delivering works on projects whilst waiting to be paid, and grappling with unreasonable payment default risks. 

So, the pressing question arises: How can fintech solutions, tailored to address the specific challenges faced by small businesses in the construction sector, rescue them from this? And, can these solutions ensure that small businesses are not only paid quickly for their hard-earned work but are also equipped to manage cash flow and payment default risks more effectively? Let's delve deeper. 

The Current State of Construction Payments: 

The construction industry's payment landscape is marred by inefficiencies, delays, and no payments, particularly for the smaller players in the sector. Currently payment processes and flows have proven inadequate, causing headaches for contractors and subcontractors. 

Small contractors, often reluctant to voice their concerns for fear of commercial repercussions, already capital constrained, are forced to finance projects, exposing themselves to significant financial risks. 

Curiously, the construction sector in the UK stands as an anomaly, where diverting and using others' money without consequence is a common practice. In stark contrast, the USA has taken measures to protect subcontractors and suppliers, implementing laws like mechanics liens and trust statutes that hold large business directors personally accountable for the debts of their subcontractors and suppliers. 

This has resulted in a cultural shift in the USA whereby contractors agree that diverting funds between projects instead of paying subcontractors is an unsustainable business model. Big contractors and their lenders take seriously their ethical and moral responsibility to ensure the small businesses that have done the work and are carrying all the payment default risk get paid on projects even when the main contractor's business fails. 

In contrast, the UK government has introduced Project Bank Accounts (PBAs) on its projects as a safeguard against the misuse of project funds by low-capitalised construction companies. However, these protective measures have yet to extend to private sector projects, leaving small businesses vulnerable to financial misconduct, as exemplified by Carillion's 2018 collapse.

The numbers paint a grim picture, with construction industry insolvencies in the UK consistently ranking highest in any sector, with over 3,394 companies failing in 2023 so far. 

PROJECT BANK ACCOUNTS (PBAs) 

Project Bank Accounts (PBAs) represent a critical development in the construction industry's quest to address payment-related challenges. PBAs provide payment flows, designed to safeguard funds and accelerate payments on construction projects. They protect against the persistent issues of late payments, no-payments, and the subsequent detrimental effects on small contractors. 

But there are roadblocks. Attempts to mandate the use of PBAs protective payment flows in the private sector have been quashed in the UK. Banks are not interested in providing them due to their complex and manual nature, with nothing in it for them. This requires a fintech solution designed specifically for the sector to overcome barriers to use. 

Addressing the Working Capital Challenge: 

But, there remains a critical challenge to be resolved— The working capital gap and the requirement for contractors to 'float' projects before being paid, is made worse by using PBAs. Contractors often find themselves in the predicament of having to pay their subcontractors before they've received payment themselves. Now prevented from diverting funds between projects to manage cash flow, a common practice known as "robbing Peter to pay Paul," where does this money come from? 

In the UK, the cash flow challenges go deeper, and banks don't know how to address the unique credit risk challenges in the sector to provide affordable finance to fill sector working capital gaps, that is, until now: with a fintech solution designed specifically for the sector that promises to alleviate these challenges. 

Streamlining Payments with Embedded Finance: 

So now that the dirty truth is out, you can see that payments in construction already operate like a “Buy Now, Pay Later”, without the proper controls and risk management to ensure that the ‘pay later’ happens, with small business carrying the cost to ‘float’ projects using inappropriate and expensive finance products whilst they hope and pray they get paid later. 

Recent research underscores this reliance, revealing that 36% of small construction businesses heavily depend on credit cards and 33% on personal savings—more than double that of other sectors. 

The good news is that ProjectPay has been working with Government and banking partners to create the digital evolution of PBAs. By seamlessly integrating finance into an end-to-end digitised secure payment flow, fintech provides the vital controls and risk mitigation necessary. This ensures that payments at all contractor levels become a swift and seamless settlement process. Contractors no longer need to bear the cost of inappropriate or expensive credit to receive the payments they've rightfully earned.

This digital payment flow, enhanced with embedded finance, eliminates the need for costly and high-risk financing products. Unlike outdated financial instruments not designed for the sector, this approach ensures that small businesses aren't on the hook to repay loans if they do not receive the payments they are owed. 

Crucial Considerations for Industry Transformation

Amid a surge in startups and established players aiming to digitise construction payment processes, certain key considerations demand attention. 

First and foremost, it's essential to understand the issue from a subcontractor perspective, as they often bear the brunt of payment challenges. Incumbent companies, particularly those catering primarily to large contractors, face a significant hurdle in overhauling their existing tech to accommodate the necessary payment reforms. Merely digitising current payment methods will not meet the urgent need for guaranteed and swift payments for small businesses. Large contractors, who may have benefited from the current system, may be reluctant to disrupt the status quo. 

In the wake of financial crises like the Greensill collapse, with unethical and unfit finance products pushed onto subcontractors, it's evident that the industry and financial institutions can ill-afford another such episode. Transformation driven by industry leaders who truly comprehend the challenges that small businesses face is the need of the hour. 

Conclusion 

The fintech revolution in construction isn't just a welcome change. It's an absolute necessity. The industry has grappled for far too long with delayed payments, no-payments, and cash flow challenges that disproportionately burden small businesses—the backbone of the sector. Fintech solutions bring a new era of financial efficiency, fairness, and productivity, levelling the playing field for all businesses, regardless of size. 

Looking ahead, we anticipate a wave of innovative fintech solutions tailored to the unique needs of construction businesses. Much like ProjectPay, these solutions must prioritise addressing payment issues from the perspective of small businesses rather than catering solely to larger contractors. By shifting the payment culture, enhancing financial health, and boosting overall productivity, these new solutions will continue to transform the construction industry. 

The future of construction can shine brighter, fairer, and financially more secure, all thanks to the fintech revolution.