The finances and complex logistics of carrying out construction projects carry risks for all relevant stakeholders, from the owner (or developer), to the general contractor overseeing the project, to the lender financing. One of the biggest risks is default due to mismanagement of funds, which accounts for a majority of defaults and liens on construction projects. This involves everything from timely payment to sub-contractors, suppliers and vendors to distribution of ongoing payments for scheduled, verified milestones, and tracking change orders, especially if they are over budget.
One of the most effective ways that lenders mitigate financial risk when underwriting construction projects is to engage a third-party firm to oversee and manage funds control over the lifetime of the project. This helps ensure completion on budget and on schedule, and increase transparency to bank regulators, particularly if there is an audit.
Construction funds control is the process by which a lender or an agent they contract with (such as a third-party firm) manages the schedule, paperwork, and track record of when and how funds are allocated to principals, contractors, subcontractors, equipment and materials suppliers on a construction project. It is an alternative to a payment and performance bond that takes a detailed, proactive, ongoing approach towards identifying and correcting discrepancies before or as they occur for about half the cost of a performance bond. A performance bond, on the other hand, can only be triggered in the case of a default, and could take months to resolve pending an investigation and adjudication.
Once an agreement is in place to engage a Construction Risk Management firm for Funds Control, the firm typically begins by conducting a thorough Document and Cost Review (DCR) before construction begins, which involves a review of the contract, plans, and schedule of value to ensure that they are appropriate.
After construction begins, the CRM firm will receive and review all draw requests; inspect construction progress to ensure all work is completed and materials delivered before draws are approved; obtain lien waivers from subcontractors to protect the property from construction liens; and disburse funds to appropriate subcontractors and vendors.
Presented below are four of the most critical functions of funds control to keep projects on schedule and on budget and to prevent the kind of problems that lead to default.
1. Ongoing Funds Management There are so many payments during a construction project, it is easy for errors to occur or for payments to get missed or delayed. Funds control ensures payment not only to the General Contractor or Principal, but also subcontractors, vendors, and materials suppliers as well. Funds management also ensures that loan proceeds are not diverted to other line items in the construction schedule without proper authorization or review, or that the General Contractor does not use funds from the current project for another project they may be working on. This minimizes the risk of critical stoppages in work progress due to nonpayment or depletion of loan funds.
2. Catch and Resolve Payment Request Discrepancies This involves a thorough review of backup documentation – including all invoices and lien releases—to check for potential errors or double requests. It also involves tracking of change orders and reallocation of funds within the existing construction budget to check for “front loading” (upfront payments before work has been completed) or incorrect payments. This gives the client real-time information on cost and how it affects the construction budget.
3. Aligns Payments with Construction Progress Funding and construction progress go hand in hand. One of the critical functions of construction risk management and effective funds disbursement is early detection – to ensure that payments are not made ahead of progress and deliverables of scheduled milestones. This is achieved through Construction Progress Monitoring, a service that provides “boots on the ground” site visits and feedback about work being performed for each line item, whether the GC is performing according to the loan agreement and schedule, and review the contractor’s application for payment. Construction Progress Monitoring evaluates stored materials on-site and off-site, verifies overall project percent completion, and status of sufficient funds to complete the project on schedule.
4. Manages Paperwork All the above funds management involves keeping track of a lot of incoming and outgoing paperwork, everything from invoices to collection of lien releases and required signatures, contracts and other lender-required documentation. Funds control management organizes important documentation for stakeholders, with electronic record-keeping capabilities. This is particularly crucial for lenders if a project is audited.
To ensure sound funds control and construction risk management on your construction project, engage with an experienced firm that has a diverse portfolio of previous construction projects, in-depth industry and market knowledge, and key personnel to manage your project from start to finish.
To learn more about Funds Control, check out this informative webinar on February 20th – 6 Ways Funds Control Can Save Your Project.