Retainage is a common practice in construction where a portion of funds are withheld from a contractor or subcontractor until the project is completed. Retainage therefore, can have a significant impact on contractor cash flow. In an industry already rife with cash-flow challenges from large upfront expenses and slow, unreliable payment cycles, retainage does nothing to help contractors when it comes to cash flow management.
So, what exactly is retainage and what does it mean for your business?
What does retainage mean in construction?
Put simply, retainage in construction is a percentage that’s held back from the earnings of a contractor or subcontractor during the length of a project. The specific amount is specified in the construction contract and is usually anywhere from 5 to 10 percent of each progress payment, depending on the type of project.
Though retainage is a common practice, it’s not always required — if the contract doesn’t address it, then there is no retainage for that project. However, there are federal laws mandating retainage on federal projects, including stipulations for how it must be calculated and released, as well as state laws for both public and private projects that differ from state to state. Any construction contract that violates these regulations is invalid.
How is retainage calculated?
Retainage is calculated as a percentage of each progress payment, usually anywhere from 5 to 10 percent depending on the type of project. Each state has differing limits and regulations on retainage, and there are also federal rules for federal projects. Private construction projects typically feature higher retainage amounts, while federal, state and municipal will withhold lower amounts.
How long can retainage be held?
How long retainage is held back depends on the agreements in individual construction project contracts, though it is typically released once a project is substantially complete. Since subcontractors often complete their work before general contractors, they usually wait much longer to receive their retainage, from hundreds of days to several years.
When is retainage paid on a construction project?
The amount of time retainage is withheld depends on individual project contracts, though it’s typically held until the project is “substantially” complete. That means subcontractors often have to wait much longer than general contractors to receive their retainage, sometimes hundreds of days, since they finish their work earlier than GC’s do.
With the many variables associated with retainage, from amounts to timelines, it’s clear why this practice can bring tremendous challenges to the success of so many contractors, subcontractors and other construction industry professionals farther down the payment chain.
The benefits, and drawbacks, of construction retainage
The concept of retainage was first introduced nearly two hundred years ago as an economic incentive to ensure contractors would perform quality work and successfully complete their projects. If a general contractor defaults, retainage offers a quick source of funds the owner can draw upon to remedy the situation, from securing another GC to finish the work, to paying subcontractors and suppliers.
On the other hand, retainage poses several problems for contractors. Potential pitfalls of retainage include:
- Receiving less than the agreed-upon retainage amount once the project is complete.
- Having to wait far too long to receive retainage, from months to years in some cases.
- Never receiving retainage due to the owner or GC going bankrupt or out of business.
- Having greater amounts of retainage withheld as a subcontractor vs. a GC.
- Owners who utilize retainage as interest-free working capital to finance the project, while contractors are left to finance the project on their own.
If you’re a construction entrepreneur already operating on thin margins, high amounts of retainage withheld for long amounts of time can spell serious trouble for your bottom line.
How does retainage impact a contractor’s cash flow?
As a subcontractor, you probably already grapple with fronting the needs of projects, including materials, equipment and skilled labor, in the face of notoriously delayed payment cycles. If retainage is withheld for months or even years after work on a project is completed, you’ll be forced to find other means of financing projects while you wait to recoup the retainage.
In addition, if the retainage amount is actually greater than your profit margin on the project, then you’ll actually be in the hole on the project until you receive the retainage. Either way, it means you’ll need enough free cash or financing to make up for it so you can continue running your business.
So, how can you mitigate the impact construction retainage has on your finances? Here are five approaches to consider.
Five Ways to Navigate Construction Retainage
1. Familiarize yourself with federal and state laws on retainage
The federal government has enacted laws governing retainage on federal projects, and there are differing state laws governing the details of retainage on both public and private projects.
While retainage is completely prohibited in New Mexico, the other states fall into four categories in terms of how they limit retainage:
- No more than 5%
- No more than 10%
- A “reasonable amount”
Familiarizing yourself with the rules and regulations in your state can help you spot conflicting contractual stipulations, prevent having more retainage withheld than necessary, or avoid having to wait too long to receive what you’re owed.
2. Study the contract carefully
Before signing a construction project contract, study it carefully to ensure you understand the details about how retainage will work and how it could potentially impact your business. This is where knowing the laws in your state is extremely helpful.
For example, can your general contractor withhold the retainage you’re owed as a subcontractor until the project is complete versus when you’ve actually completed your work? What are the stipulations for funds being released? What percentages will be withheld? You can expect an average retention of 7.5% on private projects, while public projects are generally less.
3. Do the math and plan for your cash flow needs
As you study the contract, get into the details of your finances to see how retainage will impact your cash flow. If necessary, negotiate to ensure the progress payments will be enough to cover your costs for the work performed each period, minus retainage.
Once you’ve done everything you can to set yourself up for success, then it’s time to plan for the financial reality. Conduct a project cash-flow forecast to determine if you’ll need to source extra working capital until you receive the retainage. It’s better to know if this is a likelihood up front so you can prepare.
4. Utilize your lien rights if necessary
A mechanic’s lien is a powerful tool at your disposal for resolving payment issues. However, the deadline for filing a lien on a project might arrive long before your retainage money does. So, what do you do in this situation?
If your lien rights are intact, you have the right to file to resolve a payment issue, even if that amount includes retainage that is still being withheld. While the owner, lender and/or GC might take offense at this step, if there is a payment dispute, you need to do what’s necessary to protect your business and stay afloat by claiming the money you’re owed on a project.
Make sure you know the guidelines in your state that govern retainage in relation to liens, and don’t forget to take the necessary step of filing a preliminary notice to secure your lien rights.
5. Consider contractor financing options like material financing
If you lack the finances to purchase materials and equipment while you await your retainage payments, contractor financing can enable you to operate and grow your construction business with greater ease. Each financing option has its own pros and cons, so it’s important to evaluate each one against the individual needs of your business.
Contractor financing options include:
Many successful construction entrepreneurs today are choosing project-based material financing for purchasing construction materials. Why? Project-based material financing offers faster access to cash and higher credit limits than traditional lines of credit, while enabling you to get better supplier pricing on the materials you need to start new projects.
The best part is, you gain an experienced construction-industry partner who will work with you to help strategically finance your projects and successfully scale your business.
Learn more about how working with Billd can help you close the cash-flow gap, keep projects on schedule and even bid on bigger projects.