Starting your own construction business comes with a lot of learning – and not just the skills you bring as a builder or remodeler.
Running a successful construction company requires you to make a lot of correct decisions before your work even begins: on everything from choosing the right marketing approach for your business to choosing the right projects for your team. And to add to the complexity, choices that might be right for some businesses, aren’t always right for others.
So how do you navigate these uncertain waters to come out on top?
Well, this article can’t teach you how to run your business but it will shed some light on one very important factor…
Contracts are designed to protect both parties and spell out what’s expected from all those involved. As custom home builders and remodelers, you know the importance of having a signed contract. But, it’s just as important to choose the right type of contract for your business.
The most popular contracts used in the construction industry are the fixed-fee contract, cost-plus management fee contract, and cost-plus percentage contract. These all have their pros and cons and there’s a lot to consider, so let’s dive in.
Fixed-fee contracts are exactly as they sound: “fixed” aka an exact amount. The project is done at a set price despite any unforeseen challenges, making the fixed-free contract the riskiest contract type for contractors or subcontractors. However, this works both ways, so if your job goes better than expected, you reap the benefits and make a higher profit.
Keep in mind that your estimating skills should also be stellar if you're opting for a fixed-fee contract. Because if you somehow forget to cover minor things like drywall screws, guess what? You get to eat those costs. You can also end up with additional costs related to delays or mistakes.
To avoid paying for these oversights keep these things in mind:
Fixed-fee contracts can be scary, but with experience, they’re also the most straightforward and can benefit both your company and your clients.
If a home builder or remodeler wants a little more flexibility and less risk, then the cost-plus management fee contract might be a good fit. In the cost-plus management fee contract, the client agrees to pay for all the job expenses plus a set fee to cover the contractor's expenses. This isn’t the only type of contract that’s in the cost-plus category, but it is one of the more widely used contracts for residential construction projects.
Cost-plus management fee contracts are most often used when estimating is difficult because of unknown factors, like lumber price increases or unknown site conditions. It’s more favorable to the builder or remodeler because their fee is set no matter what problems might arise.
It also allows the client some control over what is spent, which can pose some difficulty for the contractor. But overall, it’s not a bad deal for the contractor.
Here are a few points to consider:
The cost-plus management fee contract might be contractor-friendly, but it can also be tricky. It’s important to spell out what the terms are and when the builder or remodeler needs to get paid.
Cost-plus contracts are all pretty similar and have a lot of the same pros and cons. In the cost-plus percentage contract, the client agrees to pay the contractor for all their expenses plus an agreed-upon percentage of profit.
This is by far the most popular of the cost-plus contracts and is used a lot when there’s a risk that costs could significantly change. It allows the contractor’s profit to automatically fluctuate when the contract price fluctuates. Most clients like this type of contract because it goes both ways, with an increase or decrease in the contract amount, the profit also changes.
However, this type of contract does require a more hands-on client because almost every expense must be approved. So you can imagine that there will likely be some issues and delays in the process. But the good news? The overall majority of the financial risk falls on the client.
The downside of this structure for the client is that they pay more to the contractor if they decide to upgrade their materials (light fixtures, plumbing fixtures, hardwood floors, etc) when there is no real additional effort for the contractor.
This can be a frustration for the client, so managing this part of the process for the contractor is important. Maybe consider "excluding" or making "fixed" certain items from the cost-plus.
In this scenario, good communication is key and the contractor might want to consider streamlining the process.
A few important tips:
With the cost-plus percentage contract, you’re protected from eating the cost of unpredicted changes, however, it requires more approvals from the client and more back-and-forth. So, consider all aspects before deciding to go with this type of contract.
Whether you choose to use a fixed-fee contract or a cost-plus contract, some things remain the same:
A home builder or remodeler should only use a fixed-fee contract if you have superior estimating skills – or else you’ll probably lose money. This contract is the riskiest, so most builders and remodelers will shy away from using it unless necessary. However, it’s one of the more favored contracts for subcontractors because the scope of work is usually narrow and specific, so it’s easier to be accurate in estimating.
The more contractor-friendly contracts are the cost-plus contracts. Whether it’s a flat management fee or a percentage, the client agrees to reimburse for all expenses plus either a set amount or a percentage of all costs. These contracts are often used when budgets are tight or costs could greatly vary. Most contractors prefer these types of contracts because it minimizes their financial risk. In these types of contracts, it’s important to keep track of ALL expenses and make sure to get your client to sign off as you go.
Pro Tip: Using a construction management tool like BuildBook will save you both time and stress during projects by giving you a single place to stay on top of your contracts, project schedule, tasks, budget, client approvals and much more.
We hope this helps you to better understand and decide which contract is right for your construction company. But no matter what, do your research and become a pro at estimating. Once that’s out of the way, you can do what you do best and create happy clients!