The Science Of Paying People
I’m going to start this month’s article with a confession. I’m not sure it’s up there with the soul-cleansing variety, but it’s a confession, nonetheless. So, here it is; I’m not the world’s most avid book reader. There, I’ve said it. And I think I may feel better already. It’s not the reading itself that’s the issue; it’s more a question of having a low boredom threshold. I’m no good at investing time in things that have delayed gratification. Spending five hours getting information out of a book is too long for me. I want answers, and I want them now. Or at least now-ish.
When I played golf for the first time, my short attention span really came to the fore (see what I did there?)
Not only did I find it almost entirely pointless, I realised that if I were going to be any good at it, I would need to invest weeks, months, and probably years practicing. There was also the issue of the challenging attire, plus a propensity to what my golfing partner at the time generously referred to as a pronounced fade, but which we both knew was a slice so large that it would have made Mr. Kipling salivate. In case you’re wondering, my second visit to the golf course remains an awaited pleasure.
But I digress; let’s get back to the books. The problem with many self-help tomes is that their core concept can easily be conveyed in a single page. It’s often a simple idea, sometimes a brilliant one, that should take five minutes to grasp and not much longer to act upon. But you can imagine the author’s conversation with their publisher, who’s just been presented with a single leaf of paper detailing said gem of an idea; “I love the concept; your fans will adore it. But, be a love and knock out another 199 pages of waffle so we can pad it out a bit, would you?” And therein lies my problem. No one writes a one-page book, so I need to endure 99.5% of padding in order to extract 0.5% of goodness. And frankly, I struggle with such a meagre rate of return.
Luckily for me, help is on hand. These days I manage to consume a book a day due to the rather wonderful innovation known as book summarisers. In fifteen minutes, I can read (or listen to) the key points of some of the world’s finest business and self-development books without any of the waffle. Then, if I like the book, I might buy it, but more likely, I’ll just read another book summary. The other benefit of book summaries is that you’re willing to take more risks with your choice of subject. If you know you’ve got to sink five or six hours into a read, then you’ll make sure it’s a good book before you start. But if you’re only investing fifteen minutes, you can afford to go off-piste and try something you wouldn’t ordinarily risk. And while it’s an approach that can uncover the occasional turkey, it can also open up your horizons in a rather illuminating way.
This principle of early gratification doesn’t just apply to fine-motor sports skills and book reading – it also extends to the rather sensitive issue of paying people. After all, when people are owed money, they not unreasonably want to get their mitts on the cash as soon as possible. And in the world of property development, the whole ‘paying people’ thing comes with a bit of baggage that we need to unpack. Let’s start by looking at who needs to get paid. The first thing to mention is that, as a rule, the developer doesn’t get paid in the same way as everyone else. Instead, they keep what’s left in the pot after everyone else has been paid. In this instance, ‘not getting paid’ is actually a good thing since the developer’s target profit margin will typically be 20% of the gross development value (the selling price of what is built). This should be significantly more than anyone else’s share, and it’s for a good reason since the developer is the one who’s taking all the risk.
The architect will get paid their fees even if you build a complete turkey of a project that no one in their right mind would want to live in. The same goes for your contractor, project manager, and structural engineer. Every one of your team of professionals will get a fee for their services, and while it won’t be anything as significant as your share, they’ll get paid it regardless of whether you sell your finished units at a profit.
If you’ll allow me another brief digression at this point, I should mention the subject of something called a Development Management Fee (or some variation thereof), which is a means by which developers can get paid during their project rather than having to wait until the end. It’s all well and good developers retaining what’s left in the pot after all the expenses have been paid out. The problem is that this only happens after all their units have been sold. So, many developers have to address the issue of what money they’re going to live on in the interim. You can imagine an impoverished developer about to receive several hundred thousand in profit in a few short months. But with no cash coming in until they’ve sold out, they’d be forced in the interim to adopt a level of subsistence that was less Pol Roger and more Pot Noodle. Luckily for them, there are some more enlightened lenders out there who recognise this problem and have found a solution. While the more hard-nosed lender might see the benefit in developers getting paid only after they’ve turned a profit, others worry that there are only so many Pot Noodles a developer can consume before they decide to take on a day job, part-time or otherwise. And this means they’ll spend less time on and apply less focus to their project. So, these lenders agree to pay the developer a fee during the construction phase, effectively reflecting the work they’re doing in having ultimate oversight of the project during that phase. Before you start popping corks, I should make a couple of points; it won’t be a king’s ransom, but it’s likely to be a few tens of thousands, depending on the size of your project. Also, while you might think they’re being exceeding generous, they’re only effectively advancing some of the profit you would otherwise get when you sold out. So, if they pay you thirty grand, your profit on completion will be thirty grand less – in other words, you’ll receive the same profit overall. But, if a development management fee sounds appealing, let your broker know in advance so they can find a lender who offers one.
Okay, digression over. Now we come to the thorny subject of timing. After all, owing money is one thing, but paying it is altogether different, and there are some complexities in development that you need to be aware of. Contractors are an excellent case in point. As a developer, you’re likely to use commercial finance to finance your projects, and there’s a lot here to like since lenders will typically advance you 100% of the development costs. This is huge since the budget for a small-scale development is likely to be many times that of a simple flip or refurb, so it’s all rather handy that, as a developer, you don’t need to dip into your own pocket to fund the work. Now, call them cynical, but l suspect commercial lenders have historically received one too many ‘Greetings from Mexico’ postcards from developers they’ve lent money to.
So, rather than simply handing over a big cheque to the developer at the start of the project, the lender will release funds on the drip in tranches. The funding will be agreed, and then the contractor will start work. At a pre-agreed point, often at the end of the first month, the contractor will send you an invoice for their work to date. You will then contact your commercial lender, who will send a surveyor around to inspect the site. Assuming the surveyor reports that the value of the work completed and materials stored on site reflects the contractor’s invoice value, then the lender will release the funds to you, allowing you in turn to pay the contractor. This tranche payment process continues until the end of the project.
You might think this is a little unfair on the contractor; after all, they could be significantly out of pocket by the time they get paid. However, contractors pay their employees and subcontractors in arrears, plus they will have trade accounts with their materials suppliers, usually with 30-day terms. This enables them to swan into Jewsons, pick up whatever materials they need and add it to the bill. Jewsons will then send them a monthly invoice. As a result, your contractor isn’t offering you a line of credit since they aren’t parting with any cash themselves until further down the line.
Most of your other professionals will send you an invoice for their work with varying payment terms. Some will want paying immediately, while others may offer 14 or 30-day terms. And as the developer, it’s your job to ensure these people get paid. However, I’ve discovered during my forty-odd years in construction that most developers like to operate what they might refer to as a ‘maximum cashflow’ model. Or, if you happen to be one of their suppliers, you’d be more likely to call it a ‘minimum payment’ model. In other words, the developer only pays the supplier right at the end of their payment terms, in many cases triggering a raft of payment reminders and phone calls, generating more work for the supplier. Believe it or not, there’s even a particular group of developers who operate an ‘extract the urine’ model, where they won’t pay a bean until their suppliers have exhausted every means possible of recovering the debt short of court orders or physical intimidation. These developers enjoy unparalleled credit terms in the industry but tend to struggle to find suppliers for their next project for some unfathomable reason.
So, let me offer you a word of advice. When it comes to paying people, you should be the one that pays early. Of course, you should wait for the invoice to arrive. But rather than sitting on it for a few weeks revelling in that slight yet ephemeral ‘having your cake and eat it’ feeling that comes with legitimately extant debt, you should instead get your bills paid as soon as they land. Why should you do this? The main reason is that the goodwill you’ll generate from your suppliers will far outstrip the marginal cashflow benefit or loss of interest that you will receive by clinging onto their money until the last possible moment. It’s true, you do lose a little benefit financially in paying early, but it really is small beer. Instead, I heartily recommend viewing early payment as an insurance policy. Firstly, you’ll become famous in various Accounts Payable teams around your immediate vicinity for your prompt and unprompted payment. You’ll set yourself apart from your laggard competitors who drag their feet, pay late, and need to get nagged and chased.
And so when you want to hire a firm or a professional to work on your next project, you’ve got a fighting chance of making it to the top of their preferred client list because you’re such a prompt payer.
But there’s another scenario that can be even more rewarding and altogether vital. Imagine that something happens on one of your projects. Perhaps there’s a delay in securing funding from the lender because the surveyor hasn’t yet signed off on the next tranche payment. Or maybe there’s some other kink in your cash flow hose. Either way, you can’t pay a supplier’s invoice, at least not at the moment. Sure, you could take advantage of their settlement terms, but what if you still can’t pay even after 30 days? You run a severe risk that your supplier will take action. The most logical thing for them to do is to down tools.
After all, why should they work on your project if you’re not paying them – you’ve become a bad credit risk. And development is a team sport – if the architect walks off in a huff without first dotting their ‘i’s, the contractor won’t know what to build, which means everything grinds to a halt. Everything, that is, except the interest you’ll be paying on your finance, which will continue to build relentlessly in the background. You won’t need to pay the interest until later, but it will dent your profits just the same. And if people aren’t working on your site, they’re not working. Unless they start working on another developer’s project, which is what they will ultimately do – they’ve got to earn a crust, after all. And then how easy will it be to tempt them back, particularly now that word has got round that you’re strapped for cash and might not pay them?
Instead, imagine having a direct, man-to-man, or woman-to-woman (insert the relevant permutation here) conversation with your supplier(s). You’ll apologise that you can’t pay them now, but you’ll explain that it’s a short-term problem. And then you’ll point to the fact that you’ve always paid every single one of their invoices on the dot (aka ‘early’) and have never once given them cause to chase you for payment. In return, you’re simply asking for a little leeway on this particular bill until normal service can be resumed. Maybe you’ll even sweeten the deal with a little extra on top for their inconvenience. Now, I’ll be the first to admit that this approach has no guarantees. But what I do guarantee is that poor cash flow can be a thorn in the side of many an unsuspecting developer. By ensuring your suppliers always view you as one of their best customers, you’ll have a fighting chance of appealing to their better nature and keeping them on side if the cashflow demon bites you on the posterior. It turns out that property development is just one on a long list of life’s experiences where a little early gratification in a relationship can go a surprisingly long way.