Table of Contents Hide
- What is Retainage?
- What Is the Process of Retainage?
- What Is the Importance of Retainage?
- Factors that influence retention likelihood
- What Percentage of the Retainage is Typically withheld?
- How Long is the Retainage Held?
- Can clients refuse to pay retainage after a project has been completed?
- Is it possible to release retainage early?
- Retention Issues: How Retention Affects Contractors and Subcontractors
- The Advantages and Disadvantages of Construction Retainage
- Understanding Retainage Laws: Legal Retainage Limitations
- Retention Management Suggestions
- Retainage FAQs
- How is retainage calculated?
- Is retainage an asset?
- How much does a retention bond cost?
Retainage is a frequent construction practice in which a percentage of the cash is withheld from a contractor or subcontractor until the job is finished. As a result, retention can have a considerable impact on contractor cash flow. In an industry already plagued by cash-flow issues due to significant upfront expenses and delayed, inconsistent payment cycles, retainage offers little to help contractors manage their cash flow.
So, what exactly is retainage, and what does it imply for your company?
What is Retainage?
Retainage is the withholding of a percentage of a contractor’s or subcontractor’s payment until the construction project is completed. It is intended to serve as a financial incentive as well as guarantee that the contractor will execute the job satisfactorily.
Retainage has been a typical practice in US construction projects for over a century. It is now a condition for almost all construction loans. Retainage on public construction projects is governed by state law, with specified percentages and release conditions, whereas it is governed by contract terms on private projects.
Retainage is a contentious phrase in the world of construction finance. It is frequently portrayed as a burden imposed by the financing institution on the owners and contractors, despite the fact that it largely serves to provide further confidence that the construction project will be finished. But, before we get any further, let’s establish what we’re talking about.
What Is the Process of Retainage?
Typically, the retainage percentage is deducted from each progress payment made during the construction process. When divided into individual instalments, retainage does not provide a significant burden on continuing construction expenditures, but it accumulates over time to provide a strong incentive for contractors to complete their work.
The proportion of retainage withheld is sometimes defined and sometimes agreed upon, but it is most typically set between 5% and 10% of the total approved money. (10% is the industry standard for public projects.) They can also be defined scalably by the contract, with varied amounts withheld for different stages of construction.
It is released and money is paid out to contractors and subcontractors once the construction project is completed – often after the final release of lien and any appropriate completion certifications have been signed.
What Is the Importance of Retainage?
Retainage is still the most efficient insurance policy for completing construction projects successfully. This is especially crucial in the closing stages of the project, when the contractor may decide that it is more financially feasible to simply go on to the next job because there are no retainage funds to collect upon the conclusion of the current project.
In the event of contractor default, retainage represents easily available funds. If a contractor is unable to complete the work or satisfy his financial responsibilities owing to a variety of circumstances (such as frozen assets, fraud, or a lawsuit), these funds can be used to correct the default, pay suppliers and subcontractors to finish the work, and so on.
Factors that influence retention likelihood
A number of factors can boost the likelihood of retention on a construction project, including:
- Broader project scope
- Project duration is extended.
- Client relationship that is newer
- The contractor’s reputation
Furthermore, private projects frequently have higher retainage rates than federal and state ones.
What Percentage of the Retainage is Typically withheld?
The amount withheld can be calculated as follows:
- A percentage of the total expected project cost or contract value retained.
- A specific monetary sum, excluding the project’s real cost.
However, calculating the amount withheld using a total percentage is usually the preferable way. According to the ASA, the usual retainage rate has typically been 10%.
Retainer fees for public works projects range between 5% and 10%. In some circumstances, retainage may be established at a low percentage at the start of a project but increased if a contractor fails to satisfy their obligations.
How Long is the Retainage Held?
In other circumstances, retainage is withheld until the entire project is completed. In other cases, it is released in stages as the project proceeds. This is frequently accomplished by designating retainage release to specific milestones.
It is critical to recognize the impact this can have on subcontractors. Because many subcontractors complete their piece of the work before the entire scope of the project is completed, they are at a distinct disadvantage. This is because of the significantly greater time lag between completing their work and being paid in full.
Can clients refuse to pay retainage after a project has been completed?
A client may be able to withhold funds if it is included in the agreement. This is yet another reason why it is critical to carefully study contracts before agreeing to them.
Clients may add additional provisions to the agreement in specific situations to ensure they are satisfied with the end product. If there is a punch list of work that has not been finished or has been completed erroneously, retainage may be withheld after project completion.
Allowing clients to keep retained monies after project completion, on the other hand, is extremely dangerous since they may try to avoid final payment. To safeguard your company, it is in your best interest to request that payments be released as soon as the project is completed, if not sooner. Another strategy to secure timely payment is to ensure that all aspects of the project are finished to the highest standards.
Is it possible to release retainage early?
Retainage can be released early, however, this is subject to the terms of your contract. This is something that subcontractors would often strive to have written into their contracts. Otherwise, subcontractors may be forced to wait until the entire project is completed, even work for which they were not responsible.
Make sure half of the payout is included in the agreement if you want to get it on time. It may not always be doable, but it is worth investigating.
Retention Issues: How Retention Affects Contractors and Subcontractors
As previously stated, retainage can be difficult for contractors and subcontractors. Some of the most prevalent problems produced by retainage policies are as follows:
- Cash flow problems
- There is a chance that you will not be reimbursed in full.
- Accounts payable and receivable retainage is incorrectly recorded in accounting.
- Being taken advantage of due to a lack of understanding of retention
- Withholding cash from subcontractors in an illegal manner
Because they typically lack a financial safety net, these issues have a greater impact on new and small enterprises than on bigger, more established rivals. Nonetheless, retainage is an oddity for both small and large contractors.
The Advantages and Disadvantages of Construction Retainage
The concept of retainage was first adopted about two centuries ago as an economic incentive to guarantee contractors performed quality work and completed their projects effectively. If a general contractor defaults, retainage provides the owner with a speedy supply of funds to fix the situation, from obtaining another GC to finish the work to paying subcontractors and suppliers.
Contractors, on the other hand, face a number of challenges as a result of retainage. The following are some of the potential drawbacks of retainage:
- Receiving less than the agreed-upon retainage amount when the project is finished.
- Waiting far too long to receive retainage, which can range from months to years in some situations.
- Never received retainage as a result of the owner or general contractor going bankrupt or out of business.
- Having more retainage withheld as a subcontractor vs a general contractor.
- Owners who use retainage as interest-free working capital to finance the project, while contractors must finance the project themselves.
If you’re a construction entrepreneur already running on razor-thin margins, large sums of retainage delayed for extended periods of time can be disastrous to your bottom line.
Understanding Retainage Laws: Legal Retainage Limitations
As previously stated, retainage can provide significant financial risk to all parties involved. However, there are a number of rules on both the state and federal levels that limit retainage. These rules are critical in ensuring that all parties, including contractors, owners, and lenders, are protected and that work is finished and payment is made.
It is critical to understand retainage regulations in order to avoid being taken advantage of.
#1. Private initiatives
Private projects, which are completed for private entities such as individual homeowners, are held to a different set of requirements than public ones. The amount of withheld retainage allowed for private projects varies by state. In Texas, for example, people are required to withhold 10% of their earnings in retainage, but no more.
One of the most significant legal requirements for private projects to be aware of is how to employ a mechanic’s lien. This enables you to file a lien claim on their property if they fail to pay the general contractor, subcontractor, or both. Make sure you understand your lien rights so that if required, you can fight for the money you’re entitled to.
Because limitations and requirements might differ greatly, you may want to seek legal counsel if the retainage appears to be excessive.
#2. Public Works Projects
The government is in charge of public works projects. Here are a few key federal statutes that apply to public works projects that you should be aware of:
- The Federal Acquisition Regulation (FAR) states that money should not be withheld without justification.
- The FAR further states that a prime contractor may establish retainage with a contractor but may not bill the government for retainage.
- Certain projects may limit subcontractor retention due to the length of time it would take for them to be paid for their services.
#3. Projects at the state, county, and municipal levels
In general, legislation governing retainage for the state, county, and municipal projects are less stringent. States have the authority to limit the amount of retainage allowed on construction contracts. As a result, it’s critical to research the laws of the state where you’ll be working.
On public projects, state retainage limits can vary greatly. In California, for example, retainage on these projects cannot exceed 5%.
To guarantee that your contracts are in compliance, conduct thorough research on retainage rules in your state.
Retention Management Suggestions
You may be able to avoid retainage on contracts with previous clients, but it is practically unavoidable in the construction industry. This is especially true if you typically work on private projects.
Because you’re unlikely to be able to totally avoid dealing with retainage, here are a few pointers to assist you to manage it better:
#1. Consider including a retainage fee in the initial contract price.
Yes, this will increase the contract amount for your clients, but it is a good strategy to ensure you have adequate funds to work with. In some situations, this may persuade clients to forego retainage entirely.
#2. Keep a close eye on your financial flow.
When retainage is included in the majority of their projects, construction companies are especially sensitive to cash flow concerns. As a result, it is in your best interest to adopt methods for closely tracking and managing cash flow.
#3. Make use of dependable accounting software.
Having competent accounting software in your business toolset can considerably help your financial management, especially when it comes to retainage. QuickBooks Online allows you to track spending, income, and cash flow while also providing deep insights into your company’s financial status.
#4. Create a sizable business savings account.
Retainage can be very taxing on your operations while you’re just getting started, especially on large-scale projects. Establish financial reserves and a savings account as soon as feasible to offset the burden that retainage places on your budget. This can help guarantee you have extra funds to draw on when needed, such as when clients try to withhold funds after the project is completed.
Retainage adds another degree of complication that contractors must learn to handle. Having a firm grasp of what is acceptable—as well as what is not—will assist you in setting limits and protecting your interests. You will have more power if you can determine how retainage is applied to contracts or even persuade clients to forego retainage.
How is retainage calculated?
The contractor should enter the percentage and multiply it by the value of the job or materials. Let’s have a look at a basic scenario. Your contract specifies a variable retainage of 10% for labour and 5% for materials. The contract fee is $100,000, and you’ve finished 25% of the work.
Is retainage an asset?
The retainage is recorded as an asset by the contractor to whom the retainage is payable. The client, who owes the contractor retainage, reports the retainage as a liability.
How much does a retention bond cost?
Retention bond charges range from 0.4 percent of the bond amount to 10% of the bond value, and some Surety providers may request additional security from the contractor if they believe the risk warrants it.