Retainage (or retention) is one of the biggest culprits of cash flow issues for construction companies—especially for subcontractors. It’s a long-standing construction payment policy that allows project owners and general contractors to hold back part of the money you’ve earned until the project is complete. It’s basically like working for a 40-hour paycheck every week but only getting paid for 30 because your boss is holding the rest of it until everyone finishes their work.
Retaining people’s paychecks isn’t tolerated in any other industry. So, why is it the norm in construction? If you’re trying to wrap your head around these questions, along with how retainage works and its impact on your company, you’re in the right place. This complete guide to construction retainage will cover:
- The basics of construction retainage
- How retainage affects subcontractors
- Tips to deal with retainage
- Collecting retainage payments faster
The Basics of Construction Retainage
Why does retainage exist?
Retainage started in the 1840s to prevent construction laborers from not finishing or poorly finishing projects. It quickly became a widely adopted way of reducing property owners’ risks and incentivizing higher-quality work.
How much money can be withheld for retainage?
It’s typically a percentage (5-10% on average) of the total contract value. Rates tend to be higher on private construction projects and lower on federal, state, and municipal projects.
How long can retainage be held?
Retainage terms typically allow payers to hold retainage until the end of the project or until a certain percentage of work is finished.
What is variable retainage?
Sometimes retainage is variable, meaning it changes depending on details defined in the contract. This can work in a couple of different ways:
- The withholding rate reduces over time. For example, the retainage could start at 10% during the first three billing periods and then 7.5% during the next three.
- Apply a different rate on different line items. For example, a GC might not hold any retention on equipment rentals, or the retention rate could be higher on materials than on labor.
What’s an example of how retainage works?
Say you’re working on a $100,000 project, and the retention rate is 10%. So, the total retainage will equal $10,000. But retainage will be withheld from each progress payment.
Let’s break it down:
- If your portion of the project will take four months and the progress billing schedule lets you bill monthly, you’ll theoretically complete (and bill for) 25% of the project each month.
- So, for each progress payment, you’ll bill $25,000.
- The GC will hold $2,500 from every progress payment they issue.
- Across the four payments, they’ll withhold a total of $10,000.
How Retainage Affects Subcontractors
Retainage affects GCs and subcontractors alike. But subs feel the brunt end of the impact as retainage trickles down through contracts. Subs pay for materials and field workers in full. They’re essentially forced to finance the job while GCs don’t have to pay anything until they’ve been paid by their client.
Additionally, GCs may charge subs higher retainage rates. If the prime contract withholds 5% from the GC, the GC will often increase the withholding percentage for subcontractors. They do this to help protect cash flow. Unfortunately, it leaves subs in quite a bind.
Retainage creates crippling cash flow issues.
Profit margins on construction projects are already thin—sometimes running as low as 5-10%. Retainage rates can easily equal (or surpass) the entire project’s profit margin.
This means that subs have to wait until a project is finished before making a dime of profit. In cases where retainage exceeds the profit margin, progress payments aren’t even enough to cover labor and material costs.
Retainage can be withheld for years.
On top of that, it can take years for subcontractors to receive their retainage payments. If the prime contract states that retainage will be paid at the end of the project, you won’t receive your final payment until the project is 100% done—even if that’s long after you’ve finished your part.
Think about it: If you run an excavating company, your team is involved very early on in the project. Once you’ve finished your part, you still have to wait for framing, HVAC, plumbing, electrical, installation, drywall, and finishing subs to complete their work.
Even after the project is finished, inspected, and approved, it can be 30, 60, or 90 days (depending on state laws) before the GC receives its retainage and, in turn, pays you. What’s worse is that subs may never receive their retention payments if the owner or GC goes bankrupt or out of business. No wonder construction companies have such a high failure rate.
4 Tips to Help Subcontractors Deal with Retainage
Unfortunately, retainage isn’t likely to go away any time soon. So, what can you do to ensure retainage doesn’t hang your company out to dry? Here are four tips to help subcontractors deal with retainage.
1. Closely read the terms of every contract.
Always understand what your company is getting into. Retainage percentage and parameters must be defined in your contract. So, pay close attention to the terms of each contract, looking specifically for details like:
- How much retainage will be withheld?
- When will retainage be released?
- What are the stipulations to receive your retainage?
2. You have a right to negotiate.
It’s not likely that you’ll get a GC to completely remove the retainage clause. But you might get them to approve more favorable terms, especially if you have a previous relationship with them or an exceptional reputation in the industry.
Some parameters you may be able to successfully negotiate include:
- Reducing the withholding percentage
- Adjusting how long retainage will be withheld
- Considering retention bonds or surety bonds as an alternative
- Getting retainage placed in an escrow account that you earn interest on
3. Brush up on retainage laws.
Retainage laws vary from state to state and can sometimes conflict with federal legislation.
For instance, New Mexico completely prohibits retainage. Texas, on the other hand, mandates it. Additionally, most states have specific restrictions on the amount of retainage that can be withheld, the duration of the withholding, and the types of projects it applies to.
It’s essential to know the retainage laws in your state. If the contract isn’t written according to law, it won’t stand up in court.
4. Plan cash flow needs ahead of time.
The best way to deal with retainage is to acknowledge how it affects your cash flow and plan proactively. This means implementing good accounting practices and having access to working capital that can float projects until they’re finished.
These tips can help maintain positive cash flow:
- Accurately estimate project costs.
- Closely monitor these estimates throughout the project’s duration.
- Bid higher to help offset retainage.
- Consider financing materials.
- Obtain access to lines of credit.
- Put financial reporting in place.
How to Collect Retainage Payments Faster
It would be nice if every GC issued retention payments as soon as they were due. But that’s not always the case. Some GCs will hold onto retainage as long as possible to protect their cash flow. So, to expedite your retainage payments, we recommend the following:
Prepare to close out from the beginning.
Make it a best practice to prepare for project close out throughout the job. You can’t get paid until you provide all of your close-out documents. So it’s important to know what documents will be required from the start. Collect them in a folder so you know where to find everything at the end of the project.
Submit accurate pay apps on time.
The first step to getting your retainage payment is to submit your final payment application accurately and on time. Ensure that you provide all the necessary paperwork and details correctly, as any missing or incorrect information may lead to GCs rejecting your pay app, which can cause further delays.
Stay on top of lien waivers.
Your final pay app should include conditional final lien waivers from your company and any lower-tier subs and vendors. Failure to provide the correct lien waiver may result in the GC withholding your retainage.
Remember not to submit your unconditional final lien waiver until after you’ve received your retainage.
Follow up on invoices.
Some subs submit the final pay app and just wait to get their retainage. We strongly encourage you to take a more proactive approach. Treat retention payments like any other payment you’re trying to collect.
- When the retainage due date is approaching, send an invoice to the GC.
- Follow up proactively to make sure they received it. Email reminders can be effective, but don’t hesitate to pick up the phone.
- Send regular invoice reminders. It’s a good idea to send a reminder shortly before the due date, just after the due date, and every ten days or two weeks following.
If you don’t receive your retention payment in a reasonable time, send a demand letter. This formal document is commonly the first legal step to take to resolve a dispute. Here’s a demand letter template you can download and customize.
Don’t forget your lien rights.
If you’ve already sent reminders for unpaid invoices to the GC, and they’re still unresponsive, consider sending them a notice of your intent to file a mechanic’s lien. If they still don’t send your payment, filing the lien is your last resort. However, timing can be tricky here. Most states require you to file a lien within 30 to 120 days of completing work on a project. Plus, in order to establish your lien rights, you must first file a preliminary notice. If the project isn’t going to be finished until six months after you finish your portion, your retention payment may not be due until long after your lien rights expire.
In these cases, it’s important to take into account the payment history and reputation of both the GC and the owner of the project. Evaluate your risk of non-payment on a case-by-case basis, and don’t hesitate to exercise your lien rights when needed.
Track Your Retainage Payments
Staying on top of retainage is part of maintaining a financially healthy construction business.
Trade contractors use Siteline to perfectly track all retainage so they never forget to bill for it. Plus, with Siteline, you can store all of your documents required for close out, generate and submit accurate and on-time pay apps, and submit the correct lien waivers for the stage of project and phase of billing.
If you need to get a handle on tracking and billing for retainage while also streamlining your billing workflow and reducing invoice aging, check out Siteline. Schedule a demo today.