By Louise Stewart, CEO of ProjectPay

On a global level, the construction industry is one of the largest sectors, and engages a very high number of small businesses. The sector is increasing under pressure, already suffering from abnormally high rates of business insolvencies, post covid inflation pressures alongside public spending surges on construction projects means that even more businesses are expected to go to the wall.

Operating on a ‘project-based structure’, the industry delivers projects involving multiple companies, with main contractors typically purchasing services from a wide range of contractors for ‘sub-projects’ within complex project hierarchies.

To address some of the payments and finance issues involved with this complexity, Project Bank Accounts (PBAs) have been used for some time as ring-fenced bank accounts which provide an alternative payment mechanism on building and construction projects. They’re used by the UK Government to ensure that main contractors, and subcontractors in the supply chain, are paid and don’t face unreasonable payment delays due to the main contractor not passing on payments.

In fact, the UK Government has recently recommended that all projects should use a transparent payment mechanism and recommended the use of these project bank accounts on all major construction projects.

Project subcontractors are paid directly from the PBA at the same time as the main contractor, rather than the main contractor being paid into their business bank account and the subcontractor waiting for their payments to be passed on. But PBAs still have several limitations and flaws which has hampered their uptake and use on building projects

They are difficult to set up and have complex legal requirements. How to effectively implement them is frequently misunderstood therefore, and they require a lot of paperwork and spreadsheet administration. They also tie up the working capital of main contractors, only protect payments for the top tier contractors and are generally vigorously disliked by main contractors.

Crucially, in traditional construction supply chains, main contractors pay subcontractors, who then pay their sub-subcontractors. This can add delays and increase average subcontractor costs for projects of around 5-10%. And if the main contractor’s business collapses subcontractors don’t get paid at all for work completed.

The construction sector is renowned for a vicious cycle of working capital disfunction. This is created by limited access to affordable working capital due to this contractual chain payment risk resulting in high rates of non-payment and business collapse in the sector – with small and micro businesses most exposed to risks with the majority of their business assets tied up in unpaid invoices. This means that the 98% of small businesses who dominate the sector don’t have the business balance sheet to attract low-cost bank finance and aren’t even considered by banks.

With the payment risk that the hierarchical payment chain creates, at least 32% of business assets being made up of accounts receivable.  This is more than any other industry and further highlights the extent of the counterparty risk faced within the building and construction industry.

This dysfunction is made worse by the power imbalance between large main contractors and the small businesses – who become default financiers on projects. In fact, main contractors frequently use money owed to small business subcontractors as their free working capital.  This provides an incentive to delay payments to small businesses for as long as possible.

It also forces some small businesses to use their personal savings or credit cards with high interest rates to cashflow their businesses and pay their employees because they don’t have access to any other finance.

To address this, a new trusted, collaborative and digital way to manage payments has been developed, using secure digital wallets to remove the insolvency risk which results in non-payment from project payments.

The digital wallets reduce project costs and provide full supply chain payment guarantees well beyond the capabilities of PBAs. By ensuring payment for services performed they remove the financial contagion associated with outstanding accounts receivables impacting the supply chain. This changes the management of working capital without the additional administration and audit compliance costs of project bank accounts (PBAs provided by the major banks) borne by project owners and main contractors.

 The new method works like this:

1. Main contractors and subcontractors sign-up and register for fast guaranteed payments
2. A project is created and linked to a digital wallet
3. Parties enter the usual building contracts electronically on the platform, which do not impact on the usual contractual terms and are connected to the project digital wallet as they are invited to join the project
4. Contractors can opt to wait for payments based on the agreed contract terms or they can register for a merchant facility to get paid immediately for a small fee.

 A good example of how this method is already making an impact in the UK is how it is limiting certain social housing issues, because the construction industry accounts for 25% of all business insolvencies in the UK; With main contractor insolvencies leaving subcontractors unpaid, and projects delayed or cancelled, this frequently impacts Housing Associations’ ability to deliver more social housing.

The new approach solves these challenges and delivers on the needs of Housing Associations. On an industry-wide level it provides a collaborative, scalable and secure payment platform that makes the entire construction project payment process simpler, faster, and protected for all parties. This enables small business contractors with increased project payment engagement and transparency on Housing Association projects

Project bank accounts require the drafting of complex legal agreements. But these new platforms allow all parties to quickly sign up to a building project’s wallet, agreeing to the wallet’s terms of use electronically when they are joined to the digital wallet as part of the simple onboarding process. This means everyone across the project’s supply chain is joined to the project wallet and can benefit from guaranteed project payments made by the contractually agreed dates or immediate payments if they register for them and agree to the merchant fee.

Primarily, they offer reduced costs for subcontractors in managing working capital, while removing the risk of non-payment and increasing trust by providing payment certainty. This facilitates lower subcontractor costs, ensuring lower project budgets and freeing up cash to invest in more housing stock.

But they also provide a range of further benefits, including:

Visibility and control

Using a fully transparent digital payment process, with a single version of the truth, available instantly to all. Approves payment requests and pays contractors and subcontractors directly with a full audit trail.

Lower administration

Completes digital setup and onboarding checks for contractors in minutes. Streamlined digital processes remove manual, paper-based systems reducing administration time and cost, and digitising the processes.

Fully secure, fast payments

Cascades secure payments via digital wallets provided by a major UK bank with two-factor authentication for security that removes the risk of misuse of project funds and fraud.

Robust supply chains

Builds trust, increases collaboration, and lowers barriers to entry to construction projects for SME subcontractors. Demonstrates a commitment to all levels of suppliers.

Full compliance

Ensures adherence to government and industry codes of practice, and contract payment terms across the supply chain. Complies to the contract terms and the Construction Act.

Reduced risk

Minimises project risk by ensuring prompt payments throughout the supply chain and guards against the potential for main contractor insolvency.

So those who typically look at PBAs for certain projects should now look at new project wallet solutions that are becoming available, which address the typical PBA limitations.

PBAs have become extremely unpopular with builders in the construction industry. They’re difficult to set up, have complex legal requirements, require a lot of administrative burden and tie up the working capital of main contractors. Conversely, the new solutions facilitate scaled adoption by the sector. This substantially increases the cost benefit and outcomes savings to the sector compared to PBAs, that only provide a ring-fenced account and transparency of payment times for top tier contractors.