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Blogs by William Manchee
6 - Defending the Small Business - Giving it away. 10/16/2008 3:40:23 PM
Small business owners often destroy their own businesses by bidding jobs too low or setting prices at a level that won't bring them a profit. Another big cause of small business failure, particularly in the construction industry, is bidding the job so low that there is no way a profit could possibly be made. This usually occurs when there is competition for the job and the small business owner desperately needs the work. It’s a very common practice in the construction business to borrow from Peter to pay Paul. It works like this.
The owner bids the job too low and then runs out of money to complete it. Rather than default on the project, get sued, and be put out of business, he runs out and gets another job. With the up-front money on the new job, he completes the old one. This will work for awhile, but eventually the contractor either won’t be able to get a new job quickly enough, or the up-front money he gets on the second job isn’t sufficient to finish the first job.
This is when I usually get the phone calls and confessions from my construction clients that they have underbid and job and can’t finish it. Before they call me, they have usually exhausted any possibility of getting a new job or borrowing the money. By this time the customer is belligerent and may have contacted an attorney. This is when I usually suggest Chapter 13 because that normally that solves the problem in short order. Unlike Chapter 7, there are no provisions in the laws governing Chapter 13 cases that allow a creditor to object to a plan on the grounds of fraud or intentional wrongdoing. The only objection that can be raised is that the Chapter 13 was brought in bad faith. In most cases, however, even if the debtor has fraudulently taken money from a creditor, he is likely filing the Chapter 13 with every intention of making it work. Hence an objection by the wronged creditor won’t stop his Chapter 13 case from proceeding. As effective as Chapter 13 is at saving the hide of imprudent contractors, it doesn’t stop criminal prosecution.
Several years ago I got a frantic phone call from a contractor who had underbid a string of jobs and was at the end of the line. Unfortunately, this last owner hired an astute attorney who knew that what the contractor had done was not only fraudulent, but violated a Texas criminal statute. He knew the contractor didn’t have any money and probably couldn’t pay a judgment, so he had his client file criminal charges. My client was flabbergasted because he didn’t see himself as a criminal. After all, what he had done was pretty common practice among his peers. But the owner and his attorney wouldn’t back off, and the District Attorney pressed on with the criminal prosecution.
Terrified of the prospect of going to jail, my client begged his family and friends to bail him out and they did. With money in hand we offered it to the owner with the stipulation that he would sign a non-prosecution affidavit. He agreed and my client tendered the money. This didn’t guarantee that the DA would dismiss the case, but normally they will if the plaintiff asks them to and there has been restitution.
So, the question is: Why do contractors underbid a job? Many times it is done inadvertently, because either the owner or the estimator doesn’t understand how to determine the total costs of doing a job, or is overly optimistic in calculating the time it will take to get it done.
Bidding a job is very complicated and easy to botch. Many contractors don’t keep books or do any kind of cost accounting, so they really don’t know how much it costs to complete a job. Oftentimes they fail to take into consideration administrative costs, depreciation of equipment, interest expense, taxes, and other expenses that don’t seem directly related to the project.
Another big problem with bidding a job is being overly optimistic. Contractors often seem to think it will take less time to finish a job than it actually does. They may underestimate the cost or quantity of materials needed or fail to consider the likelihood of price increases. Whereas these SBOs usually do quality work, they very often totally miscalculate the bid and end up in serious trouble.
The solution is to keep a good set of books with accurate cost accounting so that the business owner will know exactly what his or her costs are. Then, when the bid is calculated, a little profit can be built in to make the whole exercise worthwhile. The owner must resist the temptation to bid the job below cost or with too little profit just to keep busy. If he can’t do this he should turn over the bidding process to someone more objective and who has strict instructions to bid the job strictly on a cost plus reasonable profit basis. Whereas the owner is usually the person with the best knowledge of how to do the job, he may be the worst person to bid it.
Underbidding a job is crazy and totally avoidable, at least the second time around. The first time it might be an honest mistake, but after that it’s stupidity. If the owner bids the job correctly and doesn’t get the job, then he has to be able to just shrug it off and go on to the next one. If he bids correctly, but doesn’t get any jobs, then he must look at ways to cut his costs or improve his efficiency so he can do the job for less money. But he must be realistic. Just getting a job for the sake of getting it is foolish and an invitation for disaster.
