Sakhile Construction Business Plan — Retention and Guarantees

How retention held back on every contract and the guarantees clients demand tie up capital, and what that costs the contractor.

Retention and Guarantees

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7.1 Retention
7.2 Guarantees

Two contractual mechanisms take cash out of a contractor’s hands without appearing as a cost. Both are standard, both are non-negotiable in practice, and both must be planned for rather than discovered.

7.1 Retention

Figure 10. Retention withheld against retention still outstanding.

R’000	Year 1	Year 2	Year 3	Year 4	Year 5
Turnover	4 200	9 500	19 000	34 000	52 000
Retention withheld in the year at 10.0%	420	950	1 900	3 400	5 200
Retention released in the year	189	658	1 378	2 575	4 210
Retention outstanding at year end	231	523	1 045	1 870	2 860
As a share of turnover	5.5%	5.5%	5.5%	5.5%	5.5%
Days of turnover	20.1	20.1	20.1	20.1	20.1

Two different figures are commonly confused. R5.20 million is withheld during Year 5, being ten per cent of every certificate issued. R2.86 million is the balance still outstanding at the year end, after R4.21 million of releases from earlier contracts. The first is what the business gives up during the year; the second is what it is owed at a point in time. A contractor who plans against the wrong one will either over-fund or, more commonly, be surprised.

The retention register is the cheapest working capital in the business

Half of retention is released at practical completion and half after the defects liability period, which is typically twelve months later. Neither release happens automatically: both must be claimed, and both require the defects list to have been closed out and certified. A contractor without a retention register loses track of releases on contracts completed two years earlier, and the money simply stays with the client. At Year 5 volumes R4.21 million is released during the year — more than the entire EBITDA of the business. Maintaining a register of every contract, its practical completion date, its defects liability expiry and the amount due at each is an afternoon of administration that funds a substantial part of the growth.

7.2 Guarantees

Instrument	Typical value	When required	Effect
Performance guarantee	5% to 10% of contract value	At award on most public and larger private contracts	Contingent, not cash, but consumes guarantee facility capacity
Advance payment guarantee	Equal to the advance	Where an advance payment is negotiated	Converts a cash benefit into a facility commitment
Retention guarantee	Equal to retention withheld	Optionally, in lieu of cash retention	Releases the cash but at a fee and against facility capacity
Defects liability guarantee	2.5% to 5% of contract value	At practical completion in some contracts	Extends the commitment through the defects period

	Year 1	Year 2	Year 3	Year 4	Year 5
Guarantee facility fees, R’000	—	45	130	260	420
As a share of turnover	—	0.47%	0.68%	0.76%	0.81%

Guarantee fees reach R420 000 by Year 5, 0.81 per cent of turnover. The fee itself is modest; the constraint is capacity. A guarantee facility is sized by the provider against the balance sheet, and a contractor whose facility is fully committed against existing contracts cannot bid new work regardless of how attractive it is. Guarantee capacity, not cash, is frequently what caps a growing contractor’s order book — and it is another reason retained earnings matter more here than in most businesses.

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