Contract is the root word of what we all consider ourselves to be – Contractors.
Think about it, you can’t spell contractor without contract.
Likewise, you should NOT be doing any contracting type work without a contract.
Sure, it is not as cool a word as demo day or excavation and writing a contract is not nearly as much fun as executing a perfect miter or tearing through a wall, but it is very important to you and your business.
So, despite any initial turning of your nose at the subject, read on.
General Contract Requirements
Before getting into the weeds on the major types of contracts that are typically used, here’s a few items to lay the ground work and to keep in mind on all contracts in general:
- Be sure to include the owner(s) name and the physical address of where the work is to take place.
- You must include a VERY detailed scope of work. If it’s a renovation project or even a new build, what are the areas of the project that you have given your best effort on pricing & scoping out but cannot guarantee what will be discovered behind the existing walls or underneath the soil. We all like to say that we can see thru walls, but in reality, we can’t. So, your contract MUST be written in such a way that it covers you and has given the customer an advance notice that there might be unforeseen circumstances that are completely outside of your control.
- If the project has customer selection allowances, how will the administration of those be handled. In addition, how will the overage or underage of those allowances be handled.
- Be sure to lay out the terms of the contract. When is payment due? What happens if a payment is late? In the very worst-case scenario of default on either side, who covers the legal fees? Will you be getting paid on a percentage completed basis, draw schedule of completed tasks or some other form? Cash flow is an important topic for another day, but you should know the cash flow that you need to keep your doors open and business flourishing. The terms of your contract ALL affect how the cash flows through your business (or doesn’t).
- Are there any blueprints that will be used for the project? Be sure to reference those with the Architect or Designers name and the date of latest revision to be used for construction.
- If applicable to your project, you should include any scheduling requirements and legitimate reason for excused delays.
- Change Orders are almost always an inevitable part of any construction project. How will they be handled and administered and charged? Include the terms so that there are no question marks later.
- You should have a scope of work, blueprints, list of allowances (if applicable), draw schedule, etc. in your contract. What happens if there is a conflict among the different contract items. To alleviate this, be sure to include a Control of Documents section in your contracts. It will list from top to bottom, the order of control in case of conflict.
**As an asterisk to any statements included here, be sure to check on your individual state or local municipality requirements on any contracts that you use. Also, find a good lawyer in your area (see previous post) who can advise you on your local requirements.**
Main Contract Types
Now that we’ve gone over the broad strokes of contracts in general. Let’s dive into the weeds a little bit.
As a note to the below examples: Any surprises, additions or reductions (all change orders) are assumed to have the builder’s fee included in the numbers shown in the examples.
Fixed Cost & Fixed Fee with Allowances:
In this scenario, once the final scope of work is established, a lot of the items (labor, material, plumbing, roofing, etc.) would all have fixed numbers associated with them.
The fee would also be a fixed number.
Only reason either of these would change would be for anything unforeseen or a reduction or addition in the scope of work along the way. The allowances (windows, fixtures, lights, flooring, etc.) would be able to fluctuate up or down depending upon your final selections.
The up or down of the allowances would not affect the fee amount as it is fixed.
The allowances are also viewed as a whole.
For example, if the customer overspends on appliances and underspends on light fixtures, those overages & underages can help to balance each other out.
In this scenario, the risk vs reward is mostly on the contractor. i.e. if you are $5,000 less than you figured on the labor then that is to your advantage, on the flip side, if you are $5,000 over what you figured on labor then that is on you.
Numbers example: *The numbers used in all of the below examples are fictitious and are just for example purposes only
Starting Budget
– Fixed Costs $100,000
– Allowances $40,000
– Fixed Builders Fee $17,500
– Grand Total $157,500
*Final amount would be dependent upon actual amount spent on allowances and any surprises or addition/reductions
Final Amounts
– Fixed Costs $100,000
– Final Allowance Costs $45,000
– Surprises $5,000
– Reduction in scope of work during process (-$10,000)
– Addition to scope of work during process $3,000
– Fixed Builders Fee $17,500
– Final Grand Total $160,500
True Cost Plus Percentage:
In this scenario, once the final scope of work is established, all of the items would basically be treated as an allowance of sorts.
Labor will cost what it costs, material will cost what it costs, plumber will cost what they cost, fixtures & lights will cost what they cost, etc and all of these items will be marked up the same percentage.
Builders fee would fluctuate with actual costs accordingly.
In this scenario, your books on this particular project are completely open to the customer and they have access to all receipts, etc that they wish to see and track.
This contract type can give a customer more control over the overall budget and makes any surprises that pop up or changes they want to make along the way flow easier from a paperwork standpoint.
In this scenario, the risk vs reward is shared between the contractor and the customer. i.e. if you are $5,000 less than you figured on the labor then that is to the customers advantage, on the flip side, if you are $5,000 over what you figured on labor then that is to the customers disadvantage.
Just as in the allowances as mentioned above, any overage or underage in each individual category are viewed as a whole and can work towards balancing each other out. For example, a $5,000 overage in the carpentry material could be offset by an underage in the plumbing fixtures.
Numbers example:
Starting Budget
– Allowance Costs $145,000
– Percentage Based Builders Fee $17,500
– Grand Total $162,500
*Final amount would basically be all actual costs plus builders fee based on percentage
Final Amounts
– Actual Allowance Costs $152,000
– Percentage Based Builders Fee $19,062.50
– Final Grand Total = $171,062.50
Cost Plus with a Fixed Fee:
In this scenario, once the final scope of work is established, just as in True Cost Plus Percentage (TCPP) type contract above, all of the items would be treated as an allowance of sorts.
Labor will cost what it costs, material will cost what it costs, fixtures & lights will cost what they cost, etc, but in this scenario the markup would be fixed and would not change unless there were surprises or a change (addition or reduction) in the scope of work.
Open book and more control over budget to the customer just as in TCPP.
In this scenario, the risk vs reward is also shared as in TCPP.
Numbers example:
Starting Budget
– Allowance Costs $145,000
– Fixed Builders Fee $17,500
– Grand Total $162,500
*Final amount would basically be all actual costs plus fixed builders fee
Final Amounts
– Actual allowance costs $150,000
– Surprises $10,000
– Reduction in scope of work during process (-$8,000)
– Fixed Builders Fee $17,500
– Final Grand Total = $169,500
Other Possible Contract Types
If all finishes and fixtures are spec’d out from the very beginning, then you could jump into a true fixed cost contract, where barring any change orders or surprises, you have a set number from the very beginning.
There are also a couple of different smaller variations to the above described contract types that are not as commonly used.
Depending upon your local rules regarding contract types, knowing the different types of contracts can actually help you land more projects by being able to explain the pros & cons of each type and willing to be flexible (within reason) with your customers and their different desires regarding their project.
Punch List Tip of the Day
In our business, we do all types and sizes of custom work ranging from very simple $1,000 repairs to $1,000,000+ new home builds.
Your risk and exposure on each individual repair, renovation or build can be your guide as your tailor how to handle a contract on each type of project.
For example, using a 20-page contract for a $1,000 repair jobmight be overkill, not to mention your profitability would be out the window with your involved time and the paper needed to print out the contract before you even start the work.
Have a ready-made single page document that you can use for the smaller jobs.
Use the more extensive contract forms for those larger projects where your risk and exposure are higher.