When you’re running a construction or home repair contractor business, you need good contracts. The contract describes the work that you have to do. It fixes a price for the job and sets a deadline for completing the project. Your contract protects both you and your client. It gives you confidence that you’ll get paid on time, and it reassures your client that you’ll do the work on time.
There are 4 different types of contracts in the construction industry. It’s important to choose the right contract, and make sure that it’s written correctly.
How to Choose Between Different Types of Construction Contracts
Before you choose a contract for construction work, consider these issues:
- How detailed is the project scope? Does your client already know exactly what they want done? Are the final stages still vague and undecided? Some contracts are better suited to an uncertain project scope.
- How much risk are you willing to take? Some types of contracts in the construction industry bring more risk that you’ll lose money if costs of materials go up or the project doesn’t complete on time.
- What is the size of the project? Some construction projects go on for months or even years, while others only take a few days or week. Different construction contracts are best for different project sizes.
- Do you expect the project to complete on time? Some types of contracts in the construction industry include penalties if you don’t finish on time. If you can already see obstacles that might delay your work, you should those contracts.
The 4 Forms of Contracts in the Construction Industry
1. Fixed Price Contracts
Fixed-price contracts - also called lump sum contracts - are the simplest type of construction contract. With a fixed-price contract, you’ll bid your total price for doing the work. It’s up to you to examine the project description and drawings, calculate your costs, and come up with a final price.
If you use a fixed-price contract, there’s isn’t much flexibility for the client to change their mind about the work. A fixed-price contract has incentives for an early finish and penalties for late completion.
- Incentives for early finish mean that you can earn more if you work ahead of schedule
- Simple contract that makes it clear what work you have to do
- If you don’t get your calculations right, you could end up losing money
- You’ll have to pay penalties if you don’t complete the work on time
2. Cost Plus Construction Contract
If you’re wondering “What is a cost plus contract?” we can explain. With this contract, the client agrees to pay the costs of labor and materials, plus an extra fee which is your profit. Your fee could be set as a fixed amount, or as a percentage of the final costs.
A cost plus construction contract makes it a lot easier for the client to make changes to the work. It’s a good choice if you need to get started, but your client hasn’t made up their mind yet about all the final details.
- You can get started without waiting for the final details
- You won’t lose out if the project costs spiral out of control
- Your client could keep on changing their mind
- There’s no fixed end date, so the project might take a lot longer than you expect
3. Time and Material Contracts
With a time and materials contract, the client agrees to pay your hourly or daily rate until the work is done. They also pay for your materials and other direct expenses. It allows the client to change the scope and details of the project as you go along.
Very often, the client will want to put some kind of a cap on the project, so that they don’t end up paying for a project that keeps getting longer. They might ask for a fixed maximum price, or for a final project deadline. It’s a good residential construction contract, because it’s best for small jobs.
- You don’t need to know the total cost of materials before you start
- If the client asks for a fixed maximum price, you’ll need to calculate the possible length of the project very carefully
4. Unit Price Contracts
Federal agencies, large construction contractors, and big corporations usually use this type of construction contract. For a unit price contract, the total work is broken down into separate units, and you’ll make a bid for each unit. Your unit bid is your total price for doing the work for that unit. It includes your expenses for labor and materials, your fee, and any other costs.
Unit price contracts are best for huge projects that have many different stages or elements. They allow the client to add extra units whenever they want.
- You don’t have to wait for the client to decide on every detail before you get started
- There are no incentives for early finish
What Else to Keep in Mind When Signing a Construction Contract
As well as choosing the right types of construction contract, you also need to consider a few other issues:
- Make sure that your general liability insurance is up to date before you apply. Look for a customized contractors insurance that understands your business.
- Do your best to think about any problems that could come up, and then write them in to the contract.
- Include the payment method in your contract, so that you don’t end up waiting ages for a check to cash.
- What will happen in case of disputes? Even if it’s a short, small project, include some agreement about who will mediate if you and the client can’t agree.
Now you’re ready to pick the right type of construction contract. Read it carefully before you sign it and get started on your new construction project.