Mike Draper, Renovantage, on calculating the correct deposit amount
Mike Draper, our resident contractor coach, tells you how to figure out a reasonable and fair deposit when you win a new project
May 13, 2015 by Steve Payne
Too little a deposit and you put yourself at grave risk of losing your shirt if the customer wants out after you’ve done significant upfront work – and ordered expensive custom product, of course. Too much of a deposit, and you put your own customer at risk – and look really bad in the process. So how do you figure out what kind of a deposit to ask for? We asked our resident contractor coach, MIKE DRAPER (www.renovantage.com) to weigh in on the recent discussions in our pages about appropriate – and inappropriate – deposits. Here’s what Mike had to say on the issue.
Mike, there have been a lot of discussions on our online forum (canadiancontractor.ca) about deposits – what the right size deposit from a homeowner should be, for what type of work. Mike Holmes kicked all this discussion off, earlier this year, when he said in his nationally-syndicated newspaper column that “No good contractor needs more than 10 per cent to start a job.” Most of the contractors we heard from, disagreed. At Renovantage, what do you counsel your members about deposits?
Deposits are a frequent topic of conversation among contractors. That’s because there is no one formula for every single project – every project is obviously different. But there is a rule of thumb you can apply. The rule is that the contractor should be renovating with the homeowner’s money, not their own money. And if you use that principle for all of the money that a homeowner will provide to a contractor, the contractor should stay ahead of the homeowner on money collected based on the production that he’s got to do.
Now, if there aren’t a lot of costs associated with the beginning part of a project, the deposit can be lower. But if at the beginning of a project, the contractor has to order, say, $30,000 worth of cabinetry and there is a 50 per cent deposit required by the cabinet manufacturer, then the contractor needs a deposit of at least $15,000 so he’s not paying for that order with his own money.
Apart from the notion of cash flow management which you describe, can the deposit also be a test of good faith – and also the likely creditworthiness of the customer?
Definitely – and there is another consideration, too. If the project is a big one – say over $100,000 – the deposit should serve to hold that particular construction spot. The deposit based on that alone for a job of this scale could be about $5,000 – assuming the contractor does not have a whole lot of upfront costs associated with the project. And then on the first day of the project commencement – and possibly a week or two earlier – the homeowner should provide a larger deposit that is a reflection of the actual upfront costs that the contractor is going to incur almost immediately, as we just discussed.
At Renovantage, you’ve talked before about your mediation service that you are prepared to enact if there is a major dispute between the contractor and the homeowner. Have you ever had to do this mediation with respect to a dispute about deposits?
No, we’ve never had a deposit become a mediation issue, nor have we ever had a homeowner call us and say that one of our contractors has asked for too much of a deposit.
What about a situation where the deposit has been collected, then the homeowner wants to cancel the project at the last minute, right before work has started?
The way we would negotiate that, if it were required, would be to recognize that the moment that a homeowner gives the contractor the go-ahead to do a project, the contractor starts to incur costs. These costs will include planning and design, pre-ordering, lining up time with trades, preconstruction binders, regulatory paperwork including permits, etc. So if a homeowner cancels a deal after some of this work has been done, the homeowner needs to be held accountable for those expenses – which are real.
Would it be helpful for contractors to have some sort of template for deposit amounts based on the broad general categories of work they typically do?
Again, this is difficult. Because even though two projects may be somewhat similar, in the renovation business we all understand that no two projects are really alike. On a $50,000 kitchen renovation, you’ve got the upfront demolition and disposal of the old kitchen and the ordering of the cabinetry. That upfront cost could be 50 per cent of the value of the project so the contractor needs to make sure they aren’t fronting their own money for that. So, yes, that particular deposit will be quite large. But if the contractor wins a job in the spring that won’t actually occur until the fall, say six months later, there’s no reason why the contractor should be holding a large deposit that early.
So in that case we are talking about a nominal sum of money, as you described, to hold the construction spot?
Yes, that’s reasonable. But again, when the project actually starts, the contractor should require another, larger upfront payment for the immediate costs. The principle is always the same: The contractor should not be paying for the project outlays out of their own bank account or credit. And this principle applies right from the beginning of a job, right through the stage payments, until the final payment is received.
Earlier this year, we had the well-publicized news story, in Toronto, of GarCon Construction. Some of the multiple homeowners in that case, who had paid up to $40,000 – it was reported – for major renovation work, saw GarCon lay down its tools midway through the demolition phase, and then declare bankruptcy. They had received only a small fraction of the actual labour value that $40,000 would represent, and no materials obviously – all that had been done was that demolition had occurred. And in one case, the demolition work had opened up holes that hadn’t even been tarped. A nightmare for these customers. What lessons can be learned – though I guess they are obvious – about how careful homeowners have to be about giving deposits to contractors? In this case Mike Holmes – with his broad brush comment about 10 per cent deposits being the maximum – was certainly correct.
Well, this brings up an important point. I’ve been talking about protection for contractors. But we’ve got to protect the homeowner, too. And this is where the balancing effect is important. Deposits are supposed to protect both sides. Clearly in this case, the homeowners were totally exposed by what were reported to be inappropriate deposits. Just as the contractor can’t be paying for work they haven’t been paid for, out of their own funds, the homeowner can’t be laying out that sort of money for simple demolition work. All of the fairness principles that I’ve been talking about, with respect to the contractor, need to be reciprocated to our customers. They are the ones footing the bill. Which is why blanket statements about appropriate deposits are not to be trusted. Each case needs to be evaluated on its own merits.
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