Paying for Work - The Draw System:
What is it and why is it used?

The Risks - Back and Forth

The draw system is a method of paying a contractor for materials and labor in a fashion that limits risks to both the contractor and the customer. The draw system works by trading limited risk back and forth between the two parties.

For example, the first draw or payment is often paid to the contractor in order to allow for the purchase of materials to start the job. At this point, the customer is assuming the risk. The contractor might not show up again. This can actually happen for reasons that have nothing to do with dishonesty. For example, the contractor could have an accident and be in the hospital. Does the draw system work in this case? Yes. The customer, by paying only the money needed for the materials (or a part of the materials for a larger job), has lost some but not all of the money for the project. The draw system is not meant to eliminate risk, merely control and limit it.

Next, the draw system calls for a payment to the contractor after completing a specified amount of work towards completion. How much money and how much work depend on both how big a job the whole project is and how big a crew the contractor has. During the days leading up to this draw, the contractor is assuming more and more risk as more work is completed. The contractor is paying or owing wages, gas, consumables like nails, etc. Thus, the contractor now is as worried as the customer was when making the first payment. Now, the customer could prove dishonest or simply be unable to pay due to accident, etc. Thus, the contractor could lose all the money spent on the job.

Payments - How That Works

Normally the contractor needs an initial payment before starting work to cover initial expenses. These include materials needed to start the job. There may be only one draw for materials or there may be several stages (thus several draws) when materials are bought. Other up front expenses are: wages that have to be paid daily (for example, day laborers are usually hired to do part of demolition and cleanup), other immediate expenses such as fees at the landfill, tool rentals, fuel expenses if the job site is far away or requires fuel for equipment, etc.

Next, the work continues until some set point is reached. It may simply be a Friday or it may be a certain percentage or stage of the job. These points are usually spelled out in the contract, but may be more informal on some types of projects where it is not really necessary for such detail or where the project is unpredictable in the details. At this point, the contractor is paid either the pre-set amount in the contract or a reasonable sum is negotiated.

This step repeats, adding more material draws if needed (the full amount for materials is often avoided at first because there is often a lack of room for all the materials and/or to avoid theft of or damage to the materials) until the job is finished. The contractor is then paid in full with the last draw. Often multiple draws are paid at once. For example, a labor draw and a materials draw would often be paid together because the contractor has completed all the work required for his labor draw and therefore needs a materials draw to pay for the materials needed to start the next stage. Another common double draw occurs when the contractor finishes the labor for two different labor draws in one week. This can easily happen because one stage was finished late or early, or because one stage can be completed quicker than other stages.

One difference for the draw system between an individual and a company versus between two companies in large scale multi-unit new construction (like a home builder and a subcontractor) is that the hiring company usually withholds a sum of money from the other to pay for future corrections (called punch out work,) even though the work is theoretically fully completed. Once the work passes a final inspection (usually long after leaving for good) the money is released. The main reason for this practice is the sad fact that dishonest subcontractors are abundant in that type of construction. The hiring companies expect this behavior and often unintentionally encourage dishonesty by not paying when promised and by encouraging subcontractors to ignore quality and concentrate on speed alone. Trust begets trust and lies beget lies. Cheating on quality by the builder and not paying promptly encourages the subcontractor to think in terms of cheating, not in honest work. Funds are seldom retained when an individual hires a company because there is no ongoing relationship after the project. Once the project is completed, the contractor would often find it very difficult to collect later, for many reasons. Some of the most difficult customers to deal with are people who are accustomed to this builder-subcontractor system from their own work experience in new construction as or with subcontractors or employees. Despite many similarities, the exact practices of this type of construction do not adapt well to small jobs or remodeling. The exception to this rule is when a contractor must return at a later date to do something that cannot be done at that time. Then, the cost of that work will be retained for later payment. Sometimes a contractor will leave behind extra money when the work is a small job in order to make it "worth their while" to come back. Be aware of this possibility so that it will not be a surprise if the contractor asks for a portion of this extra money if you later cancel the delayed work. It may be $45 worth of work but the contractor might leave $175 in order to feel motivated to finish your project later when busy in a new project elsewhere. This would not be done under most circumstances. Normally, a later item will be a separate job and contract, but be sure to understand how the costs for later included work are being billed in a single contract to avoid surprises.

Sometimes, to take advantage of unexpected circumstances which may save money and/or time, materials have been bought and used sooner than planned. If those materials were supposed to be paid for using a future materials draw, then the contractor has even more concern that the next draw be paid to him on time and in full, and may justifiably ask for an early additional draw to pay for those purchases. The customer should always verify that this is the truth when a contractor asks for unexpected draws, but should pay these draws if legitimate. Situations like this may or may not be covered in the contract.

The Good and The Bad

The draw system helps protect both sides but if one side fails to come through, the other side will lose. The draw system helps to minimize loss, not totally prevent it. Despite common belief otherwise, crooked customers are as common as crooked contractors. The draw system requires a bit of flexibility for it to function well. As with all aspects of business, things will only work if both sides desire to see things turn out well, in other words: trust. That trust must be limited and cautious. The draw system is the part that limits trust to an appropriate level. When trust fails completely for whatever reason (here I do not mean an actual problem other than distrust), the draw system also fails to meet the goal of all work done correctly and paid for completely.

If the customer is unwilling to make a needed payment, the contractor may not be able to complete the project. Construction burns through money like gasoline and sometimes the customer feels scared paying so much money out so fast. Construction involves larger than "normal everyday" sums and high stress just from the noise and dust and other inconveniences. Failure to make a payment, that should be paid, earns immediate distrust from the contractor who might walk off in order to avoid losing any more money from a crooked customer (even if it is just a misunderstanding.) Now, the customer will need to find a different contractor to finish who will charge much higher than normal prices because of doubts about the customer (why did the other contractor really leave? Was he crooked or not paid?)

If the customer is too trusting and pays too fast, the contractor may not watch the money being spent closely enough. This can happen easily when many projects are in progress and the contractor does not spend enough time in the office keeping track of for whom and what the money being spent on. The best contractor is the one that does not show up every day to work 16-hour days. That one is not keeping track of things unless you are the only customer at the moment. Customers often complain loudly when the contractor misses a day during the week but the accounting that has to be done cannot be done after working a long day in the field. Thus, it is very easy for a hard working, honest contractor to really make a mess of things financially by working too much on your project in the field. Make sure you encourage your contractor to take the time to keep up with the details. It is better to hold up your project a day every week or two than for it to fail completely.

One common situation occurs that badly strains the draw system. A good contractor almost always has several different jobs in progress at any one time. It can be a bad sign if a contractor does not have any other work. But, the draw system limits payments to the contractor until certain amounts of work are completed. When multiple jobs are ongoing, sometimes the contractor simply cannot get any single job to a draw point even though all the projects are progressing nicely. Unfortunately, if a week has passed, a week's wages are now due to the employees. Other expenses have also been paid like gas, bills for the business, etc. This is a very difficult spot for both the customer and the contractor. The contractor must raise a certain amount of money from the customers in order to continue working. But how will that be done? Ask one customer for more than is appropriate for that particular job at that time? What if another customer proves dishonest and never pays, how will that lost money be made up for? Will it affect the customer that helped out? Or should the contractor try to get a little from each? What if one refuses - go back and ask for more from the others, looking very foolish? What if all say no, that the contractor must reach correct draw stage? Stop work on all jobs but one? Remember that we are talking about a set of jobs that may be progressing nicely. A really bad situation has developed because of the draw system despite everything being basically satisfactory. I do not think there is a very good answer to this type of situation. Some believe that a contractor should have enough money in the bank to cover every possible situation, but very few people in any job make enough money to do that or we would not have so many middle-class people using credit cards instead of paying cash. A contractor also has bills to pay and wants to spend money just like anyone else. A contractor with many jobs nearing a draw has a lot of risk when you add up all the bad things that can happen if every customer could and/or would not pay at the same time.

Of course the draw system has one advantage. By requiring a certain amount of work to be finished in order to get paid, it helps to set goals for and motivate both the contractor and the contractor's employees. It also give a sense of progress as each stage is completed to the customer who is suffering through what may be a long construction process which is never fun if living or working at the site.

Alternatives to the Draw System

Several other ways of making payments also exist.

"Time and Materials" is a common method. The customer is billed at regular intervals for whatever costs have been encountered by the contractor during that time period for materials and labor (plus a percentage for the contractor's profit.) This can be good method for the contractor. Unlike a fixed price, which can result in a loss for the contractor, as long as everyone is honest, there is no chance of working for free or at a loss. But, the contractor must record everything in much greater detail in order to avoid disputes about actual labor and materials costs. The risks are greater for the customer in that the job may cost more than expected (or possibly less too.) This method is especially well suited for projects that simply cannot be accurately estimated beforehand. A fixed price will guarantee either a really high price or a failure to finish the job if the price is low on these sorts of projects. So, for some projects, this method can protect the customer but can also be unexpectedly expensive (in the sense of simply costing more than everyone guessed).

"Pay in Full" before or after the work is done is also common. This is really high risk but that may not matter if the dollar amount is small compared to the inconvenience of multiple payments. This method can also be essential if the customer will be unreachable during the project. While not common, this does occasionally happen, usually because the customer is out of town traveling or living elsewhere. This can be a great method of paying for small jobs because a contractor's time is valuable and making a 40 mile trip to get paid at 8PM when the customer gets home could double the price of a small job. In other words, even if the contractor did take the money and run, you would still be have enough to pay someone else if you also paid them in advance at half the price of paying later (half price lost + half price paid = full price); sounds crazy but that's how small jobs sometimes are. For larger jobs this is probably only a good idea when the contractor and customer have already done previous business together but is still a gamble for whoever is on the risky end of things.