Opinion article for Observador | Debt and Liquidity in Construction: What’s the Risk?

In this insightful article published in Observador, Bruno Matos, an alumnus of The Lisbon MBA Executive 2014-2016 class, discusses the risks posed by debt and liquidity challenges in the construction sector.
The construction sector, contributing to over 15% of the GDP and 10% of employment, is undoubtedly one of the main drivers of the Portuguese economy. However, more than 99% of the business fabric consists of micro, small, and medium-sized enterprises, making it a highly fragmented and volatile industry, and thus relatively susceptible to economic fluctuations. As the economy contracts and credit constraints impact investments, a new crisis tends to emerge. This gains particular importance in a scenario of rising construction costs and intense price-centered competition, reducing the profitability of companies, especially in the face of high indebtedness and lack of liquidity in the sector.
Regarding indebtedness, most construction companies are funded with approximately 70% from third-party capital, reaching as high as nearly 90% in some cases, which is genuinely concerning. While debt can be positive due to increased tax benefits and greater profit generation efficiency (higher return on equity for shareholders), it can also become harmful if investments are not productive enough to meet debt servicing, leading to liquidity problems (e.g., inability to meet short-term financial obligations) or if the debt is high and extended over time, increasing vulnerability to market fluctuations (e.g., rising interest rates).
In this context, it is important to highlight Law No. 41/2015 (legal framework applicable to the construction industry), which sets minimum economic and financial requirements for companies holding a construction license (permission for construction activities based on the category/type and class/maximum value of works). This is particularly relevant for those with organized accounting and with qualifying titles exceeding class 2 (a threshold of €400,000, according to Decree No. 212/2022). As an example, the law emphasizes general liquidity indicators (capacity to meet short-term responsibilities) and financial autonomy indicators (capacity to meet financial commitments using own capital – as opposed to debt). Reference values for these indicators are set in Decree No. 274/2011. However, these values can be difficult to achieve due to common causes such as cost overruns and delays in receivables.
Having said that, senior executives of companies should ensure diligent and careful management; otherwise, they can be held directly responsible, both civilly and criminally. Notably, personal assets of managers may be used to cover company debts, and in extreme cases, insolvency (inability to meet overdue obligations) can result in up to 5 years of imprisonment. The duty to indemnify for damages caused by unlawful conduct (civil liability), that is, in violation of legal or contractual obligations (e.g., indebtedness and harm through the conclusion of ruinous transactions for personal gain), can encompass not only the company but also its shareholders and third parties.
The general duties of managers, directors, or officers can be found in the Commercial Companies Code (CSC), which, since 2006 (by Decree-Law 76-A/2006), also provides for the figure of civil liability insurance for these entities (internationally known as “Directors and Officers Insurance”), as an instrument to cover the necessary legal requirements (e.g., guarantees, legal expenses, compensations, etc.). More recently, through Law No. 94/2021, the CSC has been reinforced within the framework of the approval of a set of measures outlined in the National Anti-Corruption Strategy.
Leadership thus plays a crucial role in the health and success of organizations, requiring, in addition to the expected mobilization of people around a common vision (“soft skills”), appropriate technical skills (“hard skills”) that encompass the financial aspect, but above all, conduct guided by ethical principles. Short-term benefits are easily outweighed by medium and long-term consequences that can result in, in addition to reputation deterioration and its impact on the business and stakeholders, suspension or revocation of professional licenses, fines or penalties, and, in extreme cases, criminal proceedings.
In this insightful article published in Observador, Bruno Matos, an alumnus of The Lisbon MBA Executive 2014-2016 class, discusses the risks posed by debt and liquidity challenges in the construction sector.
The construction sector, contributing to over 15% of the GDP and 10% of employment, is undoubtedly one of the main drivers of the Portuguese economy. However, more than 99% of the business fabric consists of micro, small, and medium-sized enterprises, making it a highly fragmented and volatile industry, and thus relatively susceptible to economic fluctuations. As the economy contracts and credit constraints impact investments, a new crisis tends to emerge. This gains particular importance in a scenario of rising construction costs and intense price-centered competition, reducing the profitability of companies, especially in the face of high indebtedness and lack of liquidity in the sector.
Regarding indebtedness, most construction companies are funded with approximately 70% from third-party capital, reaching as high as nearly 90% in some cases, which is genuinely concerning. While debt can be positive due to increased tax benefits and greater profit generation efficiency (higher return on equity for shareholders), it can also become harmful if investments are not productive enough to meet debt servicing, leading to liquidity problems (e.g., inability to meet short-term financial obligations) or if the debt is high and extended over time, increasing vulnerability to market fluctuations (e.g., rising interest rates).
In this context, it is important to highlight Law No. 41/2015 (legal framework applicable to the construction industry), which sets minimum economic and financial requirements for companies holding a construction license (permission for construction activities based on the category/type and class/maximum value of works). This is particularly relevant for those with organized accounting and with qualifying titles exceeding class 2 (a threshold of €400,000, according to Decree No. 212/2022). As an example, the law emphasizes general liquidity indicators (capacity to meet short-term responsibilities) and financial autonomy indicators (capacity to meet financial commitments using own capital – as opposed to debt). Reference values for these indicators are set in Decree No. 274/2011. However, these values can be difficult to achieve due to common causes such as cost overruns and delays in receivables.
Having said that, senior executives of companies should ensure diligent and careful management; otherwise, they can be held directly responsible, both civilly and criminally. Notably, personal assets of managers may be used to cover company debts, and in extreme cases, insolvency (inability to meet overdue obligations) can result in up to 5 years of imprisonment. The duty to indemnify for damages caused by unlawful conduct (civil liability), that is, in violation of legal or contractual obligations (e.g., indebtedness and harm through the conclusion of ruinous transactions for personal gain), can encompass not only the company but also its shareholders and third parties.
The general duties of managers, directors, or officers can be found in the Commercial Companies Code (CSC), which, since 2006 (by Decree-Law 76-A/2006), also provides for the figure of civil liability insurance for these entities (internationally known as “Directors and Officers Insurance”), as an instrument to cover the necessary legal requirements (e.g., guarantees, legal expenses, compensations, etc.). More recently, through Law No. 94/2021, the CSC has been reinforced within the framework of the approval of a set of measures outlined in the National Anti-Corruption Strategy.
Leadership thus plays a crucial role in the health and success of organizations, requiring, in addition to the expected mobilization of people around a common vision (“soft skills”), appropriate technical skills (“hard skills”) that encompass the financial aspect, but above all, conduct guided by ethical principles. Short-term benefits are easily outweighed by medium and long-term consequences that can result in, in addition to reputation deterioration and its impact on the business and stakeholders, suspension or revocation of professional licenses, fines or penalties, and, in extreme cases, criminal proceedings.
Read the full article (original) in Portuguese here.
Source: Observador