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Growing a business requires planning for the future. Don’t pass up a project just because it requires a surety bond. Obtaining one can prove worthwhile.
Know your Business series, Part V
“The recovery is starting, and there are a lot of opportunities,” said David Cayemitte, CEO of the Minority Business Development Institute (MBDI), a nonprofit in Bordentown, New Jersey, devoted to helping contractors obtain surety bonding. “Contractors can be part of the recovery and should start the bonding process early, so they can get a bond program and share in the opportunities.”
Not only does bonding open up the type of projects a firm can bid on, it can improve operations by forcing principals to focus on finances and not take unnecessary risks or more work than is doable.
“Bonding brings additional advisers around you to help you run the business better,” adds Cayemitte, who recommends contractors establish a surety-bonding program that allows them to take jobs appropriate to their capacity.
Open communication with the surety company helps foster a strong relationship. The surety company seeks to become a trusted advisor, says John Coyne, vice president of Bond and Financial Products at Travelers Construction Services based in Hartford, Connecticut.
“The bonding company brings good insight and experience,” Coyne reports. “Contractors should use the agent and bond company liberally as a sounding board.”
Bonding also may boost a firm’s reputation, making it easier to snag jobs.
“The ability to establish a bonding line says something about the company’s character, capacity and capital,” says insurance broker Jim Marquet of Graham Company in Philadelphia. “In some ways, it’s a seal of approval for an emerging contractor. It can actually help you develop new business and be an indicator to general contractors or owners that you are a well-run business, managed prudently and will fulfill the job obligations.”
When you need a bond
Most projects involving public tax dollars, including school, municipal, state and federal work, require the contractor secure bonding. But many private owners also demand bonds, as well as prime contractors of their subcontractors.
A surety bond assures the project owner that the contractor will perform as stated in the contract documents, prevents a loss and prequalifies the contractor based on financial strength and experience completing similar work.
It’s not a difficult process, but you have to have your financial house in order.
Three types of bonds exist and work together: bid, performance and payment. The bid bond confirms that the bid was submitted in good faith; the performance bond that the contractor will fulfill the work as specified and if the contractor defaults, the surety company will be obligated to finish the work; and the payment bond that the contractor will pay the subcontractors and the suppliers.
“What you need depends on what type of work,” says Eric Goodman, senior manager with accounting firm Barnes Denning in Cincinnati. “It doesn’t take all three for every contract.”
Carl Dohn, account executive at Dohn & Maher Associates in Palatine, Illinois, says the owner typically will require a bid bond that ensures the contractor will enter into a contract if it is the lowest bidder.
“If you qualify for a bid bond, the underwriter is expecting to write the performance and payment bond if you are the lone successful bidder,” Dohn says. “They do not write bid bonds unless they are prepared to write the final bonds.”
Surety companies typically sell bonds through agents or brokers, called surety bond producers, who will select a suitable a surety company. A good suggestion would be to contact the National Association of Surety Bond Producers to find a bond producer near you.
Coyne adds that the independent agent can coach the contractor through the application and how to make a good impression.
A surety firm experienced with construction eases the process, suggests Marquet. The bond producer will submit the prequalification application to a number of bonding companies.
Going after your first bond
“It’s not a difficult process, but you have to have your financial house in order,” says Tony Stagliano, national managing director of A/E/C Industry Services at the accounting provider CBIZ MHM in Philadelphia.
On the other hand, Mark Johnson, a partner in the Environmental and Land Use Group of the law firm Alston & Bird in Los Angeles, reports bonds are harder to obtain in today’s market, particularly for a smaller company with financial struggles during the recession.
“If you have cash flow problems, you will have trouble finding a bond,” Johnson says. “That will take you out of the public market and larger private projects.”
The process begins with a prequalification application. Underwriting is a rigorous and thorough process. MBDI helps contractors prepare. Cayemitte suggests starting before having a specific job in mind, so as to avoid scrambling during a bid preparation.
“It’s a great advantage to go through the process and be ready,” Cayemitte says.
The contractor should be prepared to produce an organizational chart; resumes of key employees; contingency plans; a business plan; a schedule of current jobs; a list of largest jobs completed to date; evidence of a line of credit with a bank; tax returns; three years of financial statements with a third party compilation, review or audit; and letters of recommendation and references.
The underwriter will likely call your banker, attorney, suppliers and others familiar with your firm for references, Marquet reports. Therefore, you should inform those people of the pending bond-line application.
Dohn adds that you must be able to show experience performing the type of work outlined in the contract, as well as having enough equipment and manpower to complete the job. Additionally, for a new contractor, the surety company will look at how much money the principal is investing in the company. A company with more labor will need more capital on hand to prove it can meet payroll, Dohn says.
To judge capacity, the underwriter assesses past performance.
“If it’s a new type of work or an unfamiliar owner, the underwriter will be skeptical and ask a lot of questions,” Marquet adds.
Goodman indicates when seeking a bond for a larger contract, the contractor should supply audited financial statements. They are more detailed and contain more information.
“Surety companies like to see CPA-prepared financial statements instead of in-house financial statements,” Goodman says. “They are looking for stability, financial performance and metrics on bond capacity of current assets vs. liability. A normal calculation for bonding capacity is 10 times that working capital amount.”
Capacity may be lower depending on costs associated with other contracts. Having more cash on hand will increase working capital and help the bonding process.
“They are trying to figure out how much liability you can handle in a given time period,” Johnson says.
Financial statements prepared by an accountant experienced with construction accounting standards often makes it easier for the underwriter, adds Marquet.
If all the paperwork checks out, a representative from the surety company will visit the contractor, assess the organization and status of the equipment fleet, and meet project managers and other personnel.
“It’s more than a financial analysis,” Coyne says. “A lot of pieces go into deciding whether the contractor is capable of doing the work the company wants to bond.”
Timing and pricing for bonding
Timing depends on how well the contractor has prepared the documentation and can prove a good track record performing similar or larger jobs.
“It depends on the scope of what you normally do and what you are asking for,” Dohn says. “If you have the right information, the underwriting is straight forward.”
You should plan on a month or more of prequalification preparation, with more time needed to obtain financial statements. The bond must be in place before bidding on the work.
The U.S. Small Business Administration (SBA) offers a bonding program for smaller contractors. The underwriting process is similar, but the SBA guarantees a portion of the bond, Marquet says. The surety company may seek that guarantee.
“The surety companies are betting the contractor has the financial wherewithal to perform,” Johnson says. As added insurance, the surety company often includes an indemnity clause, saying that the contractor will pay it back if the surety has to complete any work. Also, the surety company usually asks for a personal guarantee from the principals of the firm.
Defaults happen all the time, Johnson reports, particularly during the last downturn. Owners can only declare contractors in default if they have fulfilled all of their contract obligations, including paying on time, Johnson adds. The surety company will conduct an independent analysis of the situation, and that can serve as protection for the contractor if the owner hasn’t been acting in good faith.
Performance and payment bond premiums range from 1 percent to 2.5 percent of the amount of the contract being bonded. The fee is based on financial performance and company stability.
Once a contractor is established with a surety company, the process of bonding new work goes much faster. However, even on new accounts, Dohn says he has approved bonds within 24 hours. Timing depends on the quality of the information provided by the contractor.
As Coyne says. “It’s a long-term process.”
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9 Steps to Getting Bonded
It’s not a difficult process, but you have to have your financial house in order.
1. Start the process well in advance. Depending on the circumstances, it can take one to several months to successfully obtain a bond, and it must be in place before you bid on a project that requires bonding.
2. Get bonding agent recommendations from other contractors. Another source is the National Association of Surety Bond Producers,hasbp.org. An independent agent works with a number of surety companies.
3. Listen to the bonding agent. A good agent will help coach you through the process, helping you make a good impression.
4. Get your financial house in order. If you have cash flow problems, you’ll likely have more trouble finding a bond. If you’re starting a new company, the surety will look at how much money you’re personally investing in the company.
5. Know what areas will be scrutinized. What experience do you have? How much equipment? Labor?
6. Organize. Several things will be required: an organizational chart, resumes of key employees, contingency plans, a business plan, a schedule of current jobs, a list of the largest jobs you’ve completed to date, evidence of a line of credit with a bank, tax returns, three years of third-party CPA-prepared financial statements, and letters or recommendation and references.
7. Expect an on-site visit. The surety company will want a first-hand assessment of your organization, your equipment fleet and your personnel.
8. Give a heads-up to your references. Let them know ahead of time that they may be contacted by a bonding firm as part of this process.
9. Expect progress reports. Securing the bond is a first step; the surety will often ask for updates to your financial picture.
theconstructionuniversity.com to learn more about how to keep your business healthy. While you’re there, check out tips, infographics and previous articles, including last month’s article on Marketing.
For further information:
National Association of Surety Bond Producers
Surety and Fidelity Association of America
Minority Business Development Institute
Dohn & Maher Associates
The Graham Co.
Alston & Bird
Surety Information Office
U.S. Small Business