Bonding is not insurance. It is a form of credit and is underwritten much like a loan. Like a loan, any monetary loss is expected to be repaid, therefore it should not be entered into lightly by the contractor or individual. Bonds are assumed and underwritten with the intention that there will be zero losses, same as a loan is written with the anticipation there will be zero losses.
An Indemnity Agreement is your company’s and your personal guarantee to reimburse the bonding company in the event of a loss, for any money they pay out on your behalf. All company owners and spouses must sign in order to qualify.
Roles in a Bond Transaction
Provide timely, accurate information to the agent and underwriter, and keep them informed of any change in the company’s condition — good or bad. Communicate future projects and plans with enough lead time for the agent to react.
You also need to know how your jobs are performing on an ongoing basis. Jobs go bad for many reasons — estimating mistakes, escalating material costs, supervision, subcontractors. Finding out at the end of a project is too late. With good job costing in place, problems surface early and can be reversed or minimized.
The agent’s first job is to represent the client and present them in the most favorable light to the bonding company. First impressions matter — the better the application is prepared, the more likely the contractor gets what they need.
The agent also educates the contractor on the capacity they can expect based on the information presented, and acts as liaison between contractor and bonding company to keep projects transparent.
The bonding company provides the line of credit and the guarantee the client needs to complete work.
The underwriter is employed by the bonding company to analyze the information submitted and determine the bondability of the client. The underwriter’s first duty is to protect the interest of their employer.
In response to the need for a more streamlined way for small contractors to access bonding, some companies have developed programs that can offer limits up to $3 million based only on credit score and prior job history. Although limited, these programs are a good way for small contractors to begin building a bonding relationship.
Four things every underwriter weighs before extending a bond line.
Do you have enough capital — cash flow — to support the level of work, bonded or unbonded, you want to do? Lack of capital can sink your operation even with profitable work under contract. What happens if an owner is slow to pay, or if there is a dispute and draws are withheld? Can you survive? Do you have a bank line of credit in place?
Do you have the people, equipment, procedures and management in place to perform the work? The last thing we want to do is give you the ability to get in over your head.
Like a loan, the first consideration for bonding is the credit history of the company and, more importantly, the individual(s). Prior to applying for bond credit, check your credit report to ensure the history is accurate. A poor credit history can result in denial of the application, or in arduous terms set forth by the surety company — collateral, high rates, and the like.
The character of the individuals involved is key to the extension of a bond line. Character is judged mostly by past performance and somewhat by the gut feeling of the agent and underwriter. It tells us what level of cooperation to expect from the principal and what we might anticipate in the event of a problem. The relationship between principal, agent and underwriter should be a team effort, with everyone looking out for each other’s interest.
It is important to have some form of accounting capability in-house so the contractor can track the profitability of each job (Work in Progress) and the company overall. If you don’t know you have a problem, how can you fix it? There are several accounting programs for small contractors available at reasonable cost. A well-prepared in-house statement can be used for bonding, but only for a limited time as a stop-gap measure. If you anticipate using bonding on a regular basis, you will eventually be required to seek the services of a qualified construction CPA.
There are many good CPAs that can provide financial reporting for most businesses, but only a certain number are construction specialists. While most any CPA can do a great job for a retail shop or a manufacturer, only a CPA who specializes in construction — and knows the information the bonding company needs — can truly do a good job for a contractor seeking to establish or grow bonding capacity.
Three Levels of CPA-Prepared Statements
Level 1
per project, typically
Your information formatted by the CPA and checked for mathematical accuracy. It can contain footnotes and job schedules. Because less work is involved, it is the least costly of the three. A contractor who plans to be an active bond account will eventually outgrow the compilation statement.
Level 2 — Most Widely Used
annual revenue supported
A reviewed statement requires the CPA to go much further in analyzing the contractor’s financial condition, making it far more reliable for underwriting. A review should always include footnotes and job schedules. In most cases it can support the bonding needs of contractors with annual revenues up to $50,000,000 — which is why it is the most widely used.
Level 3
required for some 8(a) firms
The audited statement is the most detailed financial report and the most reliable. It is usually reserved for larger contractors. In the case of 8(a) certified contractors, however, the SBA requires that those with annual revenue over $5,000,000 provide an audited statement.
Not sure where your company stands? Ask DEWCO for an objective analysis of your bond line.