Do You Really Value Your Surety?

With fewer construction companies competing for work in a still healthy construction market, opportunities to expand market share are within reach for some.

The problem for many contractors, however, is they cannot take on larger projects unless they increase their bonding capacity. Unfortunately, as a result of losses in recent years, sureties have gone back to the basics in bond underwriting: A contractor has to earn the bond line, and earn it every year.

The importance a surety plays in the life of a construction company cannot be overstated. In effect, a surety provides an unsecured line of credit—unlike banks that require collateral. Contractors know they share a sacred relationship with their surety and should do everything they can to nurture the relationship. They also realize that a long-time relationship with a surety doesn’t guarantee the relationship will continue indefinitely.

Yet, a handful of other contractors take their surety for granted. They are the ones who haven’t yet experienced the pain of losing a surety partner and building a relationship all over again—if another surety partner can be found.

To solidify and/or improve relations with sureties, contractors need to treat their surety like a business partner. Information needs to be shared often, and no financial aspects should be withheld. In terms of specific information, the Surety Information Office (SIO) in Washington, D.C., says trust is strengthened when contractors regularly provide information such as:

• Proof of consistent profitability and a history of successful projects
• Work experience and descriptions of past, ongoing and future work
• Financial statements prepared by a CPA specializing in construction
• Comprehensive business plans, forecasts and short- and long-term strategies
• Continuity plans in the event of the death or loss of a key executive
• References from subcontractors, suppliers, business associates and advisers
• Successful banking relationships
• Ownership descriptions
• Disclosures of joint ventures and subsidiaries

In past years, sureties have wanted to see this information a couple of times a year, or perhaps quarterly. Today, they often ask to review selected items monthly.

Among the leading issues for contractors seeking higher bonding limits, working capital and net worth are at the top of the list, followed by receivables. Underwriters take a dim view of receivables older than ninety days. Debt, too, is a focal point. Those who are carrying too much debt might want to consider debt-reduction strategies such as selling and leasing back equipment.

When asked to increase a contractor’s bond line, a key consideration for sureties is the amount of work the contractor has in progress. Underwriters need to know whether a contractor can add work and still complete existing projects on time and profitably. Contractors who have a lot of projects underway may want to complete a few before seeking higher bonding capacity.

In general, sureties are interested in expanding bonding capacity only for contractors who can demonstrate impressive business acumen, including risk management. Stephen Cory, president of the National Association of Surety Bond Producers (NASBP), told SIO recently that sureties want to deal with contractors who have the ability to recognize, evaluate, understand and deal with risk.

“There are all these outside factors that you can’t control—owners, weather, material prices—and (contractors) have to weigh their internal risks such as finances, equipment, staff and capital. Contractors must be disciplined and selective,’’ Cory said.

A record of astute risk management is proof that a contracting firm is well managed. Other evidence can be found in a contractor’s positive earnings, his accounting and estimating systems and the controls and procedures that have been established to identify problems early.

When it comes to a contractor’s financial statements, surety underwriters pay special attention to the work-in-progress and completed-contract schedules. Sureties want contractors to demonstrate a solid relationship between their liquidity level and debt level, as well as a growing level of equity as a buffer between the surety and a possible loss. Therefore, contractors should always try to keep a lid on debt while also retaining as much money in the business as possible.

It’s important to remember that sureties aren’t looking for contractors to build a project; they’re looking for sound businesspeople who run construction companies. The surety isn’t going to increase credit when projects are merely breaking even: They want to know whether a contracting firm can continue to grow while increasing fees.

The key to attaining higher bonding, then, is to have a well-established, ongoing relationship with the surety. The contractor should provide the surety partner well-developed financial statements, work schedules, inventory reports, business plans, etc. on a regular basis. At the same time, sureties should be treated like the valuable partners they are. Except for a contracting firm’s owner, no one is risking as much on behalf of the contractor as the surety. Therefore, it should never be taken for granted.

Contractors who want to learn more about bonding can draw on numerous resources including the following: Surety Information Office (www.sio.org), Surety Association of America (www.surety.org), National Association of Surety Bond Producers (www.nasbp.org) and the U.S. Small Business Administration (www.sba.gov).

Construction Business Owner, September 2007