Ensure your company meets surety requirements and receives bonding by following these guidelines.
1. Retain a construction-oriented CPA
Not many CPAs know construction accounting and how to present data to a surety company without causing any red flags. Surety companies expect financial statements to be prepared a certain way, and they scrutinize small businesses inside out for credit purposes. Surety is similar to banking. If you want adequate surety credit, you need a stellar construction-oriented CPA firm to make a lasting impression with a surety company. High-quality financial reporting could reduce your bond rate.
2. Execute a Teaming Agreement Correctly
When you undertake a teaming agreement, be sure it discloses that your teaming partner will bond back its portion of work or indemnify it to your surety company. This will let the surety company know they can proceed with the project underwriting based on a stated cooperation from the teaming partner. If you get into a teaming arrangement for the first time, you may be asked by the surety to place the project in funds control or escrow to keep the payments in check. Escrow does not disburse payments due from over-billings, and the escrow agent can serve as a good mediation source for both parties. (Note that the The U.S. Small Business Administration’s (SBA) Surety Bond Guarantee (SBG) program does not recognize teaming arrangements yet.)
3. Understand Joint Venture Possibilities
Please speak with your bonding agent and surety before engaging in joint ventures to understand how they will underwrite the job and treat the joint venture as part of your backlog. Each surety is different. However, each joint venture partner can bond his respective portion of work, or one joint venture can bond the entire job with the other partner providing an indemnity in lieu of a bond back. Often, a new entity (LLC) is formed to house the joint venture work and maintain the profits until the project is complete. Again, speak to your surety for more insight on underwriting before you solidify the agreement. SBA will consider joint ventures for bonding, but both partners cannot exceed their industry North American Industry Classification System (NAICS) codes for small business.
4. Manage Credit Relationships
Manage your credit by monitoring it closely. Use resources like Dunn & Bradstreet for your credit report, and pull your own credit score and report often. You never know what might cause a dent in your surety and bank relationship. Sureties rely on these tools when making underwriting decisions, especially for small businesses that may not be well capitalized.
5. Be Realistic About Job Size
Typically, sureties will support a contractor for jobs that are (at the most) two times the largest job ever completed. Your bonding agent can provide this data to you. If you completed a job three to five years ago, you can make a statement that your largest job completed would be worth more money now given the increase in materials and labor, but be realistic.
6. Consider the SBA surety Bond Guarantee Program
The U.S. Small Business Administration’s (SBA) Surety Bond Guarantee (SBG) program can guarantee bid, performance and payment bonds for individual contracts of $2 million or less for small and emerging contractors who cannot obtain surety bonds through regular commercial channels. The SBA requires that your backlog (whether bonded or not bonded) does not exceed 10 percent of your working capital (current assets - current liabilities x 10 percent). If you lack the working capital and have a working capital line of credit with an unused portion, you may be in luck. To increase working capital, the SBA will allocate the unused portion of your credit line to your current assets with no offset to your liabilities. SBA charges a fee of 0.729 percent of the contract price. This fee is in addition to the premium the surety will charge. The premium is typically required upfront for SBA bonds.
7. Maintain a Complete Job Cost Accounting and Reporting System
Complete and accurate accounting systems are extremely important to surety companies. The percentage-of-completion accounting method is required by most sureties. This method is derived by dividing cost-to-date by total cost. This percentage is then multiplied by your expected profit to determine profit earned. Sureties require that all fixed-priced contracts be part of a work-in-progress schedule that calculates the percentage of completion, the profit earned and whether you are over-billed or under-billed on the project. Without understanding cost accounting and its application to the balance sheet and income statement, sureties will not be generous with their bonding support.
8. Update your Business Plan
You should update your business plan every three to five years and when you hire key personnel. Your surety will want you to build your infrastructure and hone your strategies for competition. They will want to know what new tasks your new key personnel will undertake to grow your company.
9. Develop a continuity plan, and retain life insurance
A continuity plan is essential for small businesses. If something happens to the owner, how will the work be completed and who will be in charge to close out the company? As your company grows and takes on new partners, a buy-sell agreement is the next step. Either way, all continuity plans need to be funded by life insurance. The life insurance should be payable to the company. The surety can use the life insurance proceeds to complete the work on your behalf if the work is bonded. Having adequate insurance in place will prevent a surety company from exercising subrogation rights under the indemnity agreement.
10. Have an attorney review your contracts
Always retain an attorney to review your contracts before signing them. Contract attorneys see many contract agreements and will know what can be eliminated or negotiated for your benefit. If you subcontract work, include flow-down language in the subcontracts to protect your liability. If you are a subcontractor, always ask for a copy of the prime contract between the general contractor and project owner due to the flow-down language contained in the agreement. And if the general contractor is bonded to the owner, secure a copy of their payment bond prior to signing the contract. This will allow you to promptly file a claim on the bond if necessary.
Construction Business Owner, May 2011