Strategies to Increase Bonding Capacity - Starting with the Submission Process
What happens to a submission once a bonding agent has viewed the documents?
What surety companies will they target for a bonding program? Is the agent knowledgeable in surety or only in commercial insurance? These are important questions to ask for contractors who want to grow bonding beyond the typical “fast-track” creditbased surety program limits. For startups and contractors seeking a surety bond program up to $1.5 million, the underwriting process is not cumbersome. For companies with a proven track record in project delivery that want to grow and scale up, the underwriting process can be complex. Agents in the latter situation will need to canvass every aspect of the contractor’s operations. Their letter to the surety may include a full list of topics including:
- Company and Owner(s) Personal Credit and Payment History with Creditors
- Banking Relationships and Bank Line Borrowing Capacity, if any.
- Company History & Largest Projects Completed (Sureties tend to extend two-times largest job completed for bonded jobs and two-times largest backlog completed for aggregate limits. Typically, backlog is defined as the total cost to complete at any one point in time.)
- Ownership and Experience of Owners and Key Staff
- Subsequent Events (if any)
- Financial Statement Analysis (Three to 5 years of history to discuss changes in working capital, net worth, key ratios, intercompany accounts, stockholder borrowing, and equipment spending habits, etc.)
- Personal Financial Trends
- Affiliated Companies
- Work in Progress History (This section discusses any profit fade, key projects and pending change orders.)
- Insurance Coverages
- Legal Issues (if any)
- Indemnity Package
1 If your projects involve a scope of work
that is repetitive in nature, such as laying
carpet tile for example, surety companies
may look beyond the “two-times
The more information supplied under such headers, the more likely the underwriter will negotiate favorable surety credit terms.
A contractor has every right to asktheir agent what surety companies will be targeted for their account. It is always best if the agent doesn’t use a mass marketing approach. Sending out submissions to multiple surety companies at one time is typically used only to block access by competing agents, because once an agent submits an account to a surety company, no other agent can access that surety unless the contractor provides them with a broker of record letter. This letter will essentially “fire” the incumbent agent from that surety company and allow the new agent access. Since the surety underwriter may uncover and reveal some issues (not known to the agent) to the contractor, it is best to find out what they are and address them before sending the submission to another surety. Keep in mind that a surety broker makes credit worthy statements on the applicant’s behalf to the surety. If a contractor fails to fully disclose any and all issues to their broker, it can damage the applicant’s and the broker’s reputation with the surety company.
Financial Statements and Internal Accounting
Just as a person can outgrow or make major renovations to their home, contractors need to rethink the presentation of their financial statement and possibly the CPA firm they have engaged. Surety companies enjoy working with certain CPA firms. It’s advisable to routinely inquire with the CPA firm regarding which surety companies they work with. If a CPA does not network with surety companies or is not known to them, this may raise concerns for the surety underwriter. As an aside, if seeking a bond program of $50 million or more, an audited financial statement may likely be required. If a business is receiving bonding support under the SBA Office of Surety Guarantees, the SBA requires CPA Audits to support projects $6.5 million and higher.
A sophisticated cost accounting system that can update jobs weekly is necessary to grow bonding capacity. This will most likely be the surety’s first line of questioning. The surety may require quarterly or monthly work in progress schedules if support for a large spike in bonding capacity is requested.
Increasing and maintaining a surety program can be costly. Producing a CPA Reviewed or Audited statement and implementing a cost accounting software program can increase overhead substantially. Such costs can be considered indirect job costs and allocated to project costs. In this manner, a company will be positioned to absorb the impact to the bottom line.
Indemnity Concessions and Financial Benchmarks
When growing bonding capacity, it’s also wise to ask about any indemnity concessions and the financial benchmarks the surety requires for such consideration. For example, if a contractor can demonstrate that their company is not their “personal bank” (i.e., no large stockholder or owner receivables or unnecessary large distributions; able to forecast sales to show modest growth, not exponential growth; and amassed retained earnings in the company that are at or in excess of $1 million), then certain reasonable indemnity concessions can be requested.
If the applicant firm is pledging both company and personal indemnity, the surety may – given the scenario above– waive the applicant’s homestead. For example, if the applicant has a long-term relationship with the surety, they may consider a capital retention agreement, limited dollar indemnity, or perhaps waiving personal indemnity. It all depends on the surety and how much excess liquidity the applicant has in the statement to support the program currently or in the future.
To bolster liquidity, applicants may consider subordinating any stockholder or owner notes payable. Subordinating the debt to the surety will convert the payable to quasiadditional capital in the “eyes of the surety,” not the IRS. If you are Sub S or an LLC, consider converting such notes payable to additional capital for stronger consideration of the cash infusion. (Converting such notes into capital in a C-Corporation is not advised because the money will be taxed twice.) Keep in mind, stockholder or owner notes receivable are not treated as a current asset for underwriting purposes. If such notes have plateaued or increased over time, the IRS could consider them as additional salary and apply tax on the outstanding amount and assess a penalty. The surety would rather an owner increase their salary than show such receivables on the balance sheet. Such notes payable can be a red flag for sureties and banks.
Growing capacity may also affect bond premium rates. Every surety company has a different rate structure accompanied by unique guidelines. If the company is not an active bond user, chances are that preferred or super preferred rates will not be offered. Nonetheless, there are surety companies that may offer a very low premium rate structure just to capture new accounts. Though low initial premiums seem ideal, such rates are often subject to an increase. Additionally, shopping rates can cause diminishing returns for a firm’s reputation as a contractor. Sureties do not see themselves as a commodity. If a firm is looking to scale up and win support from a surety company that will take the business to the next level, it’s important to be upfront and candid about the rate structure without making it a priority. The agent should know how to finesse this situation to the business’ favor.
Above all, firms should find an agent knowledgeable in surety. A local commercial insurance agent will most likely not possess the skill set needed to establish or grow a firm’s bonding capacity. Remember, a surety agent is not an adversary, but an advocate. It does not matter if the surety agency is large or small, it just matters if the agent has the talent and a healthy amount of appointments with surety companies, along with a healthy sense of urgency.