Three Key Action Items to Achieve an Effective Bonding Program

by Matt Leskanic and Greg Angel

With the onset of the COVID pandemic in March, many contractors had their private commercial projects put on hold while other contractors continued to work on public projects deemed essential. Now that construction is starting up again, many contractors are looking for ways to diversify their backlog with government contracts so their businesses can remain operational during an economic recession and/or another potential pandemic shutdown.

A major attraction to public work is that there are always public construction projects bidding/available. In 2019, public construction spending was over $350 billion, with the federal government spending $150 billion on construction, and states and municipalities spending over $200 billion. These figures could also increase as President Trump is discussing a potential $1 trillion infrastructure investment.

The fact that payment is almost guaranteed is another attractive feature of public work. The Federal Prompt Payment Act protects all tiers of contractors, subcontractors, and suppliers from late payments on federally funded construction projects. Though it would be naive to suggest that payment is made 100% on time, the projects are always 100% financed. There is no fear of banks cutting off financing or owners running out of money.

One of the requirements for bidding and performing public work is surety bonding. Under the Miller Act, construction bonds are required for contractors performing on federal projects over $100,000. Similarly, every state has its own “Little Miller Act” which specifies the contract amount above which construction bonds are required. The different types of construction bonds that will be required are Bid Bonds, Performance Bonds and Payment Bonds.

To be successful in the public arena, the single most important thing a contractor must have in place is a surety bonding program. Here are three factors a contractor must consider in qualifying for an effective bonding program:

1. Prepare a CPA Financial Statement and Consider Working Capital and Equity

Surety programs that allow you to bid over single jobs of $1.5 million generally require a CPA financial statement, which provides additional assurance of the accuracy of the statement. The CPA Review is the most common tier recommended for both small and large contractors. In some cases, if it’s for a lone bond, or a contractor that rarely requires bonds, an internal financial statement may be acceptable. But if you want to grow your portfolio with public work and bid on multiple contracts, it’s best to prepare a CPA financial statement, specifically a CPA Review. The surety will also look for the financial statements to be arranged on a percent of completion basis. This recognizes revenue and expenditures as a percentage of the work completed during the period and provides a more accurate financial picture.

It is important to note that the surety typically looks at working capital and equity of a company in determining bonding limits. This provides an indication of how well capitalized the company is, and the company’s ability to survive the hit of a few projects gone awry. The surety will typically look at these two metrics, as well as the largest completed single project to gauge the single and aggregate bonding limits of a contractor.

2. Open a Bank Line of Credit

Banks will extend a line of credit when times are good, so don’t go to your bank asking for an umbrella when it’s raining! From a surety perspective, it’s an advantage to have this extra liquidity even if you don’t tap into it. A contractor who has a line of credit in place and has an extra cushion is less risky than one who does not.

The bank line of credit amount should support 5% of your bond program parameters. While it’s acceptable to be in-and-out of the line throughout the year for working capital, don’t run up the balance. It will appear to the surety that you are overly leveraged. Being deep into your bank line may lower working capital and tighten up your bonding limits as well.

3. Choose a Professional Surety Agent

The most important action item a contractor can do to qualify for an effective surety bond program is to choose a professional surety agent that’s the right fit for the growth of their business. A professional bond agent will learn your story and help take your business to where you want to go.

The surety agent should be responsive and provide you with the flexibility and service to handle all bond requests, even last-minute ones. Knowledge of the construction industry is key, as well as really getting to know you and your business in order to positively convey it to the surety. In addition, the agent should have access to and a thorough understanding of a number of different surety markets. This allows them to negotiate the largest program and most competitive rate/indemnity structure on your behalf.

If you’re a contractor who wants to increase your backlog of public work, you should be prepared by securing an effective bonding program. Prepare and organize financial statements, consider your company’s working capital and equity, open a line of credit, and most importantly, establish a strong relationship with a surety bond agent.

Your bond agent is the trusted partner who has the integrity and bonding experience to help you achieve your business’ growth and revenue goals.

Matt Leskanic and Greg Angel, CPA are Surety executives at Surety Bond Professionals, headquartered in Massachusetts.