For contractors, taking on larger projects is a natural part of growth in business. The challenge is that no two projects are exactly alike, and bigger isn’t always better. There can be more risk with larger jobs, and some contractors see their gross profit margins (as a percentage) go down as jobs get bigger.
For these reasons, it’s important to be able to explain to your surety why the larger project you want to pursue is a good opportunity. We find the most successful way to do that is to understand the risk factors and best practices sureties look at. After all, it’s important to remember that surety companies work with numerous contractors, and they see what works and what doesn’t.
Based on our decades of experience, here are four questions contractors should consider when looking at bigger jobs to increase the odds of success with both the project itself and their surety supporting the bond.
1. Is the scope more complicated?
Just because a project is larger doesn’t automatically mean it has more risk. A pipeline project consisting of 2,000 linear feet of pipe in a dirt field instead of 1,000 feet may not be any more complicated. However, the same pipeline project in a busy downtown area with limited work hours, traffic control, and unmarked utilities, may be 10 times more difficult.
It will be important for your surety company to understand the scope of work and how it relates to work you have performed in the past. If it is truly just “more of the same” and not any more complicated, that will help in the surety’s evaluation.
In addition, being able to demonstrate that your company has the ability to run the work is critical. This includes not only the field such as qualified supervision and equipment, but things in the office such as the ability to track daily/weekly job costs.
We work very closely with our contractors to understand each of these elements and communicate them clearly to their surety, as they often make the difference between bond approval or declination.
2. Have you done work with this owner before?
Prior experience with an owner and, in particular, the people who will manage the project (construction manager, engineers, architects, etc.) mitigates a lot of unknowns when taking a step up in job size. It can make all the difference when a contractor knows what to expect from an owner, such as how they like their pay applications structured, what kind of inspection is required, and having established strong communication.
The reverse is also true. Imagine a friend tells you about an investment he is considering. He has made small investments for years with the same financial advisor all of which have been successful. There is a track record and trust built up over time. However, your friend came across a new financial advisor that he’s never done business with, which can do much larger deals. They are the same type of investments he’s had success with in the past, so he’s going to bet everything he has. What would you tell him?
If you are looking to perform a job for the same owner, or a different owner but you have worked with the construction manager or architect before, make sure to point this out to the surety. Even better, show them a list of the jobs and the profit you made on those projects.
3. Can you cash flow the project?
There’s a saying in the surety industry that most contractors don’t go out of business because they can’t do the work; it’s because they run out of cash. Larger projects require more cash, which means it’s essential for a contractor to determine if they have enough working capital to cash flow the work.
Put simply, Working Capital = (Cash + AR Less than 90 Days + Underbillings) – (AP + Line of Credit Balance + Debt + Overbillings).
For most contractors, you should aim to have enough working capital to equal 10% of your backlog including the new large project. There is some variation to this general guideline based on the type of contractor and scope of work, and your surety agent should be able to help you fine tune this number. At CSBA, we work with our contractors closely to understand their working capital needs and how to position it to take on larger projects.
The payment terms and amount of retention can also make a big difference with cash flow. The same is true for jobs that have a large subcontractor and supplier components versus those projects that require heavy labor.
Contractors should also look to have an available bank line of credit equal to 5% to 10% of their anticipated annual volume. The ultimate number will vary based on the amount of cash the contractor chooses to carry and whether they are a general contractor or trade contractor with heavy labor.
4. Can you afford to lose 10% on the project?
Assuming the first three considerations check out, we always encourage our contractor customers to ask themselves if they can afford to lose 10% on a project. Why? We realize that no contractor goes into a job wanting to lose money, but the fact is that it happens. Therefore, it’s important to consider the worst-case scenario, and a 10% loss is around the average “bad job” that we see.
If a contractor can’t afford to lose this 10% amount and still have enough working capital to complete the remaining backlog, it creates significantly more risk. This is particularly true when multiple large jobs are performed at the same time. Although it doesn’t eliminate the risk, requiring bonds from subcontractors is one way to reduce the risk of a major loss on a project.
In the surety industry, it is a generally considered best practice for contractors to stick with jobs that are no more than 2 times their largest project completed with the same scope. However, when all of the factors above line up, projects that are 3 to 4 times your largest completed project can be very profitable and successful.
The key with taking on larger projects is showing your surety how you plan to manage the additional risk and limit the downside, because mistakes and bad projects happen – even to the best contractors. This is where your surety agent plays a key role. CSBA helps our contractors navigate these challenges and potential pitfalls while at the same time finding surety support for those lucrative jobs that make sense. The time we take getting to understand our contractors’ operations and their projects, our strong ability to communicate how the risks are being mitigated, and the decades of trust built up with our surety companies allows us to get our contractors the bonds they need to capitalize on unique opportunities.