As the construction market continues to improve, we are seeing more contractors needing increased bonding capacity. For some contractors this means wanting the ability to bid larger projects and for others it’s a matter of more overall bonding capacity to support their growing backlog.
Here are 7 different ways that contractors can potentially increase their bonding capacity.
1. Retain Earnings in the Company
While retaining profits in the company may seem obvious, there can oftentimes be conflicting objectives facing owners of construction companies. There can be a strong temptation take money from the company to do things like purchase a home or invest in other assets. Those things are great, however, it’s critical to remember that the biggest investment you can make as an owner is in yourself and your business. Supplying the golden goose with the needed capital will normally far outweigh any return in an outside investment.
Beyond simply retaining profits, you need to be able to provide financial statements to your surety reflecting the additional retained earnings. As the market improvement continues to accelerate, providing quarterly internal financial updates can be really helpful, as it allows your surety to increase your bonding capacity on a more frequent basis than every six months with the typical financial reporting time frames.
2. Use Personal Cash to Boost Equity
For owners that have cash personally or access to a home equity line of credit, cash can be put in the business either as paid-in capital or a shareholder loan. Shareholder loans are advantageous, because they can easily be repaid when it is no longer needed, but many sureties will require the loan to be subordinated in order for them to treat the cash infusion as capital. This essentially just means that the owner agrees not to pay themselves back until the surety approves it.
If you don’t have the cash resources yourself, but a family member or friend is willing to loan money to the company and subordinate it to the surety, that can also potentially add equity to the company from the surety’s perspective.
3. Limit Fixed Asset Purchases
In times of growth, other investments in the company besides building capital are usually needed like purchasing equipment. While there is nothing wrong with buying equipment, it needs to be weighed against the need for working capital (= current assets – current liabilities) to support your company’s bond program. Every $1 in cash that is used to purchase a fixed asset like equipment will lower working capital by $1. This can equate to reducing your overall bonding capacity by $10-20.
Using long-term debt can help, but you just want to make sure you aren’t loading up on too much, because that creates concerns for sureties as well.
4. Increase your Bank Line of Credit and/or get a Home Equity Line
According to numerous studies, more contractors fail during an economic expansion than a recession, and one of the major reasons is they run out of cash. That being the case, increasing your access to cash at a time when your backlog is growing can help a surety get comfortable with stretching your bonding capacity. While a traditional bank line of credit for the company is best, home equity lines can help as well, because it still allows you to have access to cash which can be put in the business in the event of a crunch.
5. SBA Program
When most contractors hear of the SBA bond program, they generally think of small, start-up companies. While that is certainly one great use for the program, many would be surprised to hear that the SBA can bond individual contracts up to $6.5 million and contractors can have revenue up to $36 million (depending on their type of work).
Because the program is designed to help “smaller” contractors have access to increased bonding capacity, their underwriting guidelines enable them to offer more than double the bonding capacity compared to what most standard sureties will allow.
6. Bond Subcontractors
There are many good reasons for prime contractors to bond their subcontractors in today’s market. Perhaps the obvious are protection from subcontractor default, which is becoming more common as subs get extended beyond their ability, and protection against unpaid wages and penalties, which is also becoming more prevalent.
Another very good reason is it can allow your surety to stretch on a particular job or potentially even on your overall bond program if you have a consistent policy to bond subs. Bonding a sub does not mean your surety will not count that’s sub’s portion of work against your bond capacity, but it does allow your surety to be more liberal in the capacity they provide to you.
7. Use Personal Assets to your Advantage
There are many contractors that have a significant personal net worth with substantial equity in assets like real estate or stock portfolios that don’t like to keep too much idle money in their company. There are a handful of sureties that will base a contractor’s bond program heavily on these personal assets rather than requiring all the capital to be in the company.
Some sureties will even accept collateral by using real estate or stock portfolios to either stretch on a job or provide a larger bond program that way the contractor doesn’t have to put all their assets in the company.
As you can see, there are many ways you can approach increasing your bond capacity, but the first key ingredient is to communicate your needs to your agent and go over the potential options that fit your specific situation. Your agent can help you figure out if you’re with the right surety and set a plan in motion to work towards the overall objective you need. Just don’t delay, because the more time you allow for planning, the more options that are generally available, or as Richard C. Cushing put it, “Plan ahead. It wasn’t raining when Noah built the ark.”