Every successful contractor comes across the opportunity at some point to make investments outside of their company. It’s common for contractors to want to build wealth and other streams of income beyond their business, but when and how to make those decisions are not always as obvious and sometimes it may conflict with what the surety requires. This article will provide some important considerations from the likes of investor Charlie Munger and from a surety perspective to help provide a framework to work through these decisions.
Required Operating Capital
Every business needs a certain amount of capital to operate and all are different. The amount required in a construction company is typically driven by the type of work performed, how it is run, and market dynamics. For example, engineering contractors that own a lot of heavy equipment or subcontractors that have slow turning receivables may require more capital than those that don’t have these features such as general contractors subcontracting all of their work.
Surety companies often establish minimum working capital and equity positions for contractors to obtain the bonding necessary to operate the business. These parameters are typically driven by best practices to ensure contractors can manage through the ups and downs of the construction business.
When a contractor understands their business’s capital needs and the requirements of the surety, they then have a baseline for the capital they will need to keep invested in the company.
Calculating Return on Equity (ROE)
For most contractors, their company is their largest investment, but I would venture to guess that very few have ever calculated the rate of return they earn on this investment. The math is simple, but it’s not something most of us are ever taught to do.
“Equity” is in this context simply refers to the “Stockholder’s equity” section in your financial statement at the end of your balance sheet. That amount represents the money you initially put in the business and how much earnings have been retained to continue operating the company. This is your “Investment”.
To calculate the return on your “investment” (ROE), take your net income and divide it by the stockholder’s equity.
ROE = Net Income ÷ Stockholder’s Equity
According to the Construction Financial Management Association’s (CFMA) 2025 Financial Benchmarker, contractors that reported in their results earned an average return on equity of 32.7%.
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Return on Equity | 25.3% | 29.4% | 27.5% | 27.1% | 29.6% | 35.6% | 36.1% | 24.3% | 31.4% | 32.7% |
Opportunity Cost
Charlie Munger, one of the greatest investors of all time, talked often about the concept of opportunity cost as the basis for all of his financial decisions. Opportunity cost is defined as the value of the next best alternative you give up when making a decision. When describing the practical application, Munger said, “…In the real world, you have to find something that you can understand that’s the best you have available. And once you’ve found the best thing, then you measure everything against that because it’s your opportunity cost.”
This means that in order for contractors to understand the relative attractiveness of an investment outside of their company, they need to be able to compare the investment’s potential return to the return on equity for their company.
Let’s illustrate this with a simple example. Let’s say a contractor feels they have plenty of capital in their company to operate, and with that capital their surety can provide $20 million of total bonding. The contractor has opportunities for additional work that will require them to increase their bonding capacity to $30 million, and their surety will need the contractor to retain an additional $1 million of profits to support this increased bonding capacity. The contractor earns a 25% return on their equity, so with this additional $1 million of equity, they will be able to make $250,000 per year.
At the same, the contractor is presented with an opportunity to purchase a building for $1 million of cash that will net them $90,000 annually after expenses including appreciation.
What should they do?
The answer seems pretty obvious in this example. The reader may think that the example was constructed in a way to skew the results to obviously lean towards an investment in the company over purchasing asset personally. So, let’s take a look at the approximate long-term average returns for various investments in nominal terms (not adjusted for inflation):
- Stocks 9.5%
- Bonds 4 to 6% (depending on whether government or corporate and the duration)
- Real estate 8.93% (using the Vanguard Real Estate Index Fund as a proxy for all real estate)
- Gold 5.12%
Is that to say contractors should never invest outside of their company? Of course not. Sometimes people decide that they don’t want to grow their company for personal reasons or because there is a lack of opportunities to continue investing in the company at the same return on equity that they have historically. This remains consistent with the idea of opportunity cost but here the opportunities are greater outside of the company.
Conclusion
While it can feel frustrating when a surety requires more capital than a contractor would prefer to keep in the business, those requirements are rarely arbitrary. They are designed to safeguard the company, ensure stability through market cycles, and protect bonding capacity. More importantly, the capital retained in the company often produces a higher return than nearly any alternative investment available to the contractor. In this sense, what may seem like a conservative demand from the surety is, in fact, a disciplined way of guiding contractors toward their best possible investment—their own business.
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