What evolving market trends will impact middle-market contractors?

Mike Bond 
Head of Surety
Zurich

Changing project delivery methodology and increasing project size present risks and opportunities to contractors.

Traditional hard bid work is being supplanted by more complex and challenging delivery methods like integrated project delivery, gap financing and public-private partnerships (P3s). The relationships among the different stakeholders in a P3 project are more numerous and complex than a traditional project. While the debate continues on the “right” approach to bonding P3 projects, sureties are not waiting on the sidelines; they are out there innovating. Middle-market construction firms need to be capable of participating in these project delivery methods now.

Construction project amounts are increasing like never before, but surety capacity is keeping pace. While there clearly is a limit to surety capacity for any contractor, the surety industry is responding with a greater willingness to provide significant facilities to companies with the business plans, financial strength and capacity to deliver.

How can a contractor take its bonding capacity to the next level?

Antonio C. Albanese 
Vice President
Nationwide Surety & Fidelity

The secret to taking bonding capacity to the next level starts with a focus on the core business and strong management controls. It’s important to have a growing balance sheet and reasonable levels of equipment debt. The operation should be able to collect cash and handle liquidity needs with minimal outside working capital financing.

Relationships are also paramount. To be the best, contractors need to work with the best. The staff should be qualified and tenured. The CPAs, bankers and brokers/agents with whom they affiliate should be high quality.

From there, contractors need to create and maintain good relationships, not only with their agent and bonding company, but also with subcontractors, owners, suppliers and architects.

Strong communication with their surety is also key. They should have regular meetings with their bond company so everyone is on board and understands the contractor’s business plans.

How can a CPA help protect or increase a contractor’s bonding capacity?

Josh Penwell 
Vice President, Contract Underwriting
Merchants Bonding Company

Construction accounting is unique, with different methods of reporting income for tax purposes that are available to contractors. Surety companies prefer to see a financial statement where revenues are recognized on a percentage-of-completion basis of accounting, and a good construction-oriented CPA firm will provide this.

A construction-oriented CPA will become increasingly more important considering the guidance by Financial Accounting Standards Board regarding new revenue recognition standards. It also would be a valuable consultant when choosing a software program.

A surety company expects to review the contractor’s fiscal year end report within 90 to 120 days after fiscal year end. A construction-oriented CPA firm will ensure the reports are promptly available to the surety and bank. Without this, surety credit decisions are based on outdated information, limiting the contractor’s surety bond capacity.

How can subcontractor prequalification help reduce risk?

Matthew Kelly 
President
PreQual

A subcontractor default can have devastating effects on a project and a general contractor’s balance sheet. Implementing and executing a thorough prequalification program is a must to manage subcontractor exposure.

Projects are built off the backs of subcontractors’ balance sheets. With subcontractors having to lay out significant money for labor and materials, there is tremendous pressure on their cash flow. This kind of pressure is only compounded in robust construction markets like the one we find ourselves in today. 

Counter to popular belief, more subcontractors fail in the expansion of the construction market rather than the contraction, as more work applies greater pressure to their balance sheets.

Having a strong prequalification process allows general contractors to identify or recognize a subcontractor that is in trouble or heading for tough times. This simple process, if done correctly, can significantly mitigate risk and reduce failures.

Why should a contractor consider a captive to insure its risk?

Steven Davis 
Director, Senior Vice President
McGriff, Seibels & Williams, Inc.

Captive insurance companies have been a risk transfer/funding alternative for decades, with many contractors benefitting from participation. Not a short-term risk solution to the traditional insurance market, captives tend to require long-term thinking and commitments.

Generally speaking, a captive will not shelter the contractor from the current insurance cycle, but will create a paradigm shift for its loss funding, coverage and claims management. Handled correctly, this risk management tool can provide both short- and long-term solutions to the organization, insuring some or all of its exposures.

There are three basic structures for captives: single parent, group and rent/protected cell captives. Benefits vary depending on structure and purpose, but generally include: cost stabilization and reduction, improved coverage availability, access to capacity and market leverage, and best practices for claims and loss control.

Remember, captives are not created equally, so proper due diligence is critical in the decision process.

What is credit insurance and how does it protect a contractor’s business?

Mark Brundage
President
Global Financial Corporation

Most business owners do not insure one of their largest assets: their accounts receivables. A business without credit insurance coverage can quickly find itself on the verge of collapse when a customer unexpectedly files for bankruptcy. Few contractors know about this valuable protection. Here are some of the benefits:   
  • Gain access to high-level information to make informed decisions about creditworthiness.
  • Systematically approve new credit quickly and with precision.
  • Establish safe large credit limits that will be covered immediately.
  • Mitigate the concentrated A/R risk scenario in which one failed account wipes out years of profit.
Be sure to work with a lender that is knowledgeable in how to process claims under credit insurance policies to ensure that proper payouts occur when events happen. When combined with a large line of credit, this insurance coverage allows the business to grow safely and rapidly.

What are the main legal considerations when forming a jointly bonded/insured venture?

G. Scott Walters
Partner
Smith Currie & Hancock

Although a joint venture is considered a separate legal entity, it is effectively a partnership. Regardless of the joint venture form, each member (or partner) remains liable for its own actions and for the acts of the other partners. So, understanding and addressing liability among the partners of a bonded and insured venture is paramount. 

A related consideration is allocation of risk among the co-adventurers. Construction companies typically form joint ventures to perform a specific project (usually large and complex) to leverage the partners’ capabilities. To better allocate the unique performance and payment obligations and risks associated with this project delivery method, co-adventurers should agree to obtain and maintain separate bonding and insurance programs in the name of the joint venture. Failing to do so might expose one partner (as well as its surety and insurer) to additional risk for the other partners' actions. Structuring the joint venture arrangement through a well-drafted joint venture agreement, as well as corollary documents, will aid in addressing this legal consideration.

What documentation should a contractor bring to an initial meeting for establishing a bond limit?

Henry W. Nozko, Jr. 
President
ACSTAR Insurance Company

For contractors doing $50 million per year or less, the CEO or owner and CFO should attend the first meeting with the surety. For larger companies, a senior officer and a senior financial executive should attend the first meeting. The documents they bring should be limited and straightforward, and should include the most recent year-end financial statement and either a generic questionnaire or a completed qualification statement. The questionnaire or qualification statement should include ownership information, company history and a schedule of completed projects and projects in progress.

Additional information at the first meeting is not necessary and might cause the discussion to wander from the focus of the meeting, which is to secure surety credit. At the first meeting, less is more. However, be sure to make a concise and honest statement disclosing anything negative. If the surety finds out something that wasn’t disclosed, most likely the relationship will have ended before it starts.

Most importantly, be yourself.

Constantin Poindexter
Surety Underwriter, MGA
Surety One, Inc.

Aside from a professional appearance and demeanor, a contractor should bring the following to an initial meeting:
  • A proper financial presentation prepared by a CPA and a complete personal financial statement. 
  • A complete contractor questionnaire/survey.
  • Current certificates of insurance for coverages specific to the contractor’s class of work.
  • Evidence of all credit lines established by either the contracting firm or its owners for emergency capital needs.
  • A schedule of open work prepared on a percentage-of-completion basis.
  • Résumés of key personnel and a copy of any specialty licenses or training certificates.
If a contractor has an immediate bond need, it should provide a copy of proposed project specifications, the bid submission and the proposed contract. If the project has already been awarded, then explain how the job was obtained, what was used as bid security and the estimates of the next closest bidders.