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

Ross Fisher 
Board Chair
Surety & Fidelity Association of America
Senior Vice President
The Hartford – Large Commercial Businesses

The best advice for contractors is to work with their underwriter and agent in an open and collaborative environment. Yes, they will need to build their balance sheet to support their work program, but this can be done over time and in the context of a well communicated plan. Likewise, contractors should share their plans for building their execution capacity, demonstrate proven talent and systems, and lay out their roadmap for building their organization’s muscle. Finally, contractors can demonstrate their positive character by making these commitments, by treating clients, other contractors, vendors and all of their people well, and by communicating—perhaps over-communicating—with their surety underwriter and agent. 

Surety underwriters really want to provide bonds. Good surety underwriters know that construction is not a linear business and that things don’t just happen overnight. Contractors can help their surety to help them by becoming their most transparent client.

Lynne W. Cook 
Senior Vice President
Early, Cassidy & Schilling, Inc.
National Association of Surety Bond Producers

The contractor should be prepared to explain how it plans to accomplish its business plan. A bond producer will work with the contractor to maintain and enhance its surety program, acting at all times as a trusted advisor, including providing feedback on the operational and financial steps necessary to improve its surety program.

Examples of operational steps that are beneficial include using an internal accounting system that manages the contractor’s type of work and revenues, maintaining the accuracy and timeliness of the internal financial statements and work in progress reports, ensuring the accuracy of overhead and indirect cost estimates, and developing a system that manages the change order process.

Examples of financial steps that are beneficial include reducing overall debt, retaining profits, billing all costs and estimated profits in a timely manner, collecting receivables within 90 days and adding capital to the business. Retaining net income to support growth as opposed to distributing the money is an effective way to improve bonding capacity. Improving cash flow also is helpful.

Antonio C. Albanese 
Vice President - Head of Surety

A contractor can take its bonding capacity to the next level by demonstrating proven success in job performance and operations at current levels. A second factor is profit retention from current projects. This provides growth in the firm’s liquidity and net worth to provide financial strength and an expansion cushion. There also should be a detailed business plan with a controlled pace of expansion for added capacity.

How does a surety understand and analyze a contractor’s success? The key is the use of reliable internal accounting systems and working with a professional construction-oriented CPA to verify that success via independent financial reporting (e.g., providing financial statements on a cost-to-cost percentage of completion method of accounting with all relevant schedules of open and closed projects). All of this provides the underwriter with a clear picture of the contractor’s financial health and assurance the bonding capacity the underwriter has extended is progressing well. With this comfort, the underwriter can provide additional capacity knowing the contractor has the proper tools in place to grow.

Steven Swartz 
South Coast Surety

You need to have shown the ability to successfully manage the bonded work in your current program with good profit margins that don’t fade. And you need to have a good financial presentation prepared that reflects the profit stream from those jobs and also displays your continued efforts to retain and grow the company working capital and net worth.

But, it is your professional surety agent that can help guide your firm in reaching larger work program goals. Your surety agent should be communicating regularly with your CPA, who is experienced in generating construction accounting financial statements in a form and format preferred by surety underwriters. Your surety agent should be working hand in hand with you and your staff as you start to focus on future jobs you intend to pursue.

Successful construction executives align with a strong independent advisory team of an experienced construction attorney, accounting firm and professional surety agent. When added to your own staff, this team provides the insight and support to make that path to larger bonded contracts seem easy.

JD Weisbrot 
JW Surety Bonds

The main factors that allow larger surety support for contractors are a quality financial presentation, open communication with your agent and surety, and strong support from your banker/lender. The financial presentation should come from a CPA who is familiar with the nuances of construction accounting. A presentation done on a percentage of completion basis with complete notes, disclosures and work schedules will give both your bank and surety the best insight into the company’s health.

We advise our contractors to have the CPA draft a year-end financial statement and then openly discuss their goals with their surety agent on how to properly deploy that net profit at year-end. It’s often wise to keep some, if not all, of the net profits on the balance sheet so the surety can offer enhanced support for future projects.

Lastly, sureties are always comforted by a contractor that has with a strong bank line established in case of a cash crunch, but simultaneously can get concerned if a contractor is consistently using most or all of its bank line on a regular basis.

Dillon Rosenhamer
Construction Practice Leader

To take bonding capacity to the next level, a contractor needs to go beyond capital, character and capacity. When these have been satisfied, a surety can derive a work program.

To increase bonding capacity and work program size:
  • Improve the quality of financial reports. Upgrade from in-house accrual to a review, or review to an audit. Keep an up-to-date WIP with cost to complete, percentage of completion, gross profit left in the backlog and over/under-billings.
  • Reinvest retained earnings and limit bonuses and dividends. Rather than taking an $80,000 bonus at year-end, leaving the money in the company could result in an additional $800,000 in bonding capacity.
  • Turn receivables over more efficiently.
  • Remember that cash is king. The more invested an owner is in his or her operation, the more comfortable a surety is increasing capacity.
Partnering with your agent, accounting firm and surety helps the surety gauge the stability of a contractor’s future and builds confidence at bid time.

What cash management techniques should contractors employ in order to be successful as the economy recovers?

William Waters 
Vice President - Contract Underwriting
CNA Surety

The old saying that “cash is king” is especially true during economic recovery. Revenue growth consumes cash and effective cash management starts with collecting your receivables. Accounts receivable typically make up most of a contractor’s current assets and your surety and banker normally discount any receivables older than 90 days from their calculation of working capital.

Your opportunity to convert receivables into cash in a timely fashion starts with negotiating favorable payments terms. However, your relationship with the owner and their track record for timely payment are often times more important than what is written into the contract. This is especially true with public owners because contract terms are frequently non-negotiable and some have a history of slow payment.

Good contract terms and an owner who pays in a timely fashion are just the first steps. You need to have disciplined billing processes and accountability in the field and main office for the collection of accounts receivable.

Josh Penwell 
Vice President - Contract Underwriting
Merchants Bonding Company

A critical component of a construction company’s bondability is employing best practices for cash flow management. As the economy recovers, the danger of default becomes even more prevalent as companies ramp up operations.

Company leaders should practice regular reviews of cash flow management techniques to ensure the long-term success of the company regardless of the ebb and flow of the economy.

A disciplined approach to keeping overhead from outpacing revenue, regular reviews of business areas that can tie up cash and maintaining the ability to maximize cash on hand are successful ways to avoid surety losses. Surety losses are often the result of cash flow failures.

Strong banking relationships are also a key component of a company’s cash flow picture and are viewed favorably by the surety.

Jim Bly 
Managing Director

Pay if paid clauses are not possible with many material and equipment vendors. so even the most profitable subcontractors occasionally may need to tap into their bank line of credit. Astute bankers will allow bonded receivables to be included in the borrowing base calculation if they have entered into an intercreditor agreement with the contractor’s surety. The intercreditor agreement should allow the bank the first right to bonded receivables up until the time of a surety default.

Once a default occurs, the surety is given its equitable subrogation right to all bonded proceeds, including the right to cross-apply bonded job proceeds from one bonded job to the next. This makes the surety a perfected security lender when a formal default scenario occurs and allows the surety to be more flexible in providing bonding capacity, while at the same time providing the bank with a higher collateral base. Banks are allowed to sweep the bonded job proceeds up until the time of the surety default. The surety may be given a short claw-back period of a few days to allow collection on recent bonded A/R that the bank swept.

How does character impact a contractor’s bondability?

Melissa Current 
Assistant Vice President - Surety and Fidelity
First Insurance Co. of Hawaii, LTD

The surety relationship is essentially a business partnership based on mutual trust and respect. Each party must demonstrate strong character. The surety does this by remaining consistent in support of the contractor’s surety credit program and providing input as needed. The contractor does this by following through on commitments made to the surety and keeping the surety informed of operational matters.

The surety agent/producer is an integral part of the business partnership, and must exhibit the same strength of character by providing timely, complete and accurate information, as well as experienced, actionable counsel.

A contractor’s character is the deciding factor in choosing to support a surety credit program once it has been established that the capacity and capital of the contractor warrant the size and scope of the program desired. Once the surety relationship is in place, the contractor’s character drives the ability or inability of the surety to accommodate stretch or out-of-the-ordinary bond requests.

Scott Paice 
Vice President - Head of Surety
FCCI Insurance Group

Sureties are more willing to overlook financial issues and focus on character and experience during a soft market in order to pick up new business or stretch out an existing account. Character references are key when considering start-up and spin-off operations or accounts that are still recovering from the recession.

The surety bond producer is the first line of character reference and trust. Independent agents represent a number of different surety companies and build these relationships over time based on confidence and experience. An underwriter can quickly gain a
comfort level with a new contractor account if the agent has handled the account for a while and can vouch for the firm’s integrity, track record and expertise.

Another important element is having an annual meeting with the surety and bond producer. These meetings can go a long way in demonstrating the “people behind the paper” for all parties involved. Character is apparent in the entire team that you surround yourself with, including your CPA, banker, attorney and employees.

Carl Castellano
Vice President - Contract Surety & Chief Risk Officer
Philadelphia Insurance Companies

Character is the key component of our business, best portrayed by two real-life experiences.

ABC Mechanical was a 20-year surety client when an obligee constructing a high-profile project demanded ABC to accelerate, significantly expand it scope of work and settle up later. Our indemnitor immediately called us to outline a recovery plan and request financial assistance. The indemnitor finished the project on time. The indemnitor cashed out of his IRAs, remortgaged his personal residence and transferred these funds to us, which left us with a modest loss. We then agreed with the indemnitor to continue providing surety, sharing a portion of net income, and we were ultimately repaid our loss. Without his exemplary character, the indemnitor would not have been able to continue in business and we would have suffered a loss.

Conversely, XYZ Painting enjoyed significant working capital and net worth, which left our country when XYZ encountered financial difficulty—no more surety credit and no more business.

Bart Davis 
Vice President - Contract Surety
RLI Surety

Evaluating character is one of the most difficult quantitative measures used by surety underwriters. The continuous demonstration of good character can be a differentiator for a contractor’s business. In its most simple form, sureties want to support contractors that can be trusted to deal fairly with all parties involved in a construction project.

Surety underwriters can gain some insight about a contractor’s character by evaluating their relationships with key suppliers and subcontractors. This can extend well beyond how well they pay their bills and into how well they successfully negotiate a dispute.

By becoming known as a problem solver, contractors can separate themselves from their competitors. The frequency of disputes or litigation can be used as an example. It is quite appropriate to be firm in some situations, but demonstrating an ability to find equitable resolutions to challenges that arise during the course of a project can build loyalty to a contractor’s business.

Michael P. Cifone 
Senior Vice President - Surety Underwriting
Hudson Insurance Group

A surety is continually evaluating the financial strength and character of the contractors to which it provides bonds. Character is by far one of the most important factors in determining a contractor’s bondability.

Financial statements will only take a contractor so far. The ability to develop and execute a long-term growth plan requires a strong management team and support of the surety. A contractor that builds a relationship with the surety based on trust and open communication will possess the tools to prosper.

A solid character and leadership qualities are also essential to attracting and retaining quality employees to successfully complete a project on time and within budget. Behind most successful contractors is consistent, quality work that is performed as promised.

By nature, contractors are risk-takers, and contractors with strong character may retain their surety support when times get tough. When risks are taken with honesty and integrity at the core of every decision, the risks are manageable and a surety is more likely to remain a solid partner.

Michael J. Mitchell 
Vice Chairman
The Graham Company

In my opinion, character is the most important factor when it comes to bondability. Having a strong character is powerful. It means the surety can trust the principal or owner, and trust that shared financial information is credible and accurate. That trust will always outweigh capacity and capital.

There is an instinctual element inherent to determining bondability. If a surety does not have a good feeling about supporting the contractor, then that feeling carries more weight than anything a contractor can say or do.

On the contrary, if you have a strong character, a surety will overlook some capital and capacity issues and will look for ways to support you. This is human nature: When you like and trust a person, you instinctively want to support them, but it all starts with having a strong character.

Henry W. Nozko, Jr. 
ACSTAR Insurance Company

Financial strength and experience are important elements of underwriting, but questionable character makes the surety feel like it is sitting on a two-legged stool. A financial statement is just a snapshot of how things stand at a given time. However, a principal has knowledge about the company and business conditions that will affect a financial statement. Misrepresenting the profitability on unbilled work could significantly change the stated value of a given enterprise.

Character will either maximize or diminish the level of bonding offered to a contractor. Delivering on what has been promised is one way of conveying a high level of character. When promoting your organization’s attributes, also talk about challenges and areas of weakness. Exceeding projections will raise a surety’s confidence, while missing projections has a punishing effect on the perception of character.

Sureties are unlike banks, where most of the flexibility for lenders is regulated out. Sureties have an unfettered, wide range of support in hand. Character can be the factor that moves the needle up the highest on the range of possibilities.

What are the bonding implications as the government promotes joint ventures as a way for small businesses to participate in federal projects?

Alan P. Pavlic 
Old Republic Surety Company

Generally, sureties don’t want to bond a joint venture that does not meet the set-aside requirements (affiliation with an unqualified partner). If the U.S. Small Business Administration (SBA) or U.S. Department of Veterans Affairs (VA) would qualify and approve joint ventures upfront, that would eliminate the surety’s concerns about potential disqualification. The rules now are vague. In analyzing a joint venture arrangement, a surety can only guess what the SBA or VA would say if they were to scrutinize the joint venture. Consequently, surety companies err on the side of caution, and a joint venture that does in fact qualify may not be approved.

It may be more helpful to small businesses for government entities to allow contracts in small increments, which would not necessarily require joint ventures to be formed. Getting involved in a joint venture can present various risks to small, emerging contractors that would not be presented working on their own. It is more advantageous for a small contractor to work and grow independently whenever possible.

Robert Murray 
Executive Vice President, Head of Surety

We anticipate seeing many small businesses and large contractors taking advantage of the recently expanded SBA mentor-protégé program      

Sureties may expect large contractors to seek support for bonds for SBA joint ventures (JVs), relying primarily on its own indemnity and financial strength. The reality is that the consequences of protégé default will fall more heavily on the mentor, even though the mentor will not have the direct control to manage the project.

Early surety involvement can help mentors evaluate how participation will impact risk exposure. The SBA regulations are complex, and non-compliance can have significant implications for the mentor and protégé, including penalties and financial losses. An experienced surety may be able to share past experiences and make recommendations about consulting qualified legal advisors before proceeding with SBA JV programs.  

The Executive Insights series is compiled by Donald Berry, national sales manager for Construction Executive. For more information on participating in a future Q&A, email dberry@magazinexperts.com.

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