Are You a Good Risk for a Bond?

Posted by Steve Snodgrass on Mar 18, 2015

Graniterock CFO Steve Snodgrass contributes another  article excerpted from the 1956 Engineering News-Record which shows how “the more things change the more they remain the same.”

What makes a contractor a good risk for a bond? What makes you a poor risk in the eyes of surety companies? If you are the contractor, here are some of the things they will try to find out about you and your business.

What Bond Do You Need?

First, what type of bond do you want - a bid bond, a performance bond or a payment bond? The information you will be called upon to give the surety company applies to all three types of bonds, with only minor variations. If you’re seeking a bid bond, the surety will want a copy of your most recent financial statement, a copy of the bid advertisement and a set of instructions to bidders. If you want a performance bond, or a payment bond – or both – you’ll be asked for both your current financial statement (and often statements for two or three preceding years), a copy of the contract and specifications and an explanation of exactly what part of the overall job you will perform. 

Is Your Bid Too Low?

And that’s only the beginning. Who is the architect or engineer on the job? What is the estimated contract price – and what were the other bids in comparison with yours? In this respect, the surety wants the names, addresses and bids submitted by the other bidders. This can be trouble spot No. 1 if you’re trying to get a bond, especially if your bid is substantially below the others submitted. You’ll have to answer some pointed questions if your bid was $500,000 and all other bids ranged from, for example, $700,000 and up. The sureties want to make sure you’ve included all the items required, that you’ve added the figures correctly – and that your estimates are sound.

The surety will want to know what the architect or engineer’s estimate is for the job – and what you estimate the job will cost you. You’ll be asked when the work must be started – and when it must be completed, and what penalties are provided for failure to complete by the contract date. 

How Will You Be Paid?

Naturally, the surety will want to know how the owner will pay you – and when. Will your payments be in bonds, warrants or other securities? How much of the contract price will be withheld until completion? How much of the job is guaranteed after completion? Then, you’ll be asked how much of the job you plan to sub- and whether or not your subs will be bonded. (If your subs are bonded, you’ll have an easier time getting a bond for the general contract.) If your subs aren’t bonded, the surety will want to check them carefully.

Are Your Subs Qualified?

Occasionally, the surety may feel that one or more of your prospective subcontractors lack the experience, financial resources or organization to handle the particular job in question. In that case, you’ll be asked to get another sub who is better qualified. Then, the surety will want to check on your financing for the job.

Sureties aren’t in the business of lending money – so you’ll have to get your working capital at the bank. The surety will want to know whether you have arranged for a loan for the job. If not, they’ll probably recommend that you work out your line of credit first – then come back for the bond. They’ll check the bank that has given you credit. They’ll want to know the terms of your bank loan and what collateral, if any, you had to give the bank. And, they will want to know whether you have assigned – or intend to assign – to the bank any of the payments you receive from the owner. 

Do You Have Enough Working Capital?

Your line of credit and your cash in the bank will be checked so that the surety can determine whether or not you have enough working capital for the job. Although the percentage varies, a good rule of thumb is that you should have working capital equal to about 10% of the contract price, e.g., you should have working capital of $100,000 on a $1 million contract. 

While this formula can’t be applied at all times or to all types of work, it plays an important part in the surety’s decision on whether you are a good risk on a particular job. It works as a safeguard for both contractor and surety because it often keeps a builder from taking on a job that’s too big for him to handle.

Have You Done Similar Work?

That leads into the next major item that is used to rate a contractor –experience. The surety will question you closely to find out whether you have performed similar work before – and whether you did it on your own or as an employee of another contractor. Just as banks frown upon the road builder who tries to move into the building field, or vice versa, the surety companies prefer a contractor to stay with the kind or work with which she is most familiar. The problem, of course, turns up whenever one type of construction is sagging at a time when another type of work is booming.

If you want to switch to another type of construction, and you have a good record, good financial resources and a sound organization, the sureties probably won’t shut the door in your face. But, they may urge you to go slow, start out with small jobs in the new field – and get your education when the stakes aren’t too high.

There are many other things the surety companies will want to check, but two are especially important. They’ll want to know your equipment and materials situation, and how much other work you have on the books. You’ll be asked for a list of the equipment you own, whether you’ll need to buy more equipment to handle this job and how much it will cost you. On materials, you’ll be asked whether you have firm prices on the materials you’ll need and what assurance you have that you’ll get delivery.

Do You Have Too Many Jobs?

The last big question is how much other work you have that is uncompleted – whether you have any bids in on other projects that have not yet been awarded. One of the major reasons for contractor failure is taking on too much work at one time. They don’t expect a contractor generally to have only one project under way at any given time, but they have learned from sad experience that a builder can flounder easily when he has so much work that working capital, equipment and organization is strained. 

What’s Your Reputation?

Those are some of the tangible items that sureties can check to find out whether or not a contractor is a good risk. The intangibles – often as important – are the person’s integrity, intelligence and personal habits, and there the sureties make their gambles, shrewd guesses based on years of interviewing contractors across a desk, and getting to know them personally and finding out their reputation among the builders and suppliers. Pass this acid test and you’ll find that for a comparatively small cost you’ll have security, help if you need it, and probably a better knowledge of your organization that you had when you walked through the door.

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