SURETY BONDS
Bonding Capacity 101
What Contractors Need to Know
Bonds are more than a complex and tedious part of construction projects – they can be your ticket to larger, more prominent projects.
But first you have to understand the significance of bonding capacity, which is the ability to secure a bond to help protect the owner against performance, default, financial, or warranty issues. Bonds are multi-faceted and often misunderstood, so here’s your high-level overview – and some actionable tips to help you increase your bonding capacity.
Let’s Talk Bonding Capacity
Bonding capacity is the amount of credit a surety company is willing to extend to a contractor. Like a credit card limit, bonding capacity can change based on how comfortable the surety company feels about the contractor's overall performance. A higher bonding capacity allows general contractors to bid on larger (often public) projects.
Asking for More – Managing Your Bonding Capacity
Let’s say you want to bid on a project that would take you above your current bonding capacity. You would approach the surety company to ask for an increase, just like you might ask to raise your credit card limit to make a large purchase.
Raising your bonding capacity by bidding on “stretch” projects slightly outside your current limit is a good business practice and can help show sureties that you may be ready to take on more work.
Your Financial Homework
Bonding capacity is a credit-based relationship, so financial factors carry the most weight in decisions about the limits.
Be prepared to provide several different types of financial and corporate documentation, which can include:
- Balance sheets and income statements
- Liquidity
- Cash flow projections
- Debt level
- Net valuation of the company
Surety companies will take it a step further and review several primary factors, including:
- Equity to backlog – Determining how much buffer the company has at the current backlog level.
- Cash on hand to short-term bills – Ensuring the company can meet the necessary obligations and has the liquidity to handle any bumps in the road.
- Personal Guarantees – Personal credit reports of the owner(s) to help determine the business’s creditworthiness.
- Backlog (Work-On-Hand Schedule) – The projects a contractor has under contract and their expected costs. Any incomplete portion of the contract is part of the backlog, and the remaining associated costs affect future financial projections.
- Experience – Surety companies consider a contractor’s successful completion of past projects (Schedule of Completed Contracts).
- Types of Projects – The types of projects a contractor plans to take on (Scope of Work), compared to past work.
Set Yourself Up for Success
A GC with a higher bonding capacity can give owners confidence that the company has completed a portfolio of successful contracts, so how can you work towards an increase?
- Practice sound financial management: Set yourself up for success by managing your finances and documentation well before any capacity increase requests.
- Build a portfolio of successful projects: Every satisfactorily completed project gives surety companies more faith in your ability to deliver.
- Plan an incremental increase in capacity: Sureties look at the magnitude of the increase based on a company’s track record. Plan to gradually stretch your company’s capacity for project size and type – jumping from $1 million projects to a $50 million bid is unrealistic.
- Diversify your project pipeline: By diversifying your projects, such as public and private, residential and commercial, you can mitigate risks and stabilize your bottom line if one sector dips.
- Request increases in advance: Don’t wait until the last minute to ask for a bonding capacity increase. Start communicating early in the bid process and make realistic and comprehensive plans for jobs to bid on. Don’t forget to work closely with your broker and surety company to tie up loose ends.
The Old Adage is True: Relationships are Everything
When building a solid relationship with a surety company, the growth in trust over time can help negotiate bonding capacity increases that make good business sense.
GCs who demonstrate sound business practices, successfully deliver projects, and implement responsive growth strategies are more likely to receive increases when they ask.
The CCIG team has the experience and relationships to navigate the nuanced world of bonds. If you have questions about your company’s options, email Olga.Iglesias@thinkccig.com for a conversation about your company.