The best designs for Bonds
How do you get the best surety bond for your company?
Many times, the first time that someone is introduced to a surety bond is when your company is required to get a bond in order to get a contract. These requirements developed out of a Federal statute known as the Miller Act. The Miller Act requires that anybody doing work on a federal contract that is greater than $250,000 is required to get a surety bond – usually a payment or performance bond, or both. Following the implementation of this legislation, most state and local municipalities have passed similar regulations, known as Little Miller Acts (inventive, huh?).
This was the standard that most companies were used to. But after the financial crisis in 2008, and the construction fallout that came from that (and resulting litigation), there became a new set of rules. Now, private companies are requiring surety bonds for their projects. Thus, in a large commercial strip mall or other development, a performance or payment bond is being required for each contractor that is working on the project. This is a completely new concept to many companies that have not had to deal with the requirements that surety companies require prior to issuing a bond.
What is the first step in obtaining a bond?
The first step is to apply to get a bond. There are several great companies out there. Our two favorite are: swiftbonds.com and unolife.net.
A good surety company first recognizes what type of bond is needed. That is pretty straight forward as the bond requirements are listed in the contract (or bid package). However, what is not often stated is what it takes for a surety company to underwrite the bond. It generally involves much more than a simple phone call.
What you will need to do is first figure out the size of the bond. For bonds under $350,000, there is a much more relaxed set of rules. In many cases, if you have a great credit history and are not a startup business, then you can get qualified for a bond almost immediately. For performance bonds over $350,000, you will have to provide much more documentation so that the surety has enough assurance to underwrite you for the bond. Surety companies are very, very, very conservative. Thus, they don’t want to take any risk at all.
A side story: my bond guy was contacted once by an investment banker that wanted to get a surety bond for their new oil well enterprise, which is not a problem. However, once he explained the deal, it wasn’t a surety bond that he wanted, but a guarantee for the bank. The surety guaranty was so that if the bank lost any money (that is, no oil was found), then the surety company would pay the bank back all of its loan. Obviously, the surety company didn’t write the bond (actually, they laughed). Here’s the point: the oil company wanted an equity investor and not a bond. The bond is super conservative and an equity guarantee is on the opposite end of the spectrum.
What you need to do is provide a good financial history and track record of profit-making contracts. Further, many sureties want to have capital or personal guarantee to make them whole in case there is a claim filed on the bond. Surety companies are even more conservative than a bank.
What are the roadblocks in getting a bond?
The biggest roadblock is the lack of a good track record. Specifically, a surety underwriter is wanting to see tangible net worth that is steady or climbing. An increasing balance sheet is good.
Most importantly, you will want to show increasing cash flows. Most bond claims arise not when a company is losing contracts, but when they are winning contracts. The problem is not that they aren’t getting work, or even that their work is under-priced, but that their cash flow is unable to sustain their current business model. Thus, the underwriter will really focus on the cash flow of the company and whether it can sustain any downturn in business or any spike in business.
The next biggest roadblock is your personal situation. A surety bond is just a guarantee that you will perform (or pay) according to the terms of the contract. Thus, what a surety is really wanting to know is whether you are a person of integrity. Someone who will fight tooth and nail to make sure that everyone is paid back. A personal bankruptcy or multiple court actions are severe limitations to getting a bond.
What is the typical cost for a performance bond?
The typical cost for a performance or payment bond is approximately three percent (3%) for bonds less than $350,000. As we mentioned above, these bonds are easier to get and, therefore, a bit pricier than other bonds. For larger construction jobs, the bond price decreases as a percentage of the contract, although the total dollar amount continues to climb. We see most large jobs being priced at less than one percent (0.75%) to three percent (3%).
How can you increase your bonding capacity?
One of the great things about being bonded is the increased amount of work that you can then go bid. More importantly, these jobs are abundant and generally include the bond price within the contract. Thus, the bond is being paid for by the owner (government usually) and not being taken out of the general profit margin of the job. Further, you should always try and get owners to require a bond, which will reduce competition.
The drawback is that each firm has a general capacity that can be bonded at any one time. For most businesses, this amount is two jobs that are less than $600,000 (using separate bond companies can get you here). But after that, you would have to become qualified for larger bonds, which is similar to being underwritten for a single large bond. This requires the full blown underwriting process for those bids and you will have to utilize best practices in your financials.