It is important to maximize your bond capacity to keep your construction business booming. You do this by winning lucrative projects. You win those projects by building your relationships with both your clients and your surety bond company. It is important to remember that a surety bond is not typical insurance. While it is true that you pay a premium for the bond, it acts less like insurance for you and more like insurance for your customer.
Here are the three major players:
The principal who needs and posts the bond.
The obligee who requires the principal to be bonded.
The surety who guarantees that the principal with meet the requirements of the obligee.
Surety bonds transfer and mitigate risk, guaranteeing that all project obligations will be met.
As you can see, it is crucial to have a good working relationship with your surety company. It is equally crucial that you, as the principal, know and understand your bonding capacity and how it is determined. Finally, it is wise to invest in a construction savvy CPA who understands these relationships. They can advise you how a surety company might view your bond application in relation to the construction industry.
How The Surety Views Your Risk
Mitigating risk falls on the construction company, not the obligee, and not the bonding company. The surety will view how stable your company is by assessing your cash flow, balance sheet, operating lines of credit, credit score, and net worth. Understanding those numbers will help you understand how an underwriter will determine your bond capacity.
Here are a couple of important terms you need to know:
single bond capacity: the amount of bond for one job only.
aggregate bond capacity: the amount of bond at any one time for more than one job.
The single capacity is listed first. The aggregate capacity is listed second. Bonds are issued per project as every project is contracted with its own provisions. Your surety company will look at projects that have been similarly bonded as a benchmark.
It is important to note that every surety bond is conditional, meaning that it can be awarded and it can be revoked. Surety companies often look to this conditionality as a benefit to them and to the obligee, as no company wants to lose their surety bond for subpar performance.
How Underwriters Determine Bond Capacity
Underwriters use no set formula to determine your bond capacity. This means that your bond capacity is not set in stone. It is an estimate of risk based on both objective and subjective criteria. Underwriters will look at your organization, its employees and your work history. This is the more subjective part of your relationship with your surety. Then your surety will look at the hard numbers. Your financials will tell the story behind the success, or lack thereof, of your company.
The underwriters will also look at your company and its experience with various types of construction jobs, determining how well you have handled smaller projects and how well you have handled projects worth millions. No two job dynamics are alike and your surety will take that fluidity into account before issuing any bond capacity.
The Value of a Construction Savvy CPA
It is valuable to work with a construction industry CPA whose knowledge maximizes your bonding capacity. Surety companies who see construction contractors working with construction savvy CPAs know that there may be less risk from default and claims. This is because the CPA has knowledge of:
current trends in the construction industry, including building methods,
industry specific risk management,
private, public, and government projects,
and complex IRS Section 4020 regulations.
A good construction focused CPA will also help you determine how to maximize your working capital in order to keep cash flowing. Your operating success is imperative in showing your surety that you can handle the lucrative projects.