In the construction industry, bonding capacity is crucial for growth and securing larger contracts. It represents the total dollar amount of bonds a contractor can be approved for at any given time. Understanding what influences bonding capacity and how to increase it is essential for contractors aiming to expand their business.
What Influences Bonding Capacity?
Three key factors determine a contractor’s bonding capacity:
- The History of Profitability
One of the first things a surety company evaluates is the contractor’s ability to make a profit. They want to know:- Can the contractor generate consistent profits from projects of various sizes?
- Does the contractor maintain healthy financials based on revenues and overhead?
To assess this, surety companies look at historical income statements and work-in-process (WIP) reports. They also consider your debt, equity, and liquidity. Liquidity, in particular, is often crucial for contractors seeking large contracts, as it indicates their ability to handle project costs.
Contractors with high debt and low liquidity are seen as higher risk, whereas those with low debt and high liquidity are more favorable. Surety companies look at trends over several years to predict future financial health based on recent data.
Source: Surety Bond Insights
- Personal FICO Score and Balance Sheet
Surety companies also examine the personal financial responsibility of the business owner. A high personal credit score, like in other financial matters, makes it easier to qualify for bonds and lowers the cost of premiums. Surety companies want reassurance that the business is being run by someone who responsibly manages personal and business finances.A strong personal balance sheet shows the contractor’s business is in capable hands, giving surety companies confidence in approving larger bonds. - Past Experience and Reputation
Surety companies also evaluate a contractor’s past experience and reputation in the industry. While they may look at the largest project a contractor has completed, they also consider:- How the contractor has handled previous projects,
- The skill of the contractor’s team, and
- The quality of relationships with subcontractors.
In some cases, a contractor might be approved for a bond much larger than their past project sizes if the circumstances are right. For instance, a contractor may qualify for a larger bond if they’ve consistently demonstrated reliability and have worked for the same satisfied client before.
Source: Construction Surety Bond Guide
Example of Bond Approval for a Growing Contractor
Two years ago we were submitting a bond request for a contractor we’ve been working with. He needed a $6.3 million dollar bond — something way above his current bond limit as his largest project to date was $1.8 million.
The reason he needed the bond is he had just completed a job for the same owner and the owner was very happy with him and invited him to bid this specific job. On paper, it didn’t make sense. But we look at more than just what’s on paper; we met with him in person and discussed his circumstances and got a strong understanding of why the contractor felt the job was a good fit.
We approved the bond with the aid of SBA. It shows we need some experience to show what are the contractors capabilities. Sometimes bond limits can be expanded with the right information.
For us, if the right job comes along, it will not trigger an automatic “no.” This is an opportunity to communicate, an opportunity for all of us to get on the same page aiming for the same goal. Financial statements are important when considering bond capacity, but you have to look more between the lines rather than just running algorithms and analyzing numbers.
How to Increase Bonding Capacity
Increasing your bonding capacity requires more than just financial health—it involves working with a team of professionals to help your business grow.
- Use an Independent CPA
Surety companies prefer financial statements prepared by an independent construction-oriented CPA. This adds a level of verification, ensuring that the numbers presented are accurate. An experienced CPA can also help with cash flow management, profitability analysis, and more.Source: Certified Public Accountants in Construction - Work With Your Insurance Agent
Your insurance agent plays a key role in ensuring that you have the proper coverage for your current and future projects. They help identify new requirements and find the right carriers for those needs. Their insights can also assist with navigating surety bond requirements.Source: Insurance and Surety Bonds - Engage a Bond Specialist
A bond professional helps contractors increase their bonding capacity by guiding them through the bonding process and advising on how to manage risk. Being bonded not only sets contractors apart but also shows that they have been thoroughly vetted by a third party, which gives project owners peace of mind.Source: Bonding Solutions for Contractors - Build a Relationship With Your Banker
Developing a strong relationship with a bank that understands the construction industry is essential. A line of credit is invaluable for managing cash flow, especially when payments are delayed. Contractors can use credit to cover payroll or pay subcontractors when needed, ensuring that work continues smoothly.Source: Construction Lending and Cash Flow - Retain Legal Counsel
Hiring a lawyer experienced in construction law can provide two main benefits. First, legal counsel helps create continuity plans to protect your company in case of unforeseen events, which surety companies view positively. Second, a lawyer can help contractors navigate complex contract terms, ensuring that you understand your responsibilities and liabilities.Source: Construction Law Expertise
Conclusion
By focusing on financial health, building a strong team of advisors, and maintaining a solid reputation, contractors can steadily increase their bonding capacity. This growth opens up new opportunities, allowing contractors to take on larger projects, build trust with clients, and secure their business’s long-term success.
Sources:
- Surety Bond Insights
- Construction Surety Bond Guide
- SBA Surety Bond Program
- Certified Public Accountants in Construction
- Insurance and Surety Bonds
- Bonding Solutions for Contractors
- Construction Lending and Cash Flow
- Construction Law Expertise
Richard Ford
