Contractor Success Forum

[CASE STUDIES] Bond Approval Secrets Revealed

• Contractor Success Forum • Season 1 • Episode 191

Share episode

Send us a text

Let's talk real life construction bonding scenarios. From startups to high-growth companies, learn what bond underwriters actually look for and how to improve your chances of getting approved. Expert bond agent Stephen Brown breaks down practical strategies for construction bonds.

Subscribe for weekly construction finance tips:  https://www.youtube.com/@CarpenterCPAs?sub_confirmation=1

#ConstructionBonds #ContractorTips #SuretyBonds

Topics we cover in this episode:

  • 01:39 - Getting insurance and bonding as a new company
  • 04:00 - Bonding and insurance for someone who has limited cash reserves
  • 06:46 - Getting bonds with limited financial records
  • 10:19 - Getting bonds as a high growth contractor
  • 12:52 - Getting bonds with outstanding legal issues
  • 15:10 - Bonding when going from subcontractor to general contractor

LINKS

Visit the episode page at https://carpentercpas.com/getbonded for more details and a transcript of the show.

Join the Profit First for Construction community!

Find all episodes and related links at ContractorSuccessForum.com.

Join the conversation on our LinkedIn page: https://www.linkedin.com/company/CarpenterCPAs

FIND US ONLINE
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

[00:00:00] Wade Carpenter: Do you ever wonder what it really takes to get a bond approved? Or how different situations can completely change the approach you take? Today we're diving into real world scenarios that show the complexities of getting bonds approved. We'll give you a behind the scenes look at how it all works.

Welcome to the Contractor Success Forum. I'm Wade Carpenter with Carpenter Companies CPAs, joined by my cohost Stephen Brown with McDaniel Whitley bonding and insurance.

Stephen, I'm really looking forward to picking your brain today on this. I think there's a lot that we can learn from talking through some real issues with contractors.

This may be a little different episode, but what are your thoughts on this today?

[00:00:34] Stephen Brown: I'm thinking of the analogy of a matchmaker, or a real estate agent. If you're a real estate agent, you want your customer to put their home on their best foot forward. If you're a matchmaker, ideally, wouldn't it be great if you were matching an absolutely perfect male to a perfect female that had every attribute that each one of them was looking for. But in the real world Wade, that doesn't happen. It doesn't happen with contractors or surety companies either.

[00:00:57] Wade Carpenter: No. I do think there's several things that can be learned from, things that you and I deal with every day. We just never think about. But I think a lot of our contractors are going through these scenarios. So what we did was compiled a list of several different scenarios, and we're just going to talk through how Stephen would approach it, and maybe I'll have some things to chime in, but we'll see.. 

[00:01:16] Stephen Brown: And more importantly, if you are a contractor in that current situation. Because so many times Wade someone will go to a surety bond agent and they'll just get the answer no. Or not this one, or we're really not comfortable with it. 

Before we start, I would say, as always talk with the surety agent, communicate push them to get some answers just as fast as you can, that are going to be relatively accurate.

Getting insurance and bonding as a new company

[00:01:39] Wade Carpenter: We created several different scenarios, but let me just start with the new contractor. Somebody that started up, they broke off from the company they've been working for, maybe they've been doing this a long time, got some good reputation, he's known in the industry, but don't really have work behind themselves.

They've got a brand new company. What are the challenges? What are your thoughts on that? 

[00:01:58] Stephen Brown: It's always hard to get insurance and bonding for a brand spanking new company. It's hard. It's a lot of work for the agent and it's a lot of work to get the bonds approved. I would say first thing for a new contractor starting off is of course you're not going to have all the history of financials. You may not have all the working capital and everything else you need to get a bond approved. 

But if you need a smaller bond, say a half a million dollar job or less would be considered a smaller bond, then I would ask your bond agent to look into a credit scoring bond program for you, just to get started.

So in that situation, you know how to do the work. The job you want to bid is something you know how to do and you can manage and you can communicate that to your bond agent. But also you have good personal credit. You haven't really had time to build up corporate credit, but you need that first bond.

What's so important is a lot of contractors will think, okay, getting my first bond based on credit scoring is easy and it's fast. I don't need to do all the things that you and I talk about all the time, that make for a good construction company and make bonding approval easy. 

One other issue, Wade is the size limitation. These credit scoring bonds can go up to a million dollars, any one single job. Then they're going to need tax returns and other financial information on you to get approved for a job that size. 

Again that would be my recommendation. What could you do to help someone in that situation? 

[00:03:15] Wade Carpenter: Same thing with getting somebody a banking relationship. You know, you're brand new and I attribute it like you're a teenager getting credit for the first time. You may have been doing this for 20 years or more. You may be well known in the industry. You may have built all kinds of stuff for somebody else, but in your world, that's a little tougher to take into account, isn't it?

[00:03:32] Stephen Brown: It is. And that's a good scenario. That's a good point you brought up, Wade, because, I get calls from people just out of the blue. I don't know how they found me. I don't know where they came from, and they want a bond I need to know a little more about them.

If I have an existing one of my customers recommend someone or someone that used to work for one of my existing customers starting out on their own, then we already have a track record. And your surety agent's sales pitch to the bonding order might just help you get something that's borderline that wouldn't be approved otherwise.

Bonding and insurance for someone who has limited cash reserves

[00:04:00] Wade Carpenter: I know we could probably spend a whole bunch of time talking about a brand new contractor, but let's talk about somebody that let's say they've been in business two or three years, but they're maybe recently launched still, but limited initial cash reserves.

They don't have a lot of cash in the balance sheet not much liquidity. What are your thoughts on that? What are bonding companies concerned with? 

[00:04:16] Stephen Brown: Well, it's, it's so easy. you know, the four C's of getting a bank loan approved. It's your cash, how much cash you have in the bank. Your character. Your capacity to do the work that you're in business to do. And with bank, there's a fourth one, you have some sort of collateral. And in the bonding world the collateral is not an issue.

 So many contractors think well, I have a bunch of equipment. It's got value built on it. Bonding companies have no way of figuring out what the fair market value of your equipment is in a fire sale. So they just don't underwrite that way. My advice to a contractor like that is to implement every practice you can, like Profit First, Wade, to maximize every penny of profit that you can make.

And keep it in the company. So many new contractors will make a little bit of money and take it right out. But if the financial stability of your company, and bond credit's important to you, keep it in your company. 

[00:05:05] Wade Carpenter: Well, you know, I know from your perspective, If I'm trying to dress up a financial statement, we're talking about like somebody with minimal cash reserves starting off. 

Is there a rule of thumb that you would say you'd like to see some kind of liquidity, some kind of cash left in the company's books at the end of the year?

[00:05:20] Stephen Brown: Yes, Wade. It's what we call a 10 percent of working capital case. So it's your current assets, that's anything that's liquid that you can turn into cash, minus your current liabilities. That's all the debt you have over the next 12 months. So maximizing working capital. 

And also, if you don't have a lot of equipment debt, then you might have more of a company net worth. Because remember, long term liabilities like equipment loans, car loans, any long term debt, something you owe over 12 months affects your net worth. 

So bonding companies ideally would like to see, outside of the credit scoring program, $100,000 of working capital. That's current assets minus current liabilities, and $150,000 of net worth. That's a great starting point for helping someone get a bond program started. 

And of course, Wade, the longer we can show a track record of having that amount in your account on your financial statement, the faster we can move as far as bumping up that job size to higher limits. 

[00:06:15] Wade Carpenter: I guess I think about it too from the standpoint of the CPA. The typical CPA just thinks about, the contractors hate the taxes, so let's minimize our taxes. So let's say we're on the cash basis for tax purposes. We spend out all our cash to knock down our taxes. That's the thing that I see all the time, is, we've wiped out all our cash. You're ruining your capacity to get a bond.

[00:06:34] Stephen Brown: It's so important, Wade, to talk to your bond agent and your accountant, and for all three of you to be on the same page. Don't just make a decision that just guts your ability to get bonds. I see it happen all the time. And it's frustrating. 

Getting bonds with limited financial records

[00:06:46] Wade Carpenter: Let's try another one of these scenarios. Let's say we got a sole proprietor that maybe they've been doing some jobs freelancing on the side. And they decided this is time to make a move. We've been a sole proprietorship. We've never set up a real company or maybe an LLC, we're just filing as just a Schedule C.

We don't have good records. We've just kept everything on spreadsheets. And I know from my perspective, I've got some things to tell you about it, but, from a bonding perspective, if they don't have records, they have limited financial records, what are your thoughts on that? 

[00:07:14] Stephen Brown: My first thought is you are limited to a credit scoring bond. If you can produce a personal financial statement that's six months older or newer, your bonding agent can help you with that, and you have good personal credit and you don't have any bad credit on your company, then you can get up to a million dollar bond with the credit scoring program.

Now, in order to get out of that limitation, Wade, you have to start being able to produce some accurate financial information. For example, if you were going to make a decision to lend someone some money, and you wanted to be relatively sure that you would be paid back--and let's take your accounting hat off.

You just say you're any person. Business person, friend, anything. What criteria would you look for to being comfortable extending that credit?

[00:07:55] Wade Carpenter: I think as a bank or whatever, they've got the same concerns. It's you got to show that you're running a profitable business and you can manage it properly. Without records. it is definitely a problem. And I see typically from your perspective, is it not three years of reviewed financial statements? 

[00:08:09] Stephen Brown: Three years of reviewed quality financial statements that show you generally make a profit on your job. So job schedules that show that you regularly maintain a steady and regular profit, that's worth its weight in gold for bonding.

Makes sense, doesn't it? Wouldn't you want to bond someone like that, Wade? 

[00:08:26] Wade Carpenter: Yeah, I want to know that they've got their act together. And too often I see these contractors trying to avoid the taxes and keep it as simple as possible, and maybe they haven't filed taxes. And they don't feel like it's necessary, 

They get to a certain point and they finally say I really need to do this, but I've never really done this and I've got several years to catch up. And the sooner you start putting that financial puzzle together, the sooner it can get better for you. That's my perspective. 

[00:08:48] Stephen Brown: That's right. You know, cash, character, capacity. We'll talk about it till the end of time as far as bonds are concerned. Do you have enough cash to be able to start the project, and complete it even if your payment is slow, in this scenario.

Every one of these cases we're talking about this morning, all come down to cash character and capacity questions.

 Can you do the type of work that you want to bid? Have you done it before? Can you explain your bond agent and your underwriter what your capabilities are? What your strengths are? That's important. And your capacity to do the work. Are you so overwhelmed with work right now you can't do the job?

Is this job too big for you? Who's to say whether it's too big for you? Whether a job's too big for you is an analytical function that a bonding company and an accountant can come up with. If you need that answer, that's something that they can come up with. 

And you say that's not fair. You don't know what I can do. You don't know what my capacity is. But in our world of accounting and bonding credit, it all ties down to cash character capacity. Can you do the type of work? Do you have the cash to cashflow that job until you get paid? Do you have a track record of doing that kind of work? 

What special things about this job are going to be important, or something that we need to focus on? If you're talking about that to your bond underwriter and your bond agent, about the things you're concerned about the job, then they're a lot more comfortable knowing that you have a grip on all the things that could be good or bad about the job.

Does that make sense?

[00:10:13] Wade Carpenter: Yeah, absolutely, and sometimes I think you're reading my mind because the next case study is, let's take the opposite. 

Getting bonds as a high growth contractor

[00:10:19] Wade Carpenter: We got a high growth contractor and you're concerned that they're overextending themselves. They're, rapid business growth, and maybe we're straining our cash flow.

What are the bond underwriters thinking about?

[00:10:30] Stephen Brown: This is the most stressful scenario for a bond agent. Sometimes it is or isn't for the underwriter. But you are pushing the edge of the envelope as far as your bond credit's concerned. So that terrifies your bond agent. And also you're in a great growth mode. You're not going to say no to stuff you can make money on.

And the whole key to making that work is your history, showing that you are still bidding the type of work you make money on, and you have the capacity, you have the crew, you have the people, you have every resource, you have every physical thing that you need to complete that project.

The equipment, how it fits in with your schedule of work, all this, the more you can communicate with your bond agent, the better job they can do. And also I might add, Wade, is this is a time that you are really testing your relationship with your surety company. So as a bond agent, you are really seeing what that company is willing and capable of doing for you. That's a great question, Wade.

Did I answer that? 

[00:11:24] Wade Carpenter: Yeah, you know, I just want to go more to the root of it, because you absolutely answered it. Where I think contractors have a disconnect is, they're saying okay, we're growing, we're doing great. Why is this a problem? Me and you have seen many contractors grow themselves right out of business.

I know I have. That's what people don't understand is that this growth can run you out of capital. And it can be the kiss of death. When you think you're killing it, all of a sudden, you have to shut your doors.

[00:11:48] Stephen Brown: Everything we've ever talked about on every podcast we've ever done, Wade, is that this particular case study we're talking about has all these elements in place. That's how you got to where you are that you are getting all the bonds you need.

Now you're in a situation where you are pushing the edge of the envelope, and you're under your bonding company's feelings about you and your capacity. Their analysis of your cash and working capital, they're understanding what type of work do you really do that you're really good at doing and your ability to get them accurate and timely in house financial information.

Most importantly, a work on hand schedule. How much work are you running a month, 30, 60, 90? We always do runoffs to show the bonding company how much. So sometimes it appears like your capacity is maxed out, but you can go in there and you can show the bonding company how much work that you are running off.

You might have a lot of jobs that are really going to hit in the next 90 days where you're going to get paid for, and that increases your capacity. So that's another trick.

[00:12:48] Wade Carpenter: If we can move on to another case study, let's take a different approach to this.

Getting bonds with outstanding legal isssues

[00:12:52] Wade Carpenter: Let's say a contractor otherwise has pretty good, solid financials, working capital equity, but they got some outstanding legal issues.

Maybe they're facing a lawsuit, reputation's been called into question, there's all kinds of financing and things like that. How would a legal issue affect my capacity to get bonds?

Well, it most certainly does, Wade. And I don't care where you are in any situation when you're involved in a lawsuit, communicating that to your bond agent, so together you can communicate it to your bonding underwriter. It's hugely important. We go back to your financial board of directors.

[00:13:26] Stephen Brown: We always say, Wade, get the best construction oriented CPA, get the best bond agent, insurance agent, get the best attorney. You can find and get the best banker you can find. 

Usually you will find that this group of people on your board of directors run in the same circle and have a different levels of experience.

So having an attorney that as a underwriter and a bond agent, they know you and trust you, let them talk to that attorney if they want to. I know it may cost you money, but the more you can do to talk about your situation, your underwriter will not be able to calculate or understand how much your legal expenses may affect your cashflow or your working capital.

But as your bond agent, I'm always concerned about that. Because when you're taking on a difficult case and your legal bills are high that's going to take a hit to your working capital till you win the case. And I'm not trying to scare anybody off who has a justifiable strong legal case. But these are things that you need to think about.

[00:14:22] Wade Carpenter: Absolutely. I've seen some cases where you're worried about the outcome. And from the banking standpoint, they get nervous. They got lines of credit. And some of that sometimes can snowball. And I'm sure that affects your ability to get bonds on that.

[00:14:34] Stephen Brown: Of course, it most certainly does. Lawsuits are going to happen. How you conduct yourself, what you do to get through that can only make you stronger. And I think getting projects started off on the right foot is one of the keys to avoiding any type of lawsuit.

Having the proper insurance in place to where when something happens beyond your control that is an insurable risk, you can check it to the insurance company to handle. That takes so much stress off of you, Wade, And you want to know that your agent has you with a good company, with a good claims department that are going to fight for you in a situation where you're in the right and someone else is in the wrong and you need defense.

Not all insurance is the same, Wade. I would give that advice as well.

Bonding when going from subcontractor to general contractor

[00:15:10] Wade Carpenter: Absolutely. I see contractors doing this in various different capacities, but let's say we got a subcontractor that has been doing whatever they're doing, earthwork or concrete or, electrical contractor.

And they're all of a sudden wanting to become a general contractor. They want to start building a building when that's not their main line of business and they see some opportunity or maybe they've got some kind of bid out there, a big, huge opportunity for themselves, and it's a bonded job.

So maybe their normal subcontractor business might be bondable. It might have good working capital and equity. But how does trying to switch from a subcontractor to being the general, how would that play into it? What would you think about? 

[00:15:50] Stephen Brown: Well, when you change roles from what you regularly do, then it's more important than ever to talk to your bond agent ahead of time of what you're thinking about and what you want to do and to take their advice.

Because one of the best things you can do, Wade, if you are stepping out of your role of doing one particular trade and you want to manage other trades, is to do some jobs on a partnership basis. Do you have a mentor that will help you learn how to do this? That's the best advice I can give you. 

The second one is, say you have a particular job that's predominantly what you do, your trade, like predominantly concrete or predominantly electrical. Then you want to emphasize the percentage of that of this project you want to bid versus the other things. 

And, if you are going to take the role as general contractor, what subs are you going to use? The problem with starting out is you haven't used those subs before. They may be friends of yours, but you haven't used them in a working relationship before.

You really want to emphasize ahead of time what subs you're going to use and that you will bond them back. They will be required to give you a bond guaranteeing that they will finish their part of the job and that they will pay all expenses. There'll be no liens and there'll be a warranty on their work. 

So that's an ideal situation. Sometimes when that doesn't work out just forming an informal partnership before you bid the job is worth its weight in gold to get the job approved.

[00:17:09] Wade Carpenter: Yeah, absolutely. I guess this one sort of hits home for several of my contractors. They just see opportunities and unfortunately, maybe they've got a great business and they make really good profits doing one thing, but they see big dollars and they're chasing big dollars and think that profitability is going to translate to a general contractor in the same proportion that the subcontracting.

And you got a good point about okay, if they got a huge part of it is their trade. They may know how to do that and pick better margin off of it, but is going down another slope I've seen it tank some contractors. 

[00:17:38] Stephen Brown: If you call me, I'm gonna ask you a lot of questions. How many moving parts are involved? What's the time limit to get this job done? What are the liquidated damages?.

How does This fit in with your current work schedule if you get the job? When would the job start? Where's the job located?

Again, Wade, there are bonding agents out there who just cram bonds through the system till they get the job approved. And there are bonding agents that give you advice and do both. 

You've got to take the advice of your bond agent, and you've got to understand what they're telling you.

So many times a bond underwriter and a bond agent will be telling someone, we don't see this as a good fit and here's why. Then you have to say do I believe you or does this just tick me off? And uh, I want to leave you. I think most importantly is what are they saying to you about this job?

Because remember, my job is to get your bond approved. And also my job is to make sure I don't bond you out of business. As soon as this pops up on your radar, start talking to your agent about it. You may discount and say, I don't even know if I'm going to bid it or not.

But in this scenario, I would say, start talking to your agent sooner than later, start bouncing things off. And believe me that bond agent will tell you exactly what we need to do to get that bond approved. And what makes it doable for surety also makes it doable for you.

[00:18:48] Wade Carpenter: Absolutely. To me, this has been fascinating to talk through this like this I've really enjoyed it. We didn't actually hit even half of our scenario list we had. So maybe we can make a part two or three out of this one. But I've enjoyed this, Stephen. 

[00:19:00] Stephen Brown: When you're talking about something you do every day, day in and day out, and that's all you do, you have opinions on things. And I just want to remind our listeners. The reason that we do this podcast is to try to let people know what they should do in order to not lose money and to not go out of business. So that's it. 

It's always moving. It's always changing. the more you communicate, the better chance you have of getting your bond agent on board and being able to plan ahead to get your accountant to help you get the reports and information you need for your bond agent to get the bond approved.

[00:19:32] Wade Carpenter: I know you talk about the accountant side all the time, but having a great bond agent like Stephen that knows the construction industry, there's plenty of people out there that sell you the Workers Com p policy, but they don't understand bonds. Or maybe they're doing bonds on the side, and they don't have the experience that Stephen has. 

An experienced construction bond agent can be worth their weight in gold. And, he doesn't charge extra for this advice. As he said, his job is to try to help you. And. the advice he gives is not costing you anything.

So I always tell my contractors, talk to your bond agent, keep them involved in your year end planning and letting them know what's going on. 

[00:20:05] Stephen Brown: Wade, we can't do our job without you as an accountant. We can't do our job without the contractor being able to do the work and communicate. 

We're always looking to help someone not make the same mistake that someone else made, because remember when you get into bond claims, there's been a failure at some level. And it's our job to see what that failure might be before the job starts. It's tough to be a salesperson and be optimistic all the time, but that's what we have to do.

And thank you for that.

[00:20:32] Wade Carpenter: Again, I think there's several more we could unpack here in maybe a different episode, but I think we're running a little long. Hope our listeners felt the same way. If you got any thoughts or feedback on today's episode, we're always happy to answer questions or hear your thoughts and other thoughts on what you'd like us to cover. Drop them in the comments below. 

Want to say thank you for listening to the Contractor Success Forum. For more information, go to Carpenter CPA's YouTube channel or ContractorsSuccessForum. com. And again, if you enjoyed the episode, please share and subscribe. It really helps out the channel.

Follow us every week as we post a new episode and we will look forward to seeing you on the next show.