Contractor Success Forum

[Ask a Bond Agent] Avoid These Bonding Pitfalls

• Contractor Success Forum • Season 1 • Episode 193

Share episode

Send us a text

Struggling to get bonded? 🤔

In this episode, we tackle real-life case studies to help you navigate the construction bonding process. Wade and Stephen share expert insights on overcoming common pitfalls.

Listen now and level up your bonding game! 💪

🚨 Apply to beta test Wade's Profit First for Commercial Construction system (for FREE!)

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

#ConstructionBonding #ContractorSuccess #BondingTips

Topics Wade and Stephen cover on this episode:

  • 00:35 - Importance of relationships with your bonding agent
  • 01:40 - Announcement: Get early access to Profit First for Commercial Construction
  • 04:52 - Seasonal revenue challenges
  • 07:09 - Equipment debt issues
  • 09:16 - Inconsistent profit margins
  • 11:12 - Taxes versus bonding
  • 14:17 - Family-owned business succession
  • 16:54 - Overdue taxes impact
  • 19:25 - Tax liens and payment plans

LINKS

Visit the episode page at https://carpentercpas.com/getbonded2 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: Getting bonded can feel like solving a puzzle. Every contractor situation is different. And the path to approval isn't always straightforward. In this episode, we're back with more real life case studies to break it all down and show you how to navigate the process.

Welcome to the Contractor Success Forum. I'm Wade Carpenter with Carpenter Company CPAs, and as always, I'm joined by Stephen Brown with McDaniel Whitley Bonding Insurance. 

Stephen, the last time we tackled this topic, we uncovered some great insights, but there is so much more to explore, and I'm sort of excited to hear your take on some of these additional case studies and dig into the lessons that contractors can take away from it.

So are you ready to dive in on that?

[00:00:37] STEPHEN BROWN: I'm ready, Wade.

[00:00:38] WADE CARPENTER: Any thoughts from last time? I enjoyed the format last time. 

[00:00:41] STEPHEN BROWN: I'm glad you did and I appreciate you coming up with it because, sometimes talking about yourself and what you do for a living it's almost boring if you talk about it so much. But this is an educational podcast and we want folks to understand that in bonding, like everything else, number one, it's about relationships.

And number two, in order for things to go smoothly, you got to communicate change way ahead of time. It's just the right way to do business. You need to treat your bonding underwriter, truly, as partners on your board of directors. And if you care about getting them the information they need and communicating with them, you're going to have a very strong ally.

 If you don't like the current situation, or you haven't even met your underwriters yet, talk to your bonding agent about it because the relationships are everything. I mentioned before, Wade, that as a bonding agent, we're kind of a matchmaker. There are different companies with different appetites, with different personalities.

Either way, we want there to be a mix. We want there to be a match. In an ideal world a marriage made in heaven. Something that goes smoothly and is an enjoyable relationship. 

[00:01:38] WADE CARPENTER: Personally, I enjoyed that last time. I think it was interesting to see these real life case studies that you and I face every day. And I know in this format, we were just hitting you with a case study and you're giving me your honest opinion off the top of your head. And I love that because, they are things that we talk about, but we don't think to tell people what we're running into. 

Join Wades FREE best test program for his upcoming book, Profit First for Commercial Construction

[00:01:54] WADE CARPENTER: If it's okay, before we do that, I'd like to make a little announcement here. I think I mentioned a few months ago that I was working on my book the first draft was written back in July and it's now December.

We're going through editing and it's been a long process. The target date is still May of 2025. But as I mentioned ahead of time, I'm looking for beta testers for the concepts in my book. For Profit First for Commercial Construction.

So the reason bringing this up was that, I even ran some of my accountants through the instant assessment that was in the original book, and people struggle with that. And my accountants couldn't do it.

 As I was researching the book, I had an engineer that is very intelligent. And he told me he got stuck on that part of it. And too often I see contractors they love the concept of Profit First, but they don't get started. 

So again, I've reconfigured the whole thing. And approaching it very differently from the traditional books. It is written in a very different format, as a business fable. But anyway, long story short, here's the deal. If you're interested this is completely free. And I am looking to do beta test with the concepts. You're going to get early access to the book and walking through the exercises specifically for contractors in a group setting.

We won't be sharing your personal numbers with anybody, but your payment to me is your commitment. Your commitment to number one doing the work and giving me honest feedback. And number two, If you like what you're seeing I'd love a Amazon review or endorsement on it. 

I'm looking for up to 20 people, a cross section of contractors. I want general contractors, subcontractors. Different revenue levels, different number of team members.

If you're serious about trying to change your cash flow game, which is what all this is about, and change your profitability, I would love to work with you on that. I can't guarantee we'll pick anybody, but we are trying to get a cross section so that we have good feedback for the book. 

If you're interested, we will have a link in the show notes, but it's profitfirstconstruction.com/ beta.

Spots are limited. So don't wait, cause we are doing this in December. So the sooner we can get some feedback and go ahead and get moving, the better. So, thank you for letting me take this off the topic for a minute.

[00:03:52] STEPHEN BROWN: Wade, that's fantastic, what you're offering to do. And I can just say this, having worked with you all these years, that if I owned a construction company, I'd jump on this offer immediately.

Because first of all, it's a chance to get to experience the Profit First methodology. And to get your help with it at no charge. You're literally walking them through that. If you say I don't even know if I have bought into this Profit First mentality. Give it a little bit of study, talk to Wade about it. But I can just tell you this. It's been the foundation of our podcast for the last, how long are we doing this, Wade?

Three years?

[00:04:27] WADE CARPENTER: We're getting closer to four.

[00:04:29] STEPHEN BROWN: Dang, wow. Okay. So four years worth of podcasts. And every success that a contractor has and every element of measuring that success ties into this mentality of how you treat your profit. it's fantastic. It's a great way to focus. And, if you're thinking about starting something like this, you've got to start somewhere.

That's my pitch. If I had a construction company, I'd be the first one to contact you. I can tell you that.

[00:04:52] WADE CARPENTER: Well, Thank you. Again, your payment is the commitment to do the work. I want to make sure that the way I'm teaching it is the best way I can possibly do. 

With that said, let's go ahead and jump on in! 

Getting bonds as a contractor with seasonal revenue

[00:05:02] WADE CARPENTER: First case study I'd love to throw at you, Stephen. Let's assume we've got a contractor with very seasonal revenue. Maybe they can't work because in the winter it's cold or something like that. Maybe a landscaper, all those that work outside, so it's very highly seasonal. 

So they've got inconsistent cash flows. A lot of times they run into problems in the winter months, and maybe they're looking for a bond from you. What would you tell them? How would you approach getting a bond when you know somebody has serious seasonal issues?

[00:05:29] STEPHEN BROWN: That's a great question. As a general rule, all the seasonal contractors are spending the off season making sure their equipment's ready for the on season. And one of the main stresses, Wade, is keeping your labor force during the off period. You keep your key people involved, but you may have to lay off some of your laborers when there's not labor to be done.

That cash flow i s going to be higher going into your off months. And then you've got to budget in there what this cost of the off season is going to be to get your equipment up and running. 

Definitely make sure that your year end financial statement correlates with the time that you're experiencing the most cash and profit, and you're showing it in your year end review financial statement if you need a lot of bonding. That would be my advice. 

What advice would you have as an accountant for these seasonal contractors? 

[00:06:13] WADE CARPENTER: Put money away for it. And that is another section of my book that's not in the other ones, but. 

[00:06:17] STEPHEN BROWN: Yeah, getting equipment ready for the on season is an obsession. But I would also mention that there's other things that you can do during the off season to make money. So is this a time that you have some money built up in your company and you might want to expand or change your scope a little bit, or take on some other things that, may not be so affected by the seasons?

Maybe you don't want to, maybe you're just happy getting everything ready for the on season and then taking a little time off. I get that too. But if the off season is stressful to you, it's going to be stressful to your bottom line. And you don't want to run a company that way. 

So I would just encourage you, it's a great time during the off season to meet with your accountant and meet with your bond underwriters and your bond agent, and just go through the numbers and start talking about things and getting some ideas. Because it's the off season that you usually have the energy and the impetus to get new initiatives started.

[00:07:06] WADE CARPENTER: That's probably a good time to reflect on those kind of things.

[00:07:09] STEPHEN BROWN: Yeah. If you do have a year end statement that's right in the middle or toward the end of your off season, and you've run off a lot of expenses, then your financial statement's not going to look as good for bonding.

So talk to your agent and accountant about that, you can minimize that.

[00:07:22] WADE CARPENTER: So I know you mentioned getting your equipment ready during off season, that kind of stuff.

How do high debt levels affect your bonding capacity?

[00:07:26] WADE CARPENTER: But let's just say we've got another contractor that has a lot of equipment. Grading guy or something like that has hundreds of thousands of dollars tied up in excavators.

So they have a bunch of money in debt. And they've run up a bunch of debt, debt debt starts getting a little out of control, monthly debt payments. are limiting what cash is available. And I know after 2008, we saw a lot of those guys that couldn't make it. But how do high debt levels affect your bonding capacity and how do the underwriters see that?

[00:07:52] STEPHEN BROWN: They're going to look at your overall net worth of your company, Wade. Remember that working capital, current assets minus current liabilities is a key indicator of providing bonds in the short run. At some point where your amount of debt drags down your net worth, that's going to be an issue with the bonding company.

[00:08:09] WADE CARPENTER: I typically throw out some different rules of thumb, but do you have any rules of thumb about debt and equity? 

[00:08:14] STEPHEN BROWN: Your equity in your company needs to be at least a third higher than your working capital. Your working capital, Wade, needs to be 10 percent of your bonding capacity. So if you're bidding a million dollars worth of bonding, your goal is to have a hundred thousand dollars of working capital, and so forth.

So that's the general rule of thumb. In order to get more bonding credit than a 10 percent case, you need to have good financial records showing your backlog gross profit that you have built into the jobs that you're currently working. What's been billed? When's it coming in? What have you paid? What are your costs? 

Does that make sense?

[00:08:48] WADE CARPENTER: Absolutely. Good advice. Let's take another one.

Getting a bond with inconsistent profit margins 

[00:08:51] WADE CARPENTER: Let's say a contractor, you've been working with them for a few years. They seem to have pretty inconsistent profit margins. One year they're up, sometimes they're down, sometimes they have a variety of different project sizes and different types of projects. Does that make a bonding company nervous about things like that?

[00:09:08] STEPHEN BROWN: Not generally. It just depends on how well you've been able to track and record those projects. From an accounting standpoint, are you able to get all the small projects knocked out? A lot of times I'll see a general contractor and any, projects under a hundred thousand dollars or 50, 000 will be lumped into a general category, so they're not itemized on the Work In Progress report. That's just too much effort. 

And as a general rule, you can see that the lumped together small contracts are always less profit than the regular jobs that are being managed carefully one at a time. And you might say well, I throw a lot of expense into those small projects, but I would think long and hard about whether you're doing a lot of small projects as favors to people, or just to keep your folks busy working at your cost basis. 

[00:09:52] WADE CARPENTER: I think that's a good answer. Sometimes people are taking jobs too low and whether it's a bidding problem or whether they actually know the numbers.

And this really wasn't one of my case studies, but since you went down this road, let's modify this a little bit. Instead of inconsistent profit margins. Let's say we got a job schedule at the end of the year, and we say we're going to make 30 percent gross profit, and it ends up with 5 percent gross profit. If they're inconsistent about their bidding, how does that affect your bonding?

[00:10:16] STEPHEN BROWN: There's always certain jobs that are going to be an exception to the rule. Bond underwriters can get over that, Wade. And there's always an explanation. We had to put X amount of cost in that we weren't anticipating, but it was actually good because it helped us do this, and that.

The number one thing is buying equipment versus renting equipment. You'll see some huge equipment purchases pop up. And again, I say, don't trade off the purchase and ownership of equipment for your working capital, the amount of cash you have on hand. This is hugely important. I have a gut feeling of how much I can use this equipment, and how I can make it pay for itself. And that in itself will build my net worth. And that's not always the answer, is it, Wade?

[00:10:53] WADE CARPENTER: No, but to spin this a little bit, I agree that sometimes you have a profit fade and things happen. Construction is very unpredictable. If you've been working with somebody four or five years and they've got a history of showing on their financial statements it's going to come in at 30 percent, but over three or four years they continually see this pattern, does that affect your thinking?

[00:11:12] STEPHEN BROWN: It does, Wade, because again, and I guess this kind of ties back into Profit First, but you have to set at all times what you want your profit to be. Just not hope. At the bare minimum, what does your profit need to be in order to support you and your family and the other owners of the company?

What does that profit need to be? And then what are your goals above that profit? you know that old expression pigs get fat, hogs get slaughtered. This mentality when you're making a ton of money and you're hoarding it, I get it. You may have had jobs where you've lost your shirt. And basically as a contractor you pretty much have to kill what you eat every day.

And that's the mentality of a salesperson as well. You have to constantly be out there pushing, but I would say push in the right direction. Because if you, as a general rule, can communicate to the bonding company that I'm a general contractor and our bottom line is 5 percent gross profit. And you consistently perform higher than that 5 percent gross profit, you can still take a huge dip and break even or lose money on a job. But as long as you have a track record of hitting a normal gross profit margin, everybody's happy. If you're bringing in 30 percent gross profit margin, everybody's thrilled. You and the bonding company.

[00:12:24] WADE CARPENTER: I guess I sometimes see it where people continually fool themselves and do think at times it can be an indicator of whether they really know their costs, or they're bidding it, or they're purposely trying to mislead.

An argument against worrying only about lowering your tax bill

[00:12:35] STEPHEN BROWN: Yeah, there's so many situations where the contractor mentality is who cares about bonding? And all I know is I don't want to pay taxes and I want to live as profitably as I can for myself through my company. What would be your argument against and for that mentality?

[00:12:50] WADE CARPENTER: We see all the time that people are doing things around their taxes. That too often they pay too much attention on that. And if they got a CPA that does any planning at all, we were just talking about this, It's on the tax planning side and not on the bonding side.

Sometimes you do need to have a balanced approach to that. Taxes, bonding, as well as the third piece of that is you know, it's not screw up your cash flow. So that's what I would say to that.

[00:13:11] STEPHEN BROWN: That's where I was hoping you were going, Wade, because if you gut your cash, you're hurting your company. And if you're hurting your company, you're hurting your ability to get bonding. so don't think about what the bonding company demands versus what taxes demand. Think about what your company demands to be healthy. And just plan on paying your taxes.

Just do it. You've heard that old expression, and we've talked about this before, contractors going broke, being obsessed about getting out of paying taxes. If you're doing that right now, I just urge you to rethink your mentality about it because, one thing in life is sure: death and taxes.

Another thing is tools and equipment that you need to do your job for construction. How logically you play that game takes a lot of stress off of things. Because when you're obsessed with not paying taxes and you're playing the not make a profit game to an obsessive level, then you are working out of a mindset of not being consistent.

 That's the scariest thing in the world to bankers, bond companies. It should be to you too. It certainly is frustrating to your accountant. When your accountant gives you advice, and they're a good accountant, take it, okay, and you get what you're paying for in that advice.

I'd say it's the same with the bonding company and banker. Everybody's on your team. Nobody's fighting. This is your company. You can do whatever you want, .

[00:14:20] WADE CARPENTER: It's not a popular thing for an accountant, to say let's keep some profit in there so we can pay some taxes, but, too many people like, I'll go to another accountant that knows what the gray is. It's one thing to know the law and do it properly.

And it's another one that, there's a lot of people that out there that, let me just cheat. And they don't think about what it does to the bonding relationship here.

[00:14:37] STEPHEN BROWN: To me, what's so much more important as the gray area and cheating is why you want to keep cash in your company, the power of it. And we've had so many episodes on cashflow. 

You have a perfect opportunity. All right, you've been playing tax game as hard as you can. You've been showing as little or no profit as you can. You've been showing losses, basically just for tax purposes. And then you say to the bond underwriter and you hear this, oh no, I made money. Yeah, okay. 

So the reason you want to do it the right way, which is to keep some cash in your company is for the unforeseen things, the ability to say, hey, this is a great job. This is so much bigger than we've done before. And we want to tackle it. And here's why. 

Well, you make that sales pitch to the bonding company, then they're more inclined to say yes if you have a reputation of running your company the right way. If there's a huge distribution at the year end and it goes for paying taxes, big chunk of that, that's just to pay owners taxes That's so understandable. if you take all the money out of it and you put it into your lake house or something and you hide that as a job cost, that's a whole other issue. And it may be a fun game to play, but it's gonna bite you eventually. .

[00:15:44] WADE CARPENTER: Okay let's hit another one if we can. 

Bonding issues when it comes to succession plans

[00:15:47] WADE CARPENTER: You talk about doing all this for your family and just a minute ago, trying to bring home some profit and take care of your family. So let's say we got a family owned business. And I think me and you have actually had some real life cases of this, and we've talked about it. But say we've got an aging owner, and maybe somebody is coming up in the business. Or they don't have somebody that's really trained take it over. 

Maybe you do have a son or whatever, but they don't have the formal succession plan in place. Maybe the son or daughter, whoever it is just isn't really interested in the business. what kind of bonding issues do we have when we have issues like the succession plan with generations? 

[00:16:21] STEPHEN BROWN: Who's steering the ship is the most important question that any bond underwriter would have. Now, in a situation where you have family members that are young and inexperienced coming in to take over the company, you as the captain of the ship are going to have to stay around a little bit longer.

Another thing to stress during this transition period are the key employees. Make sure that your bond underwriters know who they are and that they're happy. They're going to stick around. Again, it's another reason why some of these key employees might need some ownership in your company. Or you pay them enough that their loyalty is there and someone can't hire them away. 

[00:16:52] WADE CARPENTER: I know let's hit one more of these. We're getting a little longer, but I've still got another 10 or so to go after this, so we may end up having to do another third or fourth episode. Because I've enjoyed this format. 

How do overdue taxes affect your bonding capacity?

[00:17:00] WADE CARPENTER: We were talking about taxes just a little while ago. And nobody wants to pay taxes, but I have a lot of contractors come to me, they're struggling to keep up with their tax payments. Maybe they didn't really plan for their taxes, and they're behind a few years on their taxes. And they haven't been able to get, say, a bank loan, because the government taking those taxes can come before the creditors.

How does overdue taxes affect, I know it affects business credit, but how can it affect your bonding capacity?

[00:17:25] STEPHEN BROWN: I would say do everything in your power not to have a lien, a tax lien filed against your company. going to show up on your UCC report and the bonding company is going to know about it. so the most important thing is to come clean and make sure you have a good game plan. A game plan that works for the IRS and a game plan that your accountant can hold you to.

Also to make doubly sure that you are concentrated on working on the most profitable jobs. Sometimes you're just looking for a bag to breathe in. You've gotten yourself into this situation and you don't know what to do. 

But I can tell you, with a good system in place and a good reputation for doing quality work, there's always a way to work something out over an extended period of time. Something that you can do. Because the IRS it's going to get paid. And how you work that involves getting the best people you can to help you come up with a game plan that will work for them. And to make sure that they buy into that.

So if you're in that situation now, that's the first order of business. And the second order of business is to think long and hard about the jobs that make you the most money. That you routinely can perform with your forces, and get done and make a profit on. That kind of information is again, what you take your bank and your bonding company to show that your backlog gross profit is what's going to get me out of this situation.

Folks understand that, Wade. Maybe contractors don't, but I can tell you, construction financiers, that's people that deal with lending money or credit to a construction company, they understand that. And at the time you go to negotiate with your key financiers, it's a good time to have a good CPA to go with you to do that, to communicate the plan with you.

[00:18:56] WADE CARPENTER: What if you've got a contractor that hasn't been filing taxes for years, or they've possibly got these liens or levies coming up? Does it make a difference whether they've already got a tax payment plan in place?

[00:19:06] STEPHEN BROWN: It most definitely does. They're still going to look at a snapshot picture of your working capital and net worth. Okay, so that tax debt, even if there's a lien filed, it's going to be showing up as a current liability and a long term liability. 

So if you have a plan in place, Wade, just think about it. You may have a five year plan to get caught up, what's the normal plan? How many years would you say? Two years? Five years?

[00:19:26] WADE CARPENTER: Five years is about the maximum they'll give you. 

[00:19:28] STEPHEN BROWN: But say you can negotiate a five year plan because you are really pulling things around on your current stuff, it's the back stuff you have to pay. Okay. So however much you owe in back taxes over a 12 month period will hurt your working capital.

As far as you can extend that payment plan will not affect your working capital, affect your net worth a little bit. Okay. But that's okay. That's not going to stress a bonding company.

[00:19:50] WADE CARPENTER: I agree, I see it all the time, too. It's if you got a plan in place and you know we got a set installment agreement that's X amount per month, I think that's a little easier for a bank or a bonding company to swallow than, hey, we've got all these things out there and maybe we already do have some liens filed.

[00:20:05] STEPHEN BROWN: If an underwriter or a bank officer smells chaos, they're just going to bail. So you want to go in with a plan and you want to be as professional as you can, and forthright and honest as you can about communicating it. And that's your best chance of getting the help that you need.

[00:20:20] WADE CARPENTER: Okay. I think that's good advice. I got another 10 cases to go. So I think we're running a little long on this one. Any final thoughts from you on this?

[00:20:27] STEPHEN BROWN: No I've enjoyed it, Wade. I may not have answered the questions exactly in the direction that you might've been thinking, but I was trying to tell you from a bonding underwriting standpoint of what the key issues are to most underwriters. And does that mean they're right or they're wrong? Who knows.

Bonding underwriters did not know how to build anything. So again, I have to end this podcast by reminding our listeners, get your underwriter and your agent out to look at some of your jobs that you're proud of. To show off what you did differently we're thinking we're going to make, X percent profit on this. And not being overly optimistic, but just reasonable. And you bring it in a little bit more than that, and then you wouldn't believe the traction that builds in a relationship.

[00:21:09] WADE CARPENTER: To your point too, I don't know that I had any particularly preconceived notions on these case studies because what, three and a half years doing these podcasts together, you have a different perspective than I do. I see it from the tax side and the financial statement side and sometimes dealing with the banks, but you know what these bond underwriters need. There are situations that you think about that I don't think about the same way. So this has been valuable to me.

[00:21:30] STEPHEN BROWN: Great. Let's do it again then.

[00:21:32] WADE CARPENTER: We got more of them to do. So yeah, let's go ahead and wrap this up. Thank you for doing that, Stephen. And thank you all for listening to the Contractor Success Forum. If you got questions, we're always happy to answer any of them or hear your thoughts on topics you'd like us to cover, you want to drop them in the comments below. We appreciate it. 

Thanks again for listening. If you enjoyed the episode, please share and subscribe. Follow us every week as we post a new episode and we will see you next time.