Bonding Pitfalls and How to Avoid Them – Real Case Studies

Getting bonded as a contractor can feel like navigating a maze. Join Wade Carpenter and Stephen Brown of McDaniel Whitley Bonding and Insurance in part three of our series on contractor bonding. This episode dives into real-life case studies to uncover valuable lessons for getting bonded successfully. 

Learn about the challenges of single large clients, territory issues, experience factors, high turnover rates, unstable project pipelines, high operating expenses, and specialized high-risk projects. Tune in for expert insights and practical advice to enhance your bonding process.

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Topics Wade and Stephen cover on this episode:

• 00:20 Welcome to the Contractor Success Forum
• 00:41 Understanding Case Studies
• 01:10 Challenges with Single Large Clients
• 02:24 Experience and Reputation in Bonding
• 04:36 High Turnover and Its Impact
• 06:28 Backlog and Project Pipeline
• 08:07 Subcontractor Bonding Issues
• 09:30 Financial Planning and Overhead
• 13:56 High-Risk Projects

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Visit the episode page at https://carpentercpas.com/getbonded3 for more details and a transcript of the show.

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

Transcript

[00:00:00] Wade Carpenter: Getting bonded can sometimes feel like navigating a maze. Every contractor situation is unique, and the path to approval can take unexpected turns. What if you could learn from real life stories of contractors who've been here?

This is part three of our series on getting bonded with real case studies. And we're diving into even more scenarios to uncover lessons you can take away and apply to your own journey. 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 and Insurance.

Stephen, we've already explored some fascinating cases, but I'm excited to hear what you got for us today. These case studies have so much to teach us. about what it takes to get bonded successfully. So let's dive in.

[00:00:40] Stephen Brown: Thanks, Wade. The case study is just a story of something that happened to someone else, some situation that you could learn from. I always liked case studies, in school and everything else, use a case study to tell a story of something that happened. In the first two parts of this, basically you were asking me questions about different case studies.

What do you do in case of this? I had a situation where this happened. How do you handle that? Let's get into it.

[00:01:05] Wade Carpenter: Okay, well I got several more lined up that we haven't talked about yet. Let's get going with that. 

I've had contractors do different, whether a general contractor or an electrical contractor, whatever it is, they get in with a national company and they will send them all over the country.

But, from a bonding standpoint. If you've got a contractor with one single large client and they've got to get bonded, is that a challenge? Is there any issues with having that one single large client , if they ever went away, might spell disaster for them?

[00:01:35] Stephen Brown: Well, it is, it just depends on how many bonds are needed. You have one client, of course there's always the pay issues to deal with, and then there's the operating territory. Getting paid for example, a private owner, I always say use your bonding agent and your bonding company to verify that funding's been set aside to pay you for that project. Put it on them to get a letter to make sure that money's there before you get started. 

And the second thing, of course is this a territory you know you can operate in? You may know your job. It may be an indoor job, and you may do it all the time. Who knows? It may be an outdoor job. You don't know the terrain, the territory. But also in every region that you're going to be working, there's something different.

There's always something different. Is it an open shop? Is it a closed shop? what permits? What else do I need to operate in this city or town? 

[00:02:24] Wade Carpenter: What if we had somebody, like, whether they had limited experience in a certain type of construction, maybe they had limited industry experience with what they're doing, but maybe they had somebody that supposedly did that in a former job.

How does not having experience or a reputation or doing more like a certain type of work, does that play into the bonding issue?

[00:02:46] Stephen Brown: It sure does, Wade. It's a major factor. The most fundamental thing a bonding company wants to know before they bond you on a project is, do you have experience and knowledge to get that job done? So many times it's our job to talk to and convince the bonding company that our customer has experience and is capable of doing the job they want to be in.

You might say, look, I just want to bid this job. I haven't even gotten it yet. And by the way, I'm going to throw a lot of extra profit in there. So if I get it, I can work through problems. That's how you work through problems. By having too much profit, right?

But this experience issue, Wade, is something that If you know what you're doing and you know that you can overcome that with proper help, proper alliance with subcontractors, then let your bonding agent know about that now.

First of all, don't just say, ah, we can do it because I said we can do it. Let your bonding agent know the facts so they can help get involved and get that bond approved for you. And also, what if the answer's no? You don't have enough experience. This is not a job you should do. Are you willing to accept that as an answer?

Or are you going to fire your bond agent? I've been on both sides of that before, Wade. 

[00:03:54] Wade Carpenter: Most people think I can just find somebody else to do it, but a lot of times, if one bond agent says no, most of them are probably going to say no.

[00:04:02] Stephen Brown: Yeah, Wade, and I also see so many times that experience factor. We're subbing that out, so that's not an issue. Do you know those type of subs? What if that sub falls through or bails on the job and you have to replace them? Do you have the knowledge and ability to find that person? A lot of times I'll see one part of a job is extremely difficult and they've picked one sub to do it and they don't have relationships with anyone else.

You can develop that relationship again with enough money. You can go get someone to do the work for you. But it's a hard learning curve, as you know, 

[00:04:34] Wade Carpenter: Right. Let's take another case study. What if you had a contractor that had high turnover? I know I've actually got one right now. They have a lot of service type work in construction. 

But this guy has actually more than doubled or, he's gone through three or four times the number of employees in one year's time. It's scary, but, from a bonding standpoint, if you see a bunch of turnover in employees, and sometimes it may affect the ability to get the work done, does anybody take that into account from a bonding perspective? standpoint?

[00:05:03] Stephen Brown: They sure do Wade. And here's where it shows up. It shows up in your ability to estimate your profits and maintain those profits. You might say well, I'm having to fire people in order to maintain my profit level. It's not my purpose in life to give people jobs. It's their purpose to work for me to get the job done.

So that makes perfect sense, right? But if you haven't invested to get the best workforce and you're not bidding the jobs where you can pay the good folks the money they need, then maybe you need to rethink how your bidding work. And again, Wade, we've had so many podcasts on how to do that. They're almost too numerous to count, wouldn't you say?

[00:05:41] Wade Carpenter: Yeah, it's a very common topic. 

[00:05:43] Stephen Brown: So from a bonding standpoint, does the bonding company know that you're turning over a lot of employees? You see it based on the productivity. Even if an employee gets hurt on a job, someone else has to take them to the doctor, the hospital, there's productivity that's lost. Something happens. 

Same thing with having to fire and hire and train new employees. The learning curve for most construction employees is tremendous. Not to mention just the training for safety and other key issues that come with hiring a new employee.

You may not be able to right now. You may not be able to see the forest for the trees, and you just have to keep doing what you're doing. But at some point you've got to stop and take a deep breath and address the issue and solve it.

Those profits are going to fade. And so is your bonding capacity.

[00:06:27] Wade Carpenter: Let's take another scenario. , I know lot of times you're asking about what kind of backlog does a contractor have. But what if they don't have a stable project pipeline, out there, whether it's just they're out of work or It seems to come and go. How does that affect your bonding? 

[00:06:41] Stephen Brown: These are a lot of the situations ,where we see customers bidding a whole lot of work. Just throwing out bids everywhere. And finding everything that may remotely fit and bidding it. It's at a time where you need working capital and cash flow in order to get all those bonds approved.

We see that happen a lot, Wade. 

[00:06:58] Wade Carpenter: Let's just talk in general. How does a bonding company think about backlog and whether they've got work? 

[00:07:02] Stephen Brown: Your backlog gross profit is a key factor in determining your bondability. Not only is your working capital analyzed and whether you're making profit year to date. And your work in progress report showing whether you're having profit fades. But on top of that, if you have a good solid backlog of gross profit and a track record with that bonding company and financially over the years, you have shown that your ability to maintain profit on most of your projects, then that's worth its weight in gold as far as getting bonding is concerned. The backlog that is starting to fall off. The bonding company knows you're going to be bidding more projects. And are you going to be tempted to bid bigger projects, hoping to make up for a lot of things that you're worried about?

There's nothing more wonderful than having a good backlog. Taking you through the next six months or a year. I see so many customers of mine with backlogs that are two years, four years, five years projects. And that's usually a larger project. The backlog is taken care of, but also you need more bonding capacity. 

[00:08:04] Wade Carpenter: Well, let's take another thought here. There's a couple , ways we could approach this one too. Scenario one, you're a general contractor and you got some under you and you're planning on those subs bonding part of it, but they have limited bonding experience.

So when the general is trying to bond somebody with a sub that has questionable ability to bond, or from the sub standpoint, when you have limited experience, how does that play into it? 

[00:08:28] Stephen Brown: It definitely plays into it. A lot of times you're stepping into a relationship with a sub. You may feel comfortable they can do their work, but if they can't get bonding, there's other issues going on behind the scenes that you don't know about. There's credit issues. Are they paying for their materials and supplies?

Who's going to pay for it if you sub a job they can't bond back to you? Who's going to pay for that if a claim occurs? You are. It's totally coming out of your profit. If there's enough to pay for it at the end of the job. And it might be coming out of your equity. If the profit's deleted.

It just sounds so depressing, , but I would say let your bonding agent help you run traps on new subs. We call it running the traps, but it's just checking and seeing what their reputation is. What their track record is. 

Some subs are just never asked to get a bond before. And that may be the issue. It may be a sub that's never bonded. And if that's the situation, just go to your bond agent and say, hey, I need you to talk to this sub and get them bonded for me.

So that's the best scenario. And I do that for a lot of my clients. 

[00:09:29] Wade Carpenter: Let's take another spin here. There's a lot of ways we could approach this as well, but contracted with poor financial planning skills, or they don't seem to plan ahead or don't really have their act together from a financial standpoint.

 That's a common topic around here, but they do a poor job of looking ahead and seem to always get in trouble just because they're not planning. 

[00:09:53] Stephen Brown: That materializes all the time in my business, and with the underwriters. They're being pushed by a bonding agent to approve jobs without any financial information. And sometimes you can pull that off for a couple of times and then eventually the well dries up. The answer is just going to be no, you can't bid the job.

Do you want that to happen? I can just say from dealing with those type of situations for the last 35 years or more as a bond underwriter, it gets old. You know we need our job. It's kind of like asking your workforce to do a job without the proper tools. 

First of all, we have to have it. That's from my perspective, Wade. We have to have it. But from your perspective, you need to have it. What would you say to that?

[00:10:30] Wade Carpenter: It's frustrating to me. Number one, getting on top of where you are is one thing, but when you actually get the plan in place, but you don't really figure out how to look forward, I've seen people wreck their own growth. Maybe they got it to a profitable state, but then they think let's just ramp this up and end up growing themselves out of business.

Unfortunately, I've got some horror stories on things like that. 

[00:10:52] Stephen Brown: Well, we both do. It's almost too sad to talk about, from both of our perspectives. But again, I just want our listeners to know if you're in that situation, and you're wondering why good things aren't happening, just consider it from our point of view. Our job is to, number one, for Wade, to provide you the systems to get the information you need and prepare for your taxes.

My job is to get your bonds approved.

[00:11:15] Wade Carpenter: Okay, let's take another case study here. Let's say you're in Tennessee, but, here in Georgia, there's some middle of the state, something like that, where sort of rural type contractor, there's not a lot of opportunities around them. And they just basically have limited opportunities out there to even get the type of work.

Does that ever play into the bonding issues? 

[00:11:35] Stephen Brown: It sure does, Wade. It goes back to the question we had earlier about territory. I can tell you that the main thing that costs contractors profit when they move to new territories or rural territories is access and soil conditions. Access to the job site and then the soil conditions. 

Are you working in a flood zone? What issues do you have with the weather, natural disasters? What knowledge do you have of that area? What friends do you have in the area that can help you when you have a problem? These are all key considerations. 

[00:12:04] Wade Carpenter: Just got a few more of these here and which this all of these seem like common topics around here. But let's say you got a contractor with high operating expenses, high, let's just call it overhead. And, they have to continually keep that revenue rolling to be able to cover all that. Maybe they're overextended, they got all the nice office and they just way too much overhead. How do you take that into account? 

[00:12:38] Stephen Brown: Well, you can have as much overhead as you want as long as you're making profit on all of your projects after the overhead's applied. Of course, that goes without saying. My first suggestions when I see overhead out is, are you allocating overhead properly to job costs, first of all. That's the number one thing to look for.

And then the second thing is how is your overhead out of control compared to other contractors? And that's something a construction CPA and a good bonding agent can tell you. 

As a general rule, when I started off as a bond underwriter, we were trained for looking for overhead of never being more than 12 percent of your sales. That was a rule of thumb.

But the good contractors we deal with, they're keeping it at 5%. does that mean? What if mine is 20? What if it's minus 25%? Well, you might be a design build contractor. That has going to have more overhead and you got to figure out how to build that into the jobs that you go after.

So there's a lot of things that can affect this overhead. So it's not necessarily good or bad. It's just something you need to be aware of. And again, Wade, I can't tell you how many contractors bid work without even considering overhead. Especially the ones starting off. It's a real cost, Wade, but they don't see it yet. They're too busy.

And then they're in their trucks doing all the paperwork themselves. And until they just can't and everything starts going backwards. And then they yell at their spouse, you got to step in and handle this. I don't have time to handle this. You know, that's the beginning of it, Wade, wouldn't you say?

And as you get larger you've heard that expression, the tail wagging the dog, that's what overhead can do. 

[00:13:54] Wade Carpenter: A couple more to get through here. If you've got a contractor specializing in like some kind of high risk projects, sometimes maybe they're getting into specialized things that-- I know you talked about sometimes carriers won't bond certain types of jobs.

Any thoughts on that?

[00:14:08] Stephen Brown: Now, first thing that popped into my mind is working on some implosion projects in the past. Implosion contractors like CBI who invented implosion, demolition literally had to figure out how to fund and control the risk, every aspect of that project. Talking about the highest possible risk, but as also wearing a hat as an insurance agent, when you go into a riskier type of work, the first order of business is safety.

Can you control the safety of that? And the second one is, can you control the output of it? Those are the two things that you have to have in mind before you go after an inherently risky project. A lot of contractors of mine make money having reputations, doing the dirty stuff. We do the stuff other folks won't do.

That's why you call us. And we're going to charge you more. we'll get down there and get dirty and get the job done. My answer to that question is the reward worth the risk that you're willing to take? And there's always a way to measure that before you do that risk.

There's always a way to analyze it from the backwards going forward to how it's going to affect you and then make a logical decision. And again, I would say your construction CPA and your bonding and insurance agent will be a good first stop. Then maybe your attorney. And then figuring out what specialized equipment you're going to need in the financing for it. So maybe your banker.

Again, your financial board of directors may need to be involved with that decision. 

[00:15:29] Wade Carpenter: I think that's pretty much my list of case studies here. I appreciate all the insights here. Any other final thoughts on this? 

[00:15:35] Stephen Brown: No, just as listeners, if you have any other situations or a situation that you're in that you just want to bounce off of us, just let us know in the comments section, and we'll get back to you. If we're not getting back to you fast enough you can reach out to us, you can call us on the phone. Wade at Carpenter Company CPA in Atlanta, and I'm Stephen Brown with McDaniel Whitley Insurance and Bonding in Memphis, Tennessee. 

[00:16:00] Wade Carpenter: Said that very well. Thank you all for listening to the Contractor Success Forum. For more information visit the websites or give us a call. If you enjoyed the episode, please share, subscribe and follow us every week as we post a new episode and we will look forward to seeing you next time.