Top 4 Mistakes That Bankrupt Contractors (Avoid Them!)

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ℹ ABOUT THIS EPISODE

Most contractors don't fail from one bad job—they go broke slowly over time. Liberty Mutual's claims analysis reveals the top 4 categories that bankrupt contractors: cash flow deterioration, dangerous changes, subcontractor network failures, and risky bond terms. 

Wade Carpenter and Stephen Brown break down each category with practical insights to protect your business and maintain strong surety relationships.

⌚️ Key moments in this episode:

• 00:00 Why Contractors Fail Slowly
• 00:25 Liberty Mutual Claims Lessons
• 02:11 Category 1 Cash Flow Red Flags
• 03:08 Job Borrow and Late Financials
• 06:28 Category 2 Dangerous Change
• 10:13 Category 3 Subcontractor Network Risk
• 12:13 Category 4 Contract and Bond Traps
• 14:42 Surety Support During Claims
• 16:07 Key Takeaways for Bonded Work
• 17:45 How to Reach Stephen
• 19:03 Wrap Up and Subscribe

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

Transcript

[00:00:00] 

Wade Carpenter: Most contractors don't go broke because of one bad job. They go broke the same way. A tire goes flat, slowly, mile after mile until one day you're riding on the rim and you don't even know how you got there.

This is the Contractor Success Forum. I'm Wade Carpenter with Carpenter & Company CPAs alongside Stephen Brown with McDaniel Whitley Bonding and Insurance.

Stephen, this was some great research you sent me. So kick us off. What are we talking about today? 

Stephen Brown: Well, the whole idea for this podcast came from Liberty Mutual, one of our best surety companies, and they sent out claims lessons that they learned and some discussions for contractors. So when you have one of the largest surety companies in the world, and they have claims, these claims occur for a reason, right? That's the business I'm in, surety bonding.

So claims occur, and what Liberty wants to do as a company, of course, is to analyze the scenarios that cause those claims to happen, and to categorize them and get that information out to all [00:01:00] their contractors so it doesn't happen.

This makes a lot of sense, Wade, because surety companies don't wanna lose contractors because they go into claims. But if you go into claims with the surety company, you're out of business with that company until it's resolved. So, it's serious. But it's the same time, what can you do when you get claims and you have bogus claims or claims where you need defense? Claims that are designed to intimidate you and scare you and into doing something you wouldn't ordinarily do? Can a surety company help with that? Can your surety agent help with that? Well, absolutely. That's our job. So the premium you pay for a surety bond includes that.

So Liberty Mutual sent this out to me as an agent, and I just loved it. Because it's exactly what we do in our is try to make contractors successful and not fail.

We wanted to share with our listeners these categories of what they found. And a lot of this Wade we have done a lot of podcasts [00:02:00] on in the past. There's literally no surprises, but there's also some really good information that's been popping up lately that our listeners need to know about.

So why don't we just break it down?

Wade Carpenter: That sounds good. They basically broke it down into four major categories, and-- 

Stephen Brown: Well, that's right. Hey, first category is right up your alley, Wade. 

Wade Carpenter: But in your perspective, basically cashflow, liquidity what were they talking about in this thing?

Stephen Brown: Deterioration in your cash position. Significant increase in bank line usage, job profit fades, and deterioration in financial reporting or quality of accounting.

So bonding companies look for some fundamental financial information to make a decision. Without that information, they don't make the decision, or they make a decision fast. The answer's no.

Wade Carpenter: As far as the cash flow, we talk about that all the time, but I think what they were getting at, and you correct me if I'm wrong, essentially what I say all the time is like, are they borrowing from a future job? Or overbilling? Are [00:03:00] they deteriorating from the cashflow standpoint?

They talk about some of the red flags. Anything you wanted to walk through on that in particular? 

Stephen Brown: Yeah. First and foremost what you just said, job borrow. How do you define that Wade?

Wade Carpenter: Well, everybody wants to bill upfront if they can, but as we talked about like getting job deposits, are you paying for the last job with the next job? If you're getting behind on those kind of things, that's essentially what they're figuring out from the overbilling.

Stephen Brown: A contractor's overbilled by more than their estimated gross profit on a project. Yeah.

Wade Carpenter: Not good. 

Stephen Brown: It's simple. And so you've also heard that expression, robbing Peter to pay Paul? That's taking money from one job to prop up another one, and next thing you know you can't finish your jobs.

Then you can't finish your jobs and they're bonded. Then the bonding company takes over. So, you're like, well, that's their problem, not mine. You're absolutely right. It is, once you go out of business. But they're not gonna write your bonds if you're not [00:04:00] running your business to win. So financial liquidity and cash flow problems.

Wade Carpenter: Can I throw a couple other ones out there? The obvious ones they threw out there were like increasing the accounts payable while your cash is dropping, spikes in your line of credit. But I think you see this too, the financials are late or missing or they don't have them timely.

I'd love from your perspective, why underwriters, why that bothers people. 

Stephen Brown: It is just saying that you're not managing your company, it's managing you. That's it. I mean, seriously. The most fundamental thing is to be able to communicate to others financially, how your company's doing in bonding.

 It's the same with banks. So you're having cash flow problems and you need some help and you can't explain to anyone what your true problems are, or even analyze what your true problems are.

Is it being too hard on people there? 

Wade Carpenter: No. I don't think so, but I mean--

Stephen Brown: You're an accountant, I'm a bond guy. We harp on it all the [00:05:00] time. At the same time, Wade, you could say, well, Stephen, you're old enough to remember the old contractors that, you'd ask them how they were doing they'd pull out a lot of cash from their jeans. How do you think I'm doing?

You assume they paid all their bills out of that, collected all their money. But on a simple cash basis, the simplest contractor in the world believes in no debt and pays cash for everything. As you get bigger and your pockets aren't big enough to hold a couple million dollars worth of cash, you gotta trust your accounting system.

And then we see right now with our younger contractors, Wade, those are depending so much on technology. They really are. And so many of them don't even have a checking account. That's foreign to a lot of young folks in the construction business.

So it's even more important to have your systems in place and not to trust a system that you don't understand. We talk about that all the time. Understand your system, understand the elements, and trust yourself that you can learn it because you [00:06:00] can, it's just not that hard.

And Wade, you are a master of that, and I can't tell you how much I've learned in the last five years from our podcast from you. So, thank you for that. 

Wade Carpenter: Well, like I said, by the same token, I learned a lot from you and the perspective that you bring to it, so I do appreciate it. And I know that first category is stuff we talk about all the time.

But the second category, I don't know if you wanted to introduce what they were talking about from their standpoint. 

Stephen Brown: Okay. Change is the most significant element of failure that they found. Change. And you're like, well, everybody-- change is good, good change is good. Bad change is bad. How do you know the difference?

They define it by, there's a change in the ownership structure, merger and acquisition, ESOP plan, anything like that. Key personnel changes from the president, the CFO, the controller, key personnel changes. That triggers a red flag.

Geographic expansion. You may [00:07:00] know how to do your job perfectly in your neck of the woods. But you expand into different territories, then you're expanding into a whole other world of experiences that you have to learn. And you say, well, we just replicate what we do so successfully in our world, we can do it anywhere. And that may be true and that may not be true.

But I can tell you what the local surety office in that new region that you're expanding to, at least ask your bond underwriter to talk to the manager there and say what kind of issues are there that we need to be aware of? It could be any number of things. Geography, politics, union issues, equipment costs, material availability. So all that has to do with geographic expansion and then the cost to do that.

Also, the type of work being performed. Are you doing something new? If you're doing something new, we have to explain in order for me to get it approved, how you're gonna do it.

And you might have some really good [00:08:00] subs that are gonna lead you through it. You might have some key new employees that are gonna lead you through it. But I beg our listeners, if you're gonna do that, start off with something small and get that confidence of your surety that you can do it. You don't wanna just fry a relationship because you insist on bulldogging the head with something. So my thing to ask our listeners is just, talk to your agent about it first. Don't jump into it.

And also the last one in that category is new project owners.

There are certain project owners, I see a contractor that's signed a contract with them. First thing I do is get on the phone and I'll say, here's what I know that you need to know and ask your friends that have done work with him. And you may be new with a certain engineer. You get no feedback on that particular engineer back from anyone out on the street, and it's because they're horrible. They're horrible to work with.

All right. So change, that's defining change. 

Wade Carpenter: There's so many things that you brought up in that, like [00:09:00] the change of ownership. I've seen that, and actually I picked up a client about five years ago that's why they were brought in, because we were brought in and they bought the company and they knew they were gonna lose certain people on the accounting side and all this stuff. And he wanted to have-- but key people leaving, the CFO. I've seen that happen and companies fall apart.

Had one last year or two, CEO was running $150 million, General Contractor left. He had 26 state licenses across the country, and he got pissed off and left and he started his own. And trust me, that was some disruption to them. The CFO started his own and we're working with him now.

But so many things, the changes, the leadership, exactly what you said. We've had working with a certain general contractor that's horrible to work with. They're gonna back charge you like, you're never gonna make money. Hate to say that, but some people get that reputation. 

Stephen Brown: What if you're a bond underwriter and a CFO is leaving to go [00:10:00] elsewhere? Historically the owner's just been sucking cash out of the company as hard as they can. Sometimes they're putting unreasonable demands on a CFO and that's why they're quitting. That's the first conclusion they would jump to. 

Wade Carpenter: I know the next one was subcontractor risk. What was that one about?

Stephen Brown: The title of this is called The Risk of Network Failure. Your network of subcontractors. That's what it's referring to. Your subcontractors that haven't been pre-qualified yet. They're heavily concentrated on a certain type of risk that they're doing a lot of.

So they're being stressed. Their systems are being stressed by other projects that you don't know about. They're having more work to do than that they can do properly.

The stress of your network of subcontractors is causing a lot of contractor failures. We talk about the relationships of subcontractors for general contractors all the time, in my business on [00:11:00] the podcast.

You have to negotiate before the project that your subcontractors are taken care of, that they can do what they say they're gonna do. And that comes with trust. But it also comes with good contracts and it comes with sub bonding back those subcontractors to minimize your risk. It also has a lot to do with negotiating with the owners before the project starts about what's doable and what's not doable. So that's what that means. The risk of network failure. 

Wade Carpenter: Yeah. I mean to me if they fail, if they are not coming through on that stuff, like a general contractor, they live and die by their subs and a lot of them, the smart ones will take care of their good subs, and it's disruptive if one of the key subs fails or something like that, and then you're scrambling to get a job done. 

Stephen Brown: Well, here's what they say about risk treatment mitigation for subs.

Identify any potential concentration of risks, such as one subcontractor performing vital or specialty trade scope on several [00:12:00] projects concurrently.

Review and monitor work in progress schedules on projects known to employ critical subcontractors and consider asking for copies or confirmation of subcontractor bonds.

Okay, I think we've covered that.

Wade Carpenter: I think the next one is definitely your, your wheelhouse.

Stephen Brown: Bond forms and contractual terms. The external risk is what this is called.

These include on demand versus conditional terms in your contract. What does that mean? That means that some contract language has certain demand language in there that is not fair to you.

You may say, this is reasonable, I'll do it. But a lot of this comes from the fact when surety companies take over a construction project and they've gotta rebid it to someone else, hey, you know, their job is contractually to have zero risk. And those contracts have a lot of conditional terms, demand language.

Also you have certain [00:13:00] contracts that you're reviewing and they're just onerous. The takeover language in the contract, not just for the surety, but for the general contractor taking over your portion of the job. That's the takeover language.

And then, if that job goes into claims or you have to re-let that job, you know, how do you protect yourself from a contract? So you sign a contract that has some 

Wade Carpenter: weird terms, I would

say. On demand, liquidity, bond request, unusual bond forms.

Yeah.

Stephen Brown: Joint venture back-to-back bond schemes, challenging terms combined with a new owner or other significant changes. These are what to look for. Consider the impact on demand versus conditional terms, takeover language. Try to avoid on demand language where possible and require liability caps, overpayment protections, and clear completion remedies.

If an on-demand is unavoidable. Require commensurate security and [00:14:00] consider the dramatic impact re-let exposure may have on lost incomes.

So that's a lot, right? But here's the thing. Right now, contractual language is changing. I can't tell you how AI has helped dig out some of this language that nobody was expecting to see.

How do you read a thousand page contract and understand its impacts on you? You hope that it's boilerplate, right? And you're looking at the same thing over again. It's the same thing as Stephen, how do you read and understand every insurance contract that you provide for your customers? Well, it's standard language. And so you're constantly looking for those changes that could pot you.

So from a surety standpoint these are the main four categories and if you wanna reach out to me, I'd be happy to send you their report, I'm sure with their permission. And as a, an agent of theirs, I appreciate what they do behind the scenes for their contractors.

It's pretty [00:15:00] intensive, and a lot of good sureties do this, but they have an in-house legal department that is designed, when a claim comes up, to protect you. As long as you're being cooperative, they're gonna protect you.

And then they're gonna consult you on your ratios and trends that may be going in the wrong direction. That's what we do every week on the Contractor Success Forum.

And Wade, when it comes to claims I was telling you a little bit about you know, a claim situation I had on Monday, but it's just kind of part of my life. People file claims on bonds, and how you react to that and how quickly you respond to that is how to keep that contractor out of claims.

So you'd never want to not have a cooperative claims adjuster, and the best way to have an uncooperative claims adjuster is to have a claim filed against you and don't do anything about it. Then they're gonna rally up to minimize their risk and how much they have to pay out on the claim.

Wade Carpenter: Well, that's some great advice [00:16:00] and I know you, you told me a little bit of that story and that was pretty amazing how you were able to resolve things there.

But this is great stuff. You know, what's some takeaways? I mean, what are some of the things that surety companies do, look at it, how do you look at it? What can our listeners take away from this?

Stephen Brown: Well, our listeners need to take away from it that surety companies guarantee the performance and the payment of a contract that you do. So whatever you contractually obligate yourself to, if assurity does a bond of that, the bond is tied directly to that contract. All the terms and conditions do. 

The surety is on it, and they have to trust you to be able to know what you're doing and to be professional in how you operate. So people getting into bonded work, they might say, well, I'm just not getting into it. It's too much headache, it's too much trouble. It's really not. It's just a skill set that's very simple that you have to learn and your bonding agent can help walk you through that. So that's the first thing I'd have to say.

And the second thing is, [00:17:00] out of all the surety markets that write bonded projects across the country, we see the same things over and over again. And it's why we've done this podcast.

Yet again, Liberty Mutual has put this report out based on their claim scenarios and it's tried and true. Okay. A lot of this information hasn't changed in years, but now we have things changing. With AI, with contracts, with material supply, and with communication. And it's all moving at the speed of light. But these fundamentals haven't changed and they're not gonna change going forward.

So learn them, understand them. Get a good surety agent and they'll help you through this.

Wade Carpenter: Okay. Well that's great stuff. I did wanna go ahead and throw you a plug too, because a lot of these people that I keep seeing, it's like, okay, I wanna get bonded for the first time. They keep popping up. And they don't know where to get started. And the time to try to go find you a [00:18:00] bond agent is not when you've got that contract right there ready to be signed, or even worse after you signed it. You don't have the bond, or you know, just, okay, well we'll do a credit scoring bond, but can you actually afford that?

So, how can they get in touch with you, Stephen?

Stephen Brown: They can reach out to me. My email address, stephen@mcwins.com. It's McDaniel Whitley Insurance and Bonding. We're located in Memphis, Tennessee, and we work with contractors all over. We wanna help you, and at the same time, if you've got a good bond agent we beg you to keep that relationship strong as long as they're getting you what you need. 

Wade Carpenter: And you did offer to send that report from Liberty Mutual over there, right? 

Stephen Brown: I'd be happy to. Just send me an email reach out to me to phone if you want. (901) 340-8085, and leave me a message. You might show up [00:19:00] as spam on my phone, but if you leave a message, I'll get back to you. 

Wade Carpenter: Great. Thank you again for bringing this to us. If our listeners had any thoughts or comments, we'd love to see them in the notes below. If you enjoyed this, like, share, subscribe. It always helps the channel out. We do this every single week. And we really do appreciate you and we will see you on the next show.