Today's Article Is From 

R. Burns Logan, Attorney At Law

As construction work continues to slowly improve, we see more project owners which are requiring contractors to be bonded.  For many up and coming contractors, this process is unfamiliar and can be daunting.  However, your ability to obtain and increase your bonding capacity can make a huge difference in the success of your construction business.  Below is a brief primer on the process to obtain a surety bond.

The first step is to make a good connection with a respected surety bond producer.  These are professionals who specialize in construction surety programs.

Typically, the best bond producers for your business will be those professionals which specialize in your area of construction.  Some producers specialize in large contractors, some in middle markets, some in emerging contractors, and some in specialty contractors.  A producer who is familiar with your area of construction can give you the best guidance and help you foster a business relationship with your surety company.  Also, a professional producer will be able to introduce you to other professionals and consultants, such as accountants and attorneys who can help grow your business.

Once you and your surety bond producer decide which surety program fits your business, the producer will submit information on your construction company to a surety company underwriter.  The underwriter will take an in-depth look at your entire business operations in order to determine if your construction company is capable of completing the proposed project.

Each surety company has its own underwriting standards and requirements, but there are some standards which are common to all.  Below are a few of the items which your surety company will request in order to “prequalify” you for further analysis:

1. Organizational Chart – You will be asked to provide an organizational chart of your key employees and their responsibilities;

2. Resumes – You will need to provide resumes for all your key employees;

3. Business Plan – You will need to provide a thorough and well thought out business plan which outlines what type of work your construction company seeks, the prospects for such work, and your growth and profit estimations;

4. Completed Jobs – You will need to have a list of your current work in progress and a list of your largest completed jobs.  This information should include information about the owner, the construction costs, the date of completion and the profits earned on the job;

5. Succession Plan – You will need to provide information on how the business will continue in the event of the owner’s death or incapacity;

6. Bank Relationships – Surety companies want to know you have sufficient credit to successfully manage your working capital and to handle temporary cash flow issues.  Having an established bank line-of-credit generally provides sureties with this comfort;

7. References – Sureties typically want letters of recommendation from subcontractors, owners, architects, and engineers on your completed projects.

The surety company or provider will review this information thoroughly in order to make an initial evaluation of your construction company’s business operations and prospects.  The underwriter may have a number of questions during this process.  It is important to provide timely responses and complete information to the underwriter’s inquiries.  Establishing that you are responsible during the application process will increase your odds of obtaining a bond.

After this pre-qualification process is complete, many surety underwriters will want more information on the single job size and aggregate workload for all projects, bonded or not, in your work program.  A contractor uses this information to evaluate its risk/reward exposure.

In addition to the pre-qualification process, the surety will request fiscal year end statements for at least the last three (3) years.  By far, the most important thing you can do in preparing these financial statements is to use an accountant which has specific construction-industry experience.  An accountant with construction experience knows what metrics surety companies review and how to put your construction company in the best possible light, while maintaining financial reporting standards.

Some of the financial statements which the surety will request are as follows: 

1. Income Statement – Sureties will use this statement to analyze your gross profit on contracts, operating profit and net profit before and after tax;

2. Balance Sheet – Sureties use this to evaluate your working capital and your overall financial condition of the company;

3. Statement of Cash Flows – This shows the surety how well you manage the cash flow on your projects and through your business;

4. Accounts Receivable/Payable – Again, this helps the surety understand how you manage your cash flow and credit risk on your projects;

5. Contracts in Progress and Contracts Completed – This shows the surety the financial performance of each of your contracts and provides insight into the potential for future earnings from contracts in progress;

6. General and Administrative Expenses – This shows the surety how well you manage your overhead and office expenses;

7. Accountant’s Opinion Page – This will be a statement of your accountant regarding what standards were used to prepare, audit, review, or compile the information in the financial statements.

Surety companies have different standards for the preparation of financial statements.  Some require financial statements to be audited by a certified public accountant and others do not.  Also, many sureties require the financial statements to be in compliance with the “Audit Guide for Construction Contractors” published by the American Institute of Certified Public Accountants.  In addition, sureties may ask for interim financial statements every three (3) or six (6) months to show how you are progressing on your projects.

The surety companies will use all this financial and pre-qualification information to evaluate your ability to complete the project.  One of the most important things you can do during this process is to pay close attention to what financial metrics and performance issues to which the sureties are particularly attentive.  This will give you direction on what areas you need to improve in order to grow and expand your bonding capacity.  Surety companies like to see contractors who are continually progressing.  If you can show your company is getting stronger in your market, you will have better success obtaining surety bonds and work in general.

In the vast majority of cases, surety companies require the owners of the construction company to provide personal indemnities related to the surety bond.  This is required as a demonstration of the commitment of the construction company’s owners to resolve any difficulties that may arise in the performance of the bonded work.  These indemnity agreements obligate the owners to protect the surety company from any loss or expense caused by the contractor’s failure to fulfill its bonded obligations on the project.

After you have obtained your bond, the surety will likely ask you to prepare quarterly schedules of work in progress.  These schedules will list important financial issues on your bonded projects.  This includes such information as whether you have overbilled or underbilled the project – change order issues, revisions to cost estimates, estimated final gross profits and anticipated completion dates.

Finally, it is important to understand that maintaining a good relationship with your underwriter and producer are keys to obtaining quality bonds and increasing your bonding capacity.  The decision to seek a surety bond should be based on long-term considerations.  Developing those relationships through open communication and timely reporting builds trust and can help improve your construction business’ access to bonding capacity in good times and bad.

Jumping in to bonded work world can be a challenge.  However, I think you will find that developing these deeper relationships will improve your construction company’s prospects and provide you with valuable insight into how to improve your business.  Surety bond producers, underwriters, accountants, and attorneys all have valuable information you can use to make your business more profitable.

Burns Logan is a construction lawyer focused on helping contractors, design professionals, insurers, and sureties get projects done and resolve disputes.  He blogs regularly at http://www.southeastconstructionlawblog.com and you can follow him on Twitter at @BurnsLogan.  You may contact Burns at blogan@lgwmlaw.com.

About R. Burns Logan

I help contractors, subcontractors, suppliers, architects, engineers, owners, developers, tenants, sureties, and insurers get projects done and resolve disputes.

I have extensive experience representing construction-related clients, design professionals, and real estate professionals in issues related to the design, development, financing, and construction of all types of structures.

Prior to joining LGWM, I served as corporate counsel to a Top 50 general contracting company and its real estate development affiliate. As such, I have a unique perspective into the day-to-day activities which are necessary to design and construct successful projects and to help clients navigate disputes and transactions during the project and after project completion.

I am actively involved in the Construction Industry through the Design Committee of the ABA Forum on the Construction Industry, teaching continuing education classes to AIA members, and through the Association of Builders and Contractors.

I also devote a significant portion of my practice to general commercial disputes and litigation. I am licensed to practice in Alabama and Mississippi. I also routinely assists clients in Florida, Georgia, Tennessee, and Arkansas.

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Editors Note: Having extensive experience as both a contractor and a construction accountant I cannot over emphasize the importance of having an attorney that you can call upon to help guide your construction company. I want to express my sincere thanks and appreciation to R. Burns Logan for providing the content for this article.