Construction Informer

Contractors who want to bid on large-scale construction projects most often will need to have a surety bond, and for those who are unfamiliar with the requirements for these bonds, Vic Lance, owner of Lance Surety Bonds, offers this detailed introduction to what they are, and the factors considered about a construction business when it applies for one.

Deserted construction of a water park symbolizes potential problems surety bonds try to prevent. (© Kotiki | Dreamstime.com)

What is a surety bond?

A surety bond is a contract between three parties that involves a surety (the company providing the bond), a principal (the individual or business acquiring the bond), and an obligee (the project owner or government entity requiring the bond).

How to select a surety company

Many surety companies write bonds through an agency system that uses brokers or agents to help guide customers through the bonding process. They serve as intermediaries between the surety underwriters and bond purchasers. With this system, principals have an advisor to offer business advice and technical expertise such as contract review. Once the surety agent gains a perspective into the type of business in which the bond is required and the principal’s background, he can direct the bond application to a surety producer best suited for it.

For those looking to research perspective surety companies without the authority of a broker, the National Association of Surety Bond Producers lists those agencies that meet their professional standards.

Functions of a surety underwriter

Surety brokers collect the necessary information from the principal and provide all documentation to surety underwriters, the creators of the bond. From this, the underwriter analyzes the contractor’s business model to ensure it is capable of completing the project. If necessary, the underwriter may request a meeting with the principal to find out more aspects of the business and project. Questions such as the contracting company’s current work load, (to assess if there are enough resources to complete a new project), to project financing, and the risk versus reward perspectives are investigated.

Preparing for prequalification

Before a bond’s approval, a contractor’s financial background is reviewed in great detail. Surety companies, or producers, assist the surety underwriter in completing the bond by verifying information and answering questions raised by the underwriter. In this collaboration, the surety company continues to assess if the contractor is able to fulfill the scope of the project, has the necessary background and expertise to complete new work, and has access to the materials, equipment and labor to finish the job.

During prequalification, several documents may be required such as:

• An organizational chart
• A business plan – indicating future growth and profit goals
• History of work – including the largest jobs completed to date, with contract price, profit achieved, and project owner contact information
• Resumes of employees
• A completion plan – contains the anticipated methods on how the business will progress in the event of owner’s death (in some cases, surety agencies suggest contracting companies obtain a life insurance policy with the construction business named as beneficiary)
• Line of credit – this helps surety companies know there is capital available to handle cash deficiencies. Loans and repayment schedules are also taken into consideration.
• Letters of recommendation – these can be from subcontractors, project owners, or engineers on completed projects.

Various financial statements are also requested:

• Fiscal end-of-year statements (from the past three years, if available)
• Balance statement – displays the contracting company’s assets, net worth, liabilities to date
• Income sheet
• Receivables and payable schedules
• Financial statements for previous and future contracts
• Miscellaneous expenses – indicates the amount of financial obligations for administrative and overhead expenses
• Certified public accountant (CPA) letter indicating his/her findings, recommendations and analysis on the contracting company’s organization. Note: some CPA’s do not provide letters.

Understanding surety bond costs

Unfortunately, there is no set standard on surety bond costs. Many factors are researched and will affect the amount you pay for your bond. These include:

• Type of bond
• Geography – surety regulations vary from state to state, therefore pricing can vary as well
• Credit history – because surety bonds are a financial guarantee that the principal will conduct work as specified by the bond, a risk assessment must be conducted by the surety agency prior to determining one’s surety bond amount.

There are two types of surety bond markets: the standard market, with the lowest rates, and the high-risk market. The premium, the amount of money out of pocket to buy a bond, is a percentage of the bond amount. For standard markets this can range between 1 and 3 percent. High risk applicants face higher rates, anywhere from 6 to 15 percent of the bond.

Those looking to receive standard market rates must have:

• A credit score of at least 650
• At least three years’ experience in the industry
• A personal net worth which is one to three times the bond amount