As a contracting business matures and develops, larger projects and higher bond amounts naturally come into focus. Yet, there may be an unanticipated hurdle.
Bumping against the construction bond limit, or construction bond capacity, can come as a surprise to many contractors. Oftentimes, contractors are not aware or informed enough about the existence of this limit in the first place. Or even if they are, they may not know how to increase it.
What is the construction bonding capacity?
Your construction bond limit is the maximum value of bonds that you are allowed to obtain. There is the single limit, which is the maximum value of a single bond for any project, and there is the aggregate limit (or bond line), which is the maximum total amount or value of bonds you can get.
For example, if your aggregate limit is $500,000 and your single limit $250,000, you may obtain two bonds in the amount of $250,000 or five bonds in the amount of $100,000 and so forth. But you cannot obtain a single bond that is beyond your single limit, nor may your total number of bonds exceed the aggregate bond limit. These limits, single and aggregate, are also called your bonding capacity.
How is the construction bonding capacity determined?
Typically your bond line is set by your surety when you apply for contract bonds — most often, performance and payment bonds. For smaller projects (up to $350,000) sureties will often only consider an applicant's personal credit score. Based on the score, a surety will determine the rate at which you can obtain your bond as well as your bond line.
Sureties use personal credit score as an indicator of how likely you are to trigger a bond claim but also how likely you are to sort it out. High credit scores are typically taken to mean that the person will be able to handle a claim, if one should arise, and will not default on the project.
But your personal credit score, high as it may be, is simply not enough to guarantee for how you will handle projects that are above $350,000 or in the millions. When it comes to bond lines, sureties exercise great scrutiny, so you should be prepared to provide plenty of information if you want your limit to be raised. This means providing information about the character, capacity and capital of your company, the so-called 'three Cs' of bonding.
The character is your project track record, your successes and failures (defaults), and overall performance. The capacity is the skills, resources, equipment and experience your company has. The capital is your credit score, working capital, balance and cash flow. All of these will be examined by a surety if you are applying to raise your bond capacity.
Here are some tips on what you can do to tilt the scales in your favor.
1. Work with a construction CPA
If you want to work on a big project, sureties will want you to disclose a lot more financial information and history. When it comes to this, working with a professional construction CPA is irreplaceable.
A professional construction CPA will know how to handle the different accounting methods and formats of financial statements, which are the main keys to having your bond limit raised, apart from presenting a high credit score.
2. Choose the right accounting method
According to the Internal Revenue Service's (IRS) website, there are four main methods of accounting that contractors can make use of. These are the accrual method, cash method, completed contract method and percentage of completion method.
Simply put, the first three methods are mostly to be used by small contractors who are not aiming at projects over $350,000. Each of these methods has its advantages and disadvantages — for example, the cash method typically costs the least to be prepared.
The percentage of completion method is the method of accounting you should choose if you want to significantly increase your construction bond capacity. This method is the most detailed and accurate and includes information over a few accounting periods, providing the surety with information about the financial dynamics of your company over the long-run.
3. Choose the right type of financial statement
The type of financial statement you use can greatly influence a surety's decision. There are three main types of financial statements: audit, review and compilation. The level of detail these include varies significantly.
Audit financial statements are the most detailed. These are typically only required on the biggest projects of all, but even there they can sometimes provide information that is not relevant or necessary to the surety. Review statements are considered to include the best balance and detail of information when you are trying to raise your construction bonding capacity, while compilation statements are considered the least detailed and reliable.
The right type of financial statement strictly depends on your particular situation, and if you have a good CPA they should be able to advise you about the right type of statement to be used.
4. Work with the right bonding agency
To obtain a bond you typically go to a bonding agency. Bonding agencies work with the surety bond companies that back the bonds financially. Different agencies work with different companies. Not all surety bond companies have access to the same markets, nor are all surety bond companies equally financially stable and reliable.
When looking to obtain a bond from an agency, you should look for an agency that works with A-rated and T-listed surety bond companies. These are the companies that can typically provide high bond limits and good rates. By carefully picking your agency, you are building a relationship that will support your business's growth over time and make higher bonding limits possible.
Vic Lance is the founder and president of Lance Surety Bond Associates. He is a surety bond expert who helps contractors get licensed and bonded. Vic graduated from Villanova University with a degree in Business Administration and holds a Masters in Business Administration (MBA) from the University of Michigan’s Ross School of Business.
