The post 4 Signals You’re Growing Too Quickly appeared first on CSBA.
]]>In the United States we have a strong culture of growth and pursuit of opportunity. It’s part of what makes our country so great and unique. We live by sayings like, “If you’re not growing, you’re dying.” While there’s some truth to that saying, it can imply growth is always good, but perhaps in construction it deserves a disclaimer of, “Warning: Growing too fast may be fatal.”
So how do you know if you’re growing too fast? The reality is nobody can really quantify that to a single number. A contractor that completed one project for $1 million last year and takes on a $2 million project next year will grow by 100%, but that may be totally manageable for them. However, a contractor that grows from 10 projects generating $40 million in annual revenue to 20 projects totaling $80 million in a year may burst at the seams.
Rather than focusing on a single growth rate, contractors may be better served to evaluate the strength of their business in the following four areas.
The Bar is Lowering for People
Most business owners start out with one or two superstar key employees, which help launch them out of the gates. Then as they grow, many of the new employees hired aren’t quite as good as the early employees. Some business owners are tempted to “throw bodies” at it as they grow, which can lead to disastrous consequences.
Amazon combats this by trying to “raise the bar” with every hire, meaning the next employee has to be better than the last one. This is a way of continuing to improve the quality of the team, because the success or failure of any business will be directly proportional to the quality of its people over the long term. However, getting incrementally better people with each hire is extremely difficult, because it takes an incredible amount of discipline, patience, skill, and effort to find the right people.
Equally as difficult is when you think you find the right “bar-raising” employee, and they turn out not to be quite as good as you thought. I’ve seen this have disastrous consequences in construction companies many times, because often owners will delegate tremendous responsibility based on their confidence in the new hire. However, as Michael Watkins, author of The First 90 Days, argues, transitions are among the highest-risk periods, which makes active support and coaching essential during the first few months in a new role. This isn’t micromanagement, it’s setting the new key employee up for success and safeguarding the company in the process.
All that to say, if you find yourself rushing the hiring and onboarding process, and potentially lowering your standards, you may be growing faster than the company is capable.
Profit Margins are Declining
When companies grow quickly, it is very rare for them to maintain or grow their profit margins. I call this nirvana the “Trifecta”: growing revenue, gross profit margins, and net profit margins all at the same time. I’ve only seen it a handful of times despite working with hundreds of contractors. This is usually because their people, processes, and technology can’t adapt quickly enough to growth. With new people, it takes time to get them integrated and fully productive, and even if you are able to hire all the right “bar raisers” (which rarely ever happens on the first try), communication and productivity can suffer.
Growth also strains processes and technology, requiring investments of time, energy, and money to bring those to the level where they support the organization’s higher revenue. All of this combined can cause an imperceptible drag on profit.
Watch your margins closely as you grow and ensure your systems have the ability to provide you with timely and reliable information to measure your progress.
Receivables are Taking Longer to Collect
More revenue creates more receivables that must be collected. This is a very common area that gets neglected by contractors, and if you see your average receivables growing relative to your revenue, it’s a clear sign that your AR is taking longer to collect. Outside of ensuring performance in the field, collecting receivables is probably the next most important area that needs to be enhanced with growth, because when contractors can’t collect their money, it can seize up the operation much like a car that runs out of oil.
As you grow, step up your monitoring and collection efforts. Make sure you have the right people performing the collections and that they are being held accountable.
Change Orders are Growing Dramatically
Change orders also tend to increase with growth in revenue, and just like AR, if they are growing as a proportion of revenue, that can be a signal that the process needs to be managed more closely. Having properly trained staff to pursue change orders is equally as important as receivable collections, because when people are overwhelmed and pressured to finish projects, there is a tendency for getting change orders approved to fall to the wayside. However, if you can’t bill for work performed, that can create an increasing cash flow challenge that can cripple even the best companies.
There’s a saying that most contractors don’t go broke because they can’t perform the work. They fail because they run out of cash.
Conclusion
Growth is a common goal among contractors, but sustainable growth should always take priority over rapid growth. While contractors often worry about having enough revenue, it’s important to keep in mind that too much revenue can be equally, if not more, problematic.
As your backlog and revenue increase, keep a close eye on these four indicators. If you notice hiring standards slipping, margins narrowing, receivables aging, or change orders piling up, don’t ignore the warning signs. Slow down long enough to strengthen your foundation before taking on more work.
The contractors that build lasting businesses aren’t necessarily the ones that grow the fastest. They’re the ones that grow at a pace their people, processes, and capital can support.
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]]>The post Case Study: Why Contractors Need Sufficient Capital to Survive and Thrive appeared first on CSBA.
]]>Surety companies hound contractors to build up capital in their company and this is one of the key factors that determine how much surety capacity they will extend. I often think from a contractor’s perspective that it must be hard to understand why sureties focus on a company’s capital so much. If the business is running just fine, what’s the problem, right? In some ways this may be true, but sureties do see a lot of contractor financial statements, and they have a front row seat to what happens when things go wrong. In this article, we’re going to look at one such example where a single project cost a contractor $3 million and almost put a 20-year-old-company out of business.
The details have been altered slightly to respect the privacy of those involved, but the essence remains the same.
Behind the Scenes
Our contractor had been in business for over 20 years. They were very successful and had completed projects as large as $14 million.
In 2010, they were presented with an opportunity to work on a project with an owner they had prior experience with for an $11 million job. They bid it and were ultimately awarded the work. It was the same type of work they had done before, and they bid it with a good profit margin of $1.6 million.
The project was supposed to take 2 years to complete. The job started off okay, but it soon became apparent, there were problems with the plans and unforeseen conditions. These caused delays, and by 2014, four years later, the project was only about halfway complete. The contract had grown to $20 million, and the contractor was estimating to lose $4 million. There were tons of change orders that the owner was disputing. The contractor considered walking off the job many times, but he was advised by legal counsel that would only make things worse.
The company was well capitalized when they started the project with $2 million in equity in the company, which was more than sufficient to manage the $15 million backlog they had from the surety’s perspective. However, by 2014 almost all of the company’s capital was tied up in disputed receivables and change orders with the owner. On paper, those claims may have had value. In reality, they couldn’t be used to make payroll on Friday. The contractor borrowed every dollar on their $1.5 million bank line of credit, and they had no way to get any additional cash.
Week by week they muddled through the job and ultimately finished in 2015 – more than three years later than expected. The contractor made up a little ground financially on the project and ended up losing $3 million, but it essentially wiped out their capital. It took them 6 more years of fighting and almost $1 million of legal expenses, and they finally prevailed in their lawsuit. What did “prevailing” look like, they won just over $3 million, which resulted in them losing about $1 million on the project after legal expenses.
Lessons Learned
One thing I hope contractors learn from this story is that when things go bad, they can go really bad. We work with a lot of incredible contractors who are generally right about the disputes they are forced to fight, but being right doesn’t pay the bills, and those fights can take years to resolve – six years in this example. In order to get to the finish line and “win”, contractors need to have the capital to get there.
Our contractor survived, because they had a strong capital base, a large line of credit that was fully available, and the mental strength to persevere.
So, next time your surety wants to talk about the capital in your company, remember that it is not just for their benefit, it’s for yours.
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]]>The post Understanding Surety Claims, Disputes, and Risk Management for Contractors appeared first on CSBA.
]]>In the construction industry, disputes, delays, and payment issues can quickly escalate into bond claims if they are not handled carefully. Understanding how surety claims work and how contractors can protect themselves is critical for avoiding costly mistakes and preserving business relationships.
We recently spoke with a surety claims attorney about her thoughts on common contractor pitfalls and ways to minimize costly fights. Much of this information may seem straightforward, but it is often overlooked when projects become busy or stressful. Here are several key takeaways every contractor should keep in mind.
Pause and Get Advice Before Walking Off a Job
One of the most important pieces of advice for contractors facing a payment dispute or conflict on a project is simple: do not make emotional decisions.
If a contractor is considering walking off a job, the first step should be to consult an attorney and involve the surety claims representative early in the conversation. Surety claims professionals deal with dispute resolution regularly and can often provide valuable insight into contractual obligations and potential consequences. While the Surety claims professionals won’t replace the advice of your own attorney, they can provide insight on the issue from the surety’s perspective.
Also, a critical point contractors sometimes overlook is that nonpayment is not automatically considered a breach in every state. Walking off a project prematurely can sometimes create bigger legal and financial problems than the original dispute itself.
Early communication and professional guidance can help preserve options before positions harden.
The Role of the Surety and Balancing Multiple Obligations
A common misconception is that the surety’s sole responsibility is to protect the contractor. In reality, the relationship is more nuanced. While many consider the contractor to be the surety’s customer, but the bond itself exists for the benefit of the obligee, which is the owner or entity requiring the bond. Because of this, claims attorneys must evaluate all sides of a dispute objectively.
While the surety underwriter focuses on evaluating and supporting the contractor during the bonding process, the surety claims attorney approaches situations differently. Their responsibility is to ensure that the obligations of the bond are honored. That means investigating the positions of the contractor (principal), obligee, claimant, and indemnitors before determining how the claim should be handled. Claims investigations are ultimately about weighing facts, contract terms, documentation, and obligations fairly.
Best Ways for Contractors to Mitigate Risk
Strong project management starts long before a dispute arises. Contractors can significantly reduce risk exposure by focusing on a few foundational practices that seem obvious but are easy to take for granted:
-
Read and fully understand the contract.
Some contractors do not bother to read their contracts on public projects or negotiate better terms on private projects or subcontracts. Even if you cannot get changes made, knowing your responsibilities can help you avoid bad situations in the first place. -
Carefully review bond forms and obligations.
Not all bond forms are the same. For example, some limit the surety's options or require them to respond to a claim in unrealistic timeframes, which creates more risk for the surety and therefore the contractor.
-
Understand the project’s change order procedures.
A common example is the gross profit allowed on change orders. If a contract only allows for a small markup on change orders, you want to know that ahead of time to evaluate the potential for a lot of unforeseen changes. -
Review dispute resolution language before work begins.
The claims attorney we spoke with also emphasized the importance of involving legal counsel early, even if only for a consultation. Early intervention often prevents minor disagreements from becoming major claims.
Documentation Can Make or Break a Claim
If there was one point emphasized repeatedly, it was this: Document everything. Strong documentation is often the deciding factor in disputes and claims investigations, but human nature is to not want to take the time or feel like you are escalating a situation.
Contractors should follow verbal conversations with written emails, maintain organized project records, and preserve detailed communication logs throughout the life of the project. As our claims attorney put it, “The person with the better documentation usually wins.”
Assembling Your Advisory Team
In difficult scenarios, having the right partners makes a significant difference. Initially, the surety agent plays a big role in facilitating communication with the contractor and setting expectations. The agent is often the conduit to help explain what is going on with claims.
It is also highly beneficial to have a construction oriented attorney who understands surety. The surety and the principal might have very different allowed defenses. If your attorney does not understand this, they might miss opportunities for a better outcome, because a defense for the surety is typically better for the principal as well.
Final Thoughts on Proactive Risk Management
Surety claims are rarely simple, but many problems can be minimized through preparation, communication, documentation, and early intervention. Contractors who understand their contracts, involve experienced advisors early, and maintain strong project records place themselves in a much stronger position when challenges arise. In construction, proactive risk management is often the difference between resolving a dispute and escalating a claim.
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]]>The post Winding Down Your Construction Company appeared first on CSBA.
]]>Business owners arrive at the choice of winding down their construction company for a variety of reasons. For some, it may have been the plan all along. They simply have no desire to attempt to continue the company or deal with the challenges that can be inherent with other succession planning options. For others, winding down becomes a last resort when other types of succession strategies are unworkable. We’ve seen owners attempt to sell to key employees that ultimately weren’t interested in ownership or who turned out to be incapable of running the business. Whatever the reason, winding down a construction company isn’t easy and involves many difficult decisions. If you are considering going down this road, understanding the operational, personnel, and financial implications in advance can help you avoid costly mistakes.
The Chicken or the Egg
Winding down a business inherently involves reducing the size of the organization until there is nothing left. However, construction companies that have long-term contracts need to retain employees to finish the work, and if those employees realize the company is going to be shut down, they may decide to leave before the work is complete, leaving the owner without the staff needed to finish the jobs.
Knowing who to inform on your team and when to inform them is a very delicate balancing act. Even if you no longer want to take on new work, abruptly stopping bidding or eliminating your estimator can signal to employees that something has changed.
Additionally, as jobs finish in the field, you need to decide where to move your labor, foremen, and superintendents, and which ones need to be let go. Productivity can suffer during this process. Even after the last project is complete, you remain responsible for warranty requirements in your contracts, so it’s important to keep this in mind as you’ll need to retain the ability to perform that work.
Stay Bonuses
A solution that we’ve seen many contractors use is to incentivize their key employees to stay by paying them bonuses as they complete jobs. This helps provide a financial reward to the employees and reduce anxiety over knowing their job is coming to an end by providing a financial buffer.
We’ve also seen business owners go to great lengths to arrange other jobs for their key employees. This can help align employees with other companies and owners that are a strong cultural fit beyond just meeting their financial needs. With today’s labor shortage in the construction industry, we have seen ample opportunity to find placement for good employees.
Financial Perspective
From a financial standpoint, the goal with a wind-down is typically to get as much of the equity out of the business after completing all work, collecting receivables, settling change orders, and selling property and equipment.
Oftentimes there are trailing costs that eat into the retained earnings like insurance that needs to be renewed, rent, and employees that stick around to complete work or warranties but aren’t fully productive. There may be some upside on the sale of property or equipment that has been depreciated below its true value, but oftentimes, ultimately what comes out of the business is slightly less than the retained earnings at the time the decision to wind-down is made.
This is helpful to keep in mind, because the wind-down option can be used as a base level to compare to the potential value that may be obtained from selling to a key employee or outside party.
Conclusion
Every construction company represents years, often decades, of risk, effort, and sacrifice. Deciding to wind it down is rarely easy. It involves more than financial calculations; it involves people, reputation, and legacy. By understanding the operational challenges, aligning incentives for key employees, and planning carefully for the financial closeout, you can exit in a way that honors the work that built the company. A thoughtful wind-down ensures that the final chapter of the business is handled with the same integrity and professionalism that defined its success.
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]]>The post What Size Line of Credit Do I Need Anyway? appeared first on CSBA.
]]>Surety companies commonly want their contractors to obtain a line of credit from their bank to support their bonding program. These lines of credit can act as a form of “financial insurance” from the surety’s perspective to ensure the contractor has adequate access to cash if they hit a bump in the road with a bad project or disputed receivables. And as the saying goes, “Banks will lend to you when you don’t need it, not when you do”, so it’s generally best to get these in place prior to an issue.
A common rule of thumb sureties use for determining the size of the line of credit a contractor might need is taking 5% to 10% of annual revenue. As with all rules of thumb, there are exceptions and other considerations.
Recommended Reading: 4 Factors Your Surety Company Considers When Bonding Larger Projects
Specific Considerations
Beyond using the formula outlined above, there are other factors that contractors should take into account when thinking about how much of a line of credit they want for their business.
The type of work the contractor performs can greatly influence their line of credit needs. A general contractor has much lower cash flow requirements given how little work they self-perform than a subcontractor with heavy labor who has to fund payroll weekly.
Performing work as a prime versus a subcontractor can also make a big difference. Being closer to the source of funds usually results in getting paid faster. Whereas subcontractors may have to wait for 90 to 120 days to receive payment.
The timing of payments can also be addressed by the contractor vetting the particular owners or general contractors that they choose to work for. Some simply pay faster than others.
All that to say, if you work primarily as a subcontractor for owners that routinely pay slowly, you may want to have a larger line of credit than the general contractor working directly for quick paying owners.
Worst Case Scenario
Another way to think about how much of a line of credit you might need is to consider what a worst-case scenario in your business looks like. For example, what would happen to your cash balances if you performed $1 million of change order work that the owner ended up disputing? What if this project was delayed, and that same owner was claiming LD’s withholding $500,000 of your retention? Do you have the excess cash to continue operating without any hiccups?
You can adjust the scenario and numbers to whatever may be appropriate for your particular business. For example, try imaging you have a large job with a 20% loss or that you have two jobs with problems. Consider what that would do to your business and whether your typical cash balances plus your available line of credit would be sufficient to cash flow your operations through those issues.
Self-Insurance
Not every contractor needs a line of credit. Much like insurance, it is possible to “self-insure” by carrying substantially large cash balances either corporately or personally. We have some clients that will personally loan the money to their company as needed as their source of cash flow, because they don’t like to rely on a bank for a line of credit.
Conclusion
Determining the right size line of credit isn’t about hitting a single “correct” number – it’s about understanding your business’ cash requirements. While the 5%–10% of revenue guideline is a helpful starting point, contractors should layer in real-world factors like payment timing, job size concentration, disputed change orders, and worst-case scenarios.
For some, a well-structured bank line provides critical flexibility and reassurance to their surety. For others with very strong balance sheets, self-insurance through existing cash reserves may be sufficient.
Ultimately, the goal is the same: ensuring you have reliable access to liquidity when you need it most, before a problem arises, not after. Thinking through these issues proactively alongside your surety agent puts you in a stronger position with both your surety and your bank and helps keep short-term cash flow issues from turning into long-term business problems.
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]]>The post Construction Accounting Methods appeared first on CSBA.
]]>In this educational video, Dan Huckabay of Commercial Surety Bond Agency (CSBA) explains how different construction accounting methods; specifically Cash Basis, Accrual Basis, and Percentage of Completion (POC), drastically impact the revenue and profit reported to your surety. Many contractors struggle with timing distortions found in cash and accrual accounting, which can inaccurately show significant losses on profitable projects simply due to the timing of when bills are sent or payments are received. By utilizing the POC method, which recognizes revenue based on the actual percentage of project completion (calculated as costs incurred divided by total estimated costs), you can provide a “true picture” of your company’s financial health. Establishing this accurate reporting is vital for building a successful relationship with your surety and maximizing the bonding credit available to grow your business.
You've probably heard the terms cash basis, accrual basis, and percentage of completion basis. Maybe you've been told by your surety that they can't accept your financials if they're on a cash basis, or maybe your surety has asked you to prepare your financials on a percentage of completion basis. We're going to walk through some examples to show you how the different methods of accounting can impact the revenue and profit you're reporting to your surety.
And really, ultimately, the goal in this video is to help you be in a better position to communicate your information to the surety—how you're really doing in the most accurate way—and to understand your own business better. At CSBA, we put a lot of effort and work into helping our contractors understand these concepts because the better reflection we can provide to the surety company about how our contractor customers are doing, the better chances we're going to have for a successful relationship with the surety and to really maximize the bonding credit that the surety company's going to be willing to provide.
Let's start by doing a quick overview of the different methods of accounting and then we'll jump into some examples because that's probably the best way to understand the dynamics with each of these and how they work.
With Cash Basis, revenue is recognized when you receive the cash from your customers and the expenses are recognized when you actually write checks or make payments for the expenses that you have. Accrual Basis, on the other hand, you don't necessarily need to actually receive the payments or make the payments; it's more about when you bill or get billed. When you bill your customers for the work that you're doing, that's when you'll recognize the revenue. When you get billed from your subcontractors or your vendors, that's when you would recognize the cost. As you can imagine, there's all sorts of timing issues that can happen either under cash or accrual basis accounting. We'll look at some of those, but Percentage of Completion basis was developed in order to correct and smooth out how the revenue is earned over time and adjust for those distortions that can happen in timing with the other two accounting methods.
With percentage of completion basis accounting, you recognize revenue based on the percentage complete of the project, and the percentage complete of the project is determined by how much cost you've incurred divided by how much the estimated total cost is. So if you're 50% complete with a project, you will recognize 50% of the revenue.
Let's jump into the example. Let's assume we've got a contract for $1 million with estimated costs of $700,000. That leaves you with a gross profit of $300,000. And we're going to assume that you've incurred so far costs of $350,000. Based on the definition we just said about percentage complete, that means you would be 50% complete. That's the cost incurred divided by the total estimated cost.
Now, let's take those and look at the different types of accounting. We've got Cash, which in this case, we're going to assume that you have billed but not received money yet. Let's just say you've billed $150,000, but you haven't received anything yet. And then on the cost side, let's say that you have both been billed $350,000 and you've also paid those expenses. So now you would be showing the cost of $350,000 because you've actually paid them. For your gross profit, you're going to show a negative $350,000 because of the timing issue of receiving payments and when you've made those payments.
Let's go over to the Accrual Method. You've billed $150,000, so with accrual method accounting, you will show that you have revenue of $150,000. You've incurred the bills or received bills for $350,000, so you will show those as expenses. And now you're going to show negative $200,000 of gross profit.
Lastly, we'll look at Percentage of Completion. As I said, the revenue is based on the contract amount times the percentage complete. You're going to recognize $500,000. The direct cost will remain the same ($350,000), and then that leaves you with gross profit of $150,000.
You can see in this particular situation, it's really advantageous to be on the percentage of completion basis of accounting because it's going to show a much more accurate picture of how you're ultimately doing. Either way, the reality is you're doing really well on this project—you're making 30% and $300,000—but these two methods of accounting (cash and accrual), depending on the timing of things, may not accurately show that, whereas percentage of completion is going to give that true picture. That ultimately is going to help your surety company give you more bonds based on the fact that they're seeing a more accurate picture.
At CSBA, we do have resources that can help you and your team set up your accounting systems or be able to generate financial reports on a percentage of completion basis. If you need help, please reach out to us and we'd be glad to assist. And that wraps it up for this video today. Keep an eye out for additional videos that we have coming out on various topics relating to accounting, surety, and expanding your bonding program. Thanks a lot for tuning in.
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]]>The post How to Close Out a Site Improvement Bond: Steps and Requirements appeared first on CSBA.
]]>For developers and property owners in California, securing a site improvement bond is a standard part of the project kickoff. However, knowing how to efficiently close out that bond is equally critical. Failing to properly exonerate a bond can lead to unnecessary premium costs and lingering liability long after the physical work is complete.
Here is a guide to the workflow, requirements, and proactive strategies for successfully closing out your site improvement bond.
The Workflow for Bond Closeout
Closing out a site improvement bond requires coordination between the property owner, the construction company performing the work, the government agency, and the surety company. The process typically follows these steps:
- Inspection
The property owner or developer contacts the government municipality (city or county) to arrange for an inspector to verify that all improvements are complete and sign off on the work.
- Official Release Letter
Once the inspector acknowledges completion, the owner obtains an official letter from the agency. This letter must explicitly state that the work is complete and the bond is exonerated.
- Notify the Surety
The surety company requires this official release letter to remove the liability from the property owner. Once the surety receives the letter confirming the bond number and release status, they can officially close the file.
Common Delays and How to Avoid Them
One of the most frequent causes of delay is simply forgetting the bond exists once the project is finished.
Site improvement bonds often have an initial two-year term. If a project is completed in six months, but the owner fails to notify the agency or surety, the bond remains in force. Two years later, the owner may receive a renewal invoice for a project they thought was closed.
Trying to obtain a release letter years after completion can be difficult. Staff at the municipality may have changed, and tracking down the right person to sign off on old permits can cause hold-ups and stress.
Proactive Strategies for Success
To prevent these delays, organization is key. We recommend the following:
- Maintain a Checklist: Keep a dedicated file with the permit number, inspection information, a copy of the bond, and the surety company's contact details.
- Document Contacts: Write down the names of the agency personnel you speak with throughout the project.
- Act Immediately: Request the letter of exoneration the moment the inspector signs off on the work.
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Selling a Property with an Active Bond
It is a common misconception that selling a property automatically cancels the bond. This is not the case. If a property owner sells the land without addressing the bond, the bond remains in force, and the original owner remains liable.
If the improvements are not complete or the bond is not formally replaced by the new owner, the original entity remains “on the hook” for the liability. To avoid complications, addressing the bond should be a priority before finalizing any property sale.
The Value of Surety Specialists
Navigating government requirements can be complex. Working with a specialized surety provider offers distinct advantages over a general insurance agent. Specialists understand the mechanics of automatic renewals and can explain the necessary closeout steps before you even issue the bond.
At Commercial Surety Bond Agency, we provide first-class service by helping you understand exactly what documentation you will need down the road. While we cannot control the speed of government agencies, our expert guidance ensures you are prepared to act quickly when your project is complete.
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]]>The post How to Handle Existing Improvement Bonds When Selling a Property appeared first on CSBA.
]]>For developers and property owners, selling a property with active site improvements requires careful planning. A common misconception is that selling the land automatically transfers or cancels the existing surety bond. This is not the case.
If you are listing a property with an open site improvement bond, understanding the transfer of liability is critical to protecting your interests.
Does the Bond Transfer?
The answer is no. When a property is sold, the existing site improvement bond remains in force. The government agency holds the bond to guarantee the improvements, and the entity that originally obtained the bond remains liable for the work, even after the property changes hands.
If you sell the property without addressing this, you remain responsible for the improvements unless the new owner replaces the bond.
The Replacement Process
To remove your liability, the new owner must replace your bond with one of their own. This requirement should be explicitly addressed in the buy-sell agreement. The typical workflow involves the following steps:
- Escrow Conditions: The seller should require the buyer to obtain their own bond and place it into the escrow account as a condition of closing.
- Bond Replacement: Upon the close of escrow, the new bond takes effect, allowing the original bond to be released.
- No "Transfer": It is important to note that bonds are not "transferred" from one person to another. The buyer must qualify for and obtain a brand-new bond.
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Avoiding Delays and Risks
Failing to coordinate the bond replacement can delay the sale or leave the seller exposed to unnecessary risk. If the buyer struggles to qualify for a bond or is working with an inexperienced agent, it can slow down the escrow process. To ensure a smooth transaction, we recommend the following due diligence:
- Contact the Municipality: The seller should reach out to the city or county to determine if specific documentation is required for the bond replacement.
- Verify Evidence: Ensure the buyer provides evidence of the replacement bond to escrow before closing.
- Do Not Close Early: You should not close escrow without ensuring the bond will be replaced immediately upon closing.
The Importance of Expert Guidance
Open communication between the buyer, seller, and surety providers is essential when an open bond exists. Because the new buyer must qualify independently, working with a specialized surety agency can prevent bottlenecks.
At Commercial Surety Bond Agency, we provide expert guidance to help navigate these complex transactions. Whether you are the seller needing a release or a buyer needing a new bond, our first-class service ensures that bond obligations never hold up a deal.
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]]>The post Site Improvement Bonds: Costs and Payment Structures Explained appeared first on CSBA.
]]>For developers and property owners, understanding the financial commitment of a site improvement bond is just as important as securing the bond itself. Unlike standard insurance policies, surety bonds have a unique payment and renewal structure that is dictated by rates each surety files with the state of California.
Here is a breakdown of how costs are determined, when payments are due, and how premiums are adjusted over the life of a project.
How Premiums Are Determined
The premium for a site improvement bond is calculated as a percentage of the total bond amount. While rates are filed with the state, several factors influence the specific percentage a developer pays:
- Bond Size: Premiums often follow a tiered structure. As the bond value increases, the average rate typically decreases.
- Financial Strength: For smaller bonds (under $500,000), good personal credit is often sufficient to secure a standard rate.
- Developer Profile: Large developers with audited financial statements and strong balance sheets may qualify for lower rates.
- Relationship: Establishing a bond program and having a history of repeat business with a surety can also lead to better pricing.
Payment Terms and Renewals
Surety companies typically require the premium to be paid upfront. Flexible payment options, such as installments, are generally not available for these types of bonds. The standard term structure is as follows:
- Initial Two-Year Term: The upfront premium covers the first two years of the bond. This initial premium is fully earned and non-refundable, even if the project is completed in six months.
- Annual Renewals: If the bond is not released after the first two years, it automatically renews on an annual basis. Premiums are then paid annually until the bond is formally exonerated.
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Adjustments and Refunds
While the initial term is non-refundable, there are opportunities for cost adjustments during the renewal periods or if the scope of work changes.
- Pro-Rated Renewals: If improvements are completed mid-term during a renewal period (after the initial two years), the surety may provide a return premium based on the time remaining in that term.
- Bond Reductions: If a government agency agrees to lower the required bond amount due to partial completion, they can issue documentation stating the new requirement for the penal sum of the bond. The surety can then adjust the premium based on this lower value.
Are There Additional Fees?
In most standard cases, there are no additional administrative or issuance fees beyond the premium itself. Extra fees are typically only applied if the surety requires collateral (such as an appraisal fee) or if funds control is necessary due to higher perceived risk.
The CSBA Difference
Navigating rate structures and renewal terms requires a partner who understands the industry. At Commercial Surety Bond Agency, we leverage our relationships with surety providers to offer expert guidance tailored to your financial profile. Our first-class service ensures you understand your costs upfront, so there are no surprises down the road.
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]]>The post What do Sureties Exclude from Contractor Financial Statements? appeared first on CSBA.
]]>When it comes to bonding capacity, the strength of a contractor’s financial statement plays a big role. While there are certainly other factors considered like the quality of management and operational capabilities, financial wherewithal is like the oil that lubricates the powerful engine. Without it, things can come to a screeching halt.
One of the easiest ways contractors can strengthen their financial profile from surety’s perspective is to understand the deductions sureties make to contractor’s financials, because many of these exclusions are at least partially in the contractor’s control. Let’s take a look.
Loans to Shareholders or Employees
In closely held businesses it is common for owners to loan themselves or their employees money. This removes capital from the company, and from a surety’s perspective it creates uncertainty of when and if these loans will be repaid.
- What you should do
It is generally best to avoid making these loans when possible, or at the very least, talk with your surety agent first to understand the possible impact to your bond program.
If you do not have any intention to pay a shareholder loan back, it can be better to simply reflect it as a distribution. However, this should still be discussed with your agent ahead of time if it is large, because distributions can negatively impact the financials in the same way.
Over 90 Day Accounts Receivable
Old receivables raise the question of whether there is a dispute and they are truly collectible, and as a result, sureties deduct them from a contractor’s financial statement. These can have a big impact on the way the surety views the contractor’s net worth. For example, imagine your equity in the business is $1 million and you have a receivable for $100,000 that is over 90 days. If the surety deducts that amount, your net worth from their perspective just went down by 10%.
- Practical Steps You Can Take
It takes most contractors 60 to 90 days after the close of a particular month to provide their financial statements to their surety. This gives you a lot of extra time to potentially collect those over 90-day receivables. When submitting your financials to your surety agent, note which over 90-day receivables have been collected. Also note any that are retention, because sureties don’t deduct those the same way they do regular receivables. It’s understood that retentions can take longer to collect.
If you do have a receivable that is in dispute and may not be collected, consult with your surety agent and CPA to determine whether it makes sense to write it off. If your surety isn’t going to count it as an asset anyway, it might be better to reduce your tax liability. That will help your cash flow and paying less taxes actually improves your working capital and net worth.
Disputed Change Orders
Change orders are a natural part of construction projects, but when they are disputed (either by the owner, general contractor or even subcontractors), their value and collectability is uncertain. Disputed change orders typically show up in a contractor’s financial statements as underbillings, because they can’t be billed for since they are not approved yet. A surety will sometimes discount or exclude revenues or receivables tied to disputed change orders until the dispute is resolved.
- Best Practices for Dealing with Change Orders
It’s generally best not to recognize revenue from change orders until they are approved. However, because the amounts can be so large, that can sometimes be impractical. What some contractors do is recognize a portion anywhere from 50% to 80% to account for the possibility they won’t be able to collect them all.
Be sure to communicate to your surety if you have larger disputed change orders or claims on projects. By helping them understand the nature of the disagreement, timing for resolution, and likelihood it will be resolved in your favor, there is a chance they may keep all or a portion of the disputed amount in your financials rather than just defaulting to excluding the entire amount. This is where your surety agent can really help in understanding the circumstances and communicating it clearly to the surety.
Why It Matters
Sureties have certain ratios that they use to calculate bonding capacity based on a contractor’s working capital and net worth. The deductions described above directly impact those calculations. To use a simple example, if a surety deducts $300,000 from your financial statements, that can reduce your bonding capacity somewhere between $3 to $6 million. If you make 5% net on your revenue, this could cost you $150,000 to $300,000 in lost profit!
Having a surety agent work through all of this with you before submitting your financial statements to the surety is key, because it will minimize the amount of deductions your surety company makes and thereby keep your financial statements as strong as possible to maximize your bonding capacity.
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The post What do Sureties Exclude from Contractor Financial Statements? appeared first on CSBA.
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