What is Bonding Capacity?
Bonding capacity is a measure of how much financial risk a contractor can handle. When you apply for a bond, a surety – the party that guarantees the performance of the principal – analyzes your capacity based on a variety of factors. However, before we get to how to increase contractor bonding capacity and how that capacity is assessed, it’s important to note that Capacity is divided into two types: single and aggregate.
The single job capacity limit measures the credit limit your surety is willing to extend for one particular project, while the aggregate capacity represents the credit limit the surety is willing to extend for the total of all of your work under contract on a COST TO COMPLETE basis at any given time. Now that’s out of the way let’s get back to what determines bonding capacity.
So, What Determines Bonding Capacity?
Like the commercial insurance underwriting process, surety bond underwriting is both an art and a science. While underwriters have a set of objective criteria to assess a contractor’s risk, they also use their experience and expertise to determine the final capacity they offer a contractor.
Why Bonding Capacity Matters
Most large construction projects and government contracts require surety bonds. Even if the projects you’re bidding on don’t require them, being bonded is a huge competitive advantage for your business. Increasing your bonding capacity helps you grow by:
- Taking on larger, more complex projects
- Winning bids over competitors
- Accessing more opportunities, like government and commercial contracts
If your business plan is set for growth, maximizing your bond capacity should be a top priority. More capacity means you don’t have to walk away from, or split up, jobs due to a lack of surety support. This extra capacity can lead to projects that fit your wheelhouse but were previously out of reach.
The Three Cs of Surety Bonds
A contractor’s bonding capacity is determined by the “Three Cs”: Capital, Capacity, and Character.
Capital refers to the financial strength of the company. Underwriters review your net worth, working capital, profitability, and other financial metrics to assess whether you have sufficient resources to take on more work.
Capacity refers to whether you have the bandwidth to complete the projects in question. Your past experience doing similar work, backlog, personnel, equipment, and project management skills are all considered.
Character, the most important and hardest quality to assess of the three C’s, represents your reputation for integrity and creditworthiness. Underwriters assess concrete factors like credit history and insurance claims, references, etc. but also consider more subjective traits like your relationship with suppliers and the community.
How to Increase Contractor Bonding Capacity and Maximize Your Three Cs
Let’s take a closer look at each of the Three Cs and what contractors can do to strengthen their position with a surety and increase bonding capacity.
Capital: Show Financial Strength
For contractors seeking increased surety bonding Capital is, arguably, the largest hurdle to jump over when it comes to the three “Cs.” If you’re looking to take on more and larger projects, underwriters want to see that your company has strong finances and access to working capital. A few common balance sheet metrics that underwriters look at are:
- Current assets: Cash, accounts receivable, and other liquid assets prove you can cover short-term costs.
- Net worth: Positive net worth shows sufficient equity to handle any losses.
- Debt-to-equity ratio (D/E): A low ratio shows you aren’t overleveraged with debt. A debt-to-equity ratio of 3:1 is typically the upper limit of a surety’s comfort level but many sureties are willing to work with higher ratios.
- Bank credit capacity: Having unused capacity on bank lines of credit, and acceptable D/E ratios prove you have access to capital and other lenders are willing to support your credit needs.
Focusing on these metrics can improve your position with the underwriter. However, when it comes to improving your company’s financials, it is incredibly important to keep balance sheet growth aligned with bond need growth by retaining acceptable levels of profit in the company.
Capacity: Prove ability to take on work
Your financials are a crucial piece of the puzzle, but they’re only one of the Three Cs. Underwriters also closely examine your ability to take on and successfully complete projects, which is known as your capacity. Indicators of your capacity include:
- Past project experience: Proving that you have a consistent history in your niche.
- Job Profitability: Construction accounting is based entirely on estimates. That is why it’s important to make sure your job profitability remains stable throughout the life of the job. Work in Progress (WIP) history that shows consistent job fade can cause an underwriter to question if the profitability of the current backlog will also fade over time and bring your company’s actual profitability into doubt.
- Steady revenue: Consistent revenue streams display your company’s ability to grow regardless of economic conditions and the ability to show a growth-oriented business plan to the creditors so they can see your vision.
- Personnel resources: People willing to do the work the right way are in high demand and incredibly valuable. The right people – and the right number of people – prove you have adequate personnel for upcoming, and future, jobs.
- Management expertise: Like the right personnel, the right management team shows your company has the knowledge to take on existing jobs and the ability to successfully acquire – and successfully complete – larger projects in the future.
Sureties are looking for steady stair-stepped growth, profitability, and the demonstrated ability to deliver on your work.
Character: Demonstrate reliability
We’ve discussed that underwriters have some “wiggle room” when adjusting pricing, capacity, and bond terms based on their own expertise. Character is the quality that can influence a surety to make a decision in your favor, all other factors being equal. When it comes to character, underwriters are looking for companies that:
- Maintain long-term relationships: Companies with long-term business relationships are typically companies other companies want to do business with.
- Make timely payments: A regular payment history shows that you believe that paying your employees and vendors is a priority.
- Avoid repeat lawsuits, liens, and license issues: Healthy companies do not generally have consistent legal or compliance issues.
These traits prove that you aren’t running a fly-by-night organization – but a reliable company that is trusted by its clients and vendors – and one that operates with integrity.
How to increase contractor bonding capacity and boost all Three Cs
Just as transparency is key to the client/agent partnership, building trust with a bond company is crucial when expanding bonding capacity. Always respond quickly to information requests, maintain open communication about your business plan and company’s current events, and discuss any issues proactively with your underwriter. Other ways to increase your company’s Capital and Capacity as well as the influence of its Character include:
- Enlisting a construction specialist CPA
- Placing experienced people in key positions
- Communicating thoughts, plans, and projects on your company’s horizon
Your surety relationship can literally be the most influential part of your company’s success or its largest hurdle. Contractors who view their surety as a true partner are vastly more successful than those who view their relationship with their surety as a hindrance. When you partner with POWERS, our in-house bond experts will help you identify opportunities to strengthen your business with bonds and find you the right bond company for your business..
To discover how to increase contractor bonding capacity and fuel your growth, schedule your free consultation today.