Surety bonds are a vital financial tool for the construction industry. They function as credit instruments that offer support and assistance to contractors in dealing with economic or performance issues. The bond essentially provides a line of credit that pays claims on an agreement. Because of the potential for far-reaching impact, contractors not only need a solid understanding of construction bonds, but they also need to develop a strong relationship with their surety bonding agent.
Obtaining a surety bond is a process similar to applying for a bank loan. Contractors will need to provide information that allows the bonding company to understand their experience and ability, capacity to handle the project, financial condition, and more. Surety bond underwriters will also examine the contractor’s character. Conventional wisdom might indicate that a contractor’s financial resources weigh most heavily in this process – however, integrity is arguably one of the essential factors analyzed by these underwriters.
“Sureties have learned the hard way that the amount of working capital has almost no bearing on whether or not a contractor will be successful. They have found that characteristics such as business acumen and a knack for problem-solving are better predictors of contractor success,” said Jeff Reich, president and founder of Florida Surety Bonds.
Additionally, many new contractors do not have any working capital, financial statements, or may not be sophisticated enough to obtain a surety bond. However, a good business plan, strong financial records, good character, and impressive experience can all help to piece together a valuable argument for sureties to take the risk.
When the vetting process is complete, and the surety determines that a contractor is proficient and reliable, a bond agreement is issued. Contractors should understand that although the surety initially covers a claim, the bonded contractor is responsible for reimbursing the surety for any claims against the bond. For this reason, the surety bond does not protect the contractor but the client.
As contractors complete projects successfully, they are able to secure additional bonding capacity. This offers a path for growth as it gives a contractor the ability to take on larger, more intricate projects.
No two surety companies are alike, and they all have their underwriting standards and practices. A trusted bonding agent (or surety bond producer) is key to helping contractors navigate all the intricacies of the bonding process as well as the nuances of the surety marketplace.
The Surety & Fidelity Association of America (SFAA) characterized surety bond agents as an integral part of a contractor’s external advisory team, along with lawyers and CPAs.
The SFAA defines the agent's role as:
- Preparing the contractor for the surety company’s “rigorous prequalification process.”
- Providing contractors with business advice, management consulting, and technical expertise.
It is crucial for contractors to partner with an agent who can help articulate the success story of their company in such a way that the surety develops a strong belief in the company’s management and business plan. This backing can result in a surety’s willingness to push current limits and take on additional risk. Or, as the SFAA puts it: “as a contractor develops a strong business relationship with a surety bond producer, a relationship will also develop between the contractor and surety company. A good surety company and surety bond producer can help a contractor maintain and increase its surety capacity.”
Bonding agents will also keep an eye on the surety market to negotiate the best bond terms for contractors. The good news here is that construction industry growth is positively impacting the surety market, increasing the number of surety companies competing for a contractor’s business. This news translates to a lot of capacity and competitive rates. In fact, the global surety market expects to grow to $28.77 billion by 2027 from $15.33 billion in 2018, according to ResearchAndMarkets.com.
Just as it is critical for contractors to understand all aspects of a construction project from preconstruction to close-out, they should make sure to follow the nuances of surety bonds and work with a trusted bonding agent who will develop flexible bonding solutions, negotiate the best overall bond programs and help creatively solve bond problems as they arise.