How to get bonded as a contractor

Contractors meet bonds at two points in growing a business. The first is licensing: several state licensing boards require a licence bond before a contractor can work, and some cities and counties require their own. The second is bidding: public owners, and many private owners on larger projects, require bid, performance and payment bonds before they will award a contract. In both cases the bond protects someone other than the contractor, and understanding that is the starting point for getting bonded without surprises.

A surety bond involves three parties. The principal is the contractor, who promises to do something: comply with licensing law, honour a bid, finish the job, pay subcontractors and suppliers. The obligee is the party protected, such as the state, the project owner or the public. The surety is the company that guarantees the promise. If the contractor fails, the surety pays the obligee and then, under the indemnity agreement the contractor signed, seeks repayment from the contractor and usually its owners personally. This guide covers how to get the bonds a contracting business in Arizona, Nevada, Utah or Idaho needs.

Which bonds contractors need

The bond type decides how much underwriting is involved.

• Licence bonds, required by some state contractor boards and local jurisdictions, guarantee compliance with licensing law. Arizona's Registrar of Contractors sets bond amounts by licence classification and volume, and Nevada's State Contractors Board sets its own; each board states the amount that applies to your classification.
• Bid bonds guarantee that a contractor who wins a bid will sign the contract and provide the performance and payment bonds.
• Performance bonds guarantee that the contractor will complete the work according to the contract.
• Payment bonds guarantee that subcontractors, labourers and suppliers will be paid, which matters on public projects where liens against public property are not available.
• Maintenance or warranty bonds guarantee repair of defects for a period after completion.
• Permit and right-of-way bonds, required by cities for work in public streets or on utility connections.

What to gather

Licence bonds for small amounts may need little more than an application and a credit check. Contract bonds need a fuller file.

• Business financial statements for the past two or three years; for larger bond programmes, statements reviewed or audited by a CPA who knows construction accounting.
• Interim financial statements for the current year.
• Personal financial statements for each owner, and often their spouses.
• A work-in-progress schedule listing every current job with contract value, billings, costs to date, estimated costs to complete and expected gross profit.
• A list of completed projects with owners' contact details, and résumés for key people.
• Bank line of credit documents, and the contract and specifications for the job being bid.

Step one: understand how surety underwriting works

Surety underwriting is closer to bank lending than to insurance underwriting. A surety does not expect to pay losses; it expects the contractor to perform and prices the bond on that basis. It judges the contractor on character, capacity and capital. Character is the owners' reputation, credit history and track record of paying bills and finishing jobs. Capacity is whether the business has the people, equipment and experience to do the size and type of work proposed. Capital is working capital and net worth, which show whether the business can absorb a bad job without failing.

From these the surety sets a bond line: a single job limit, the largest contract it will bond, and an aggregate limit, the total bonded work in progress it will support at once. Contractors grow their bond lines by building a record of profitable completed work and retained capital.

Step two: prepare a clean submission

Work with an agent who places surety bonds, and give them a complete file the first time. Financial statements that separate business and personal expenses, show contract revenue on a percentage-of-completion basis where appropriate, and reconcile to the work-in-progress schedule make underwriting faster and the bond line larger. A work-in-progress schedule that shows jobs losing money, billing well ahead of costs, or estimates that keep changing tells the underwriter something important, and it is better explained up front than discovered.

For a new contractor, or one moving from private to public work, sureties may start with small bonds, ask for more personal support, or use programmes designed for emerging contractors with funds control or collateral. Starting small and performing is how the line grows.

Step three: read and sign the indemnity agreement

Before issuing contract bonds, the surety requires a general indemnity agreement. The business, its owners, and often their spouses sign it personally, and it gives the surety the right to recover any loss and expense from all of them, to demand collateral if a claim is made, and to take over job funds in certain circumstances. It is the most important document in the bonding relationship. Read it with your attorney before signing, understand that it survives even if you change sureties, and keep the surety informed about trouble on a job early, while there are still options.

Common mistakes

These slow down bonding or shrink the bond line.

• Treating a bond as insurance that protects the contractor.
• Mixing personal and business finances in the books.
• Submitting a work-in-progress schedule that does not match the financial statements.
• Bidding a job larger than the bond line without talking to the surety first.
• Taking cash out of the business at year-end, which lowers working capital.
• Signing the indemnity agreement without reading it.
• Hiding a troubled job until it becomes a claim.

A worked example

Suppose an electrical contractor in West Valley City has done private work for five years and wants to bid a $1,500,000 school project that requires bid, performance and payment bonds. The business has $300,000 in working capital, $500,000 of net worth, CPA-reviewed statements and a clean work-in-progress schedule. The surety approves a single job limit of $2,000,000 and an aggregate of $4,000,000, and both owners and their spouses sign the indemnity agreement. The bid bond costs nothing extra. When the contractor wins, the performance and payment bond premium is $22,500, which the contractor built into the bid price. Two years later, after completing the school at a profit and retaining earnings, the surety raises the line to $3,000,000 per job. The figures are hypothetical; the reviewed statements and the work-in-progress schedule are what set the first line.

How to use this

If you need a licence bond or are preparing to bid bonded work, send us your financial statements, work-in-progress schedule and the bond requirements. We will tell you what the surety will need, place the bonds with sureties available through the agency, and coordinate them with your general liability, commercial auto and workers compensation so the certificates the owner asks for line up. If a licence bond is all you need today, we will keep it that simple.