Early in my underwriting career, it wasn’t unusual to meet a company owner who had recently climbed down from a ladder or the seat of a bulldozer to start a construction company. They knew how to build, and they learned how to run the business after they started it. It wasn’t unusual for them to explain how they struggled in the first few years before they figured things out to qualify for surety credit on their own. In that era, the construction business was less sophisticated, and the barrier to entry was lower. Reputation, by word of mouth, counted as much or more than capitalization.
However, the failure rate of new contractors over the years is rivaled only by that of new restaurants. As a result, it’s understandable that surety companies are hesitant to consider a start-up company for a surety program.
Today, it is no small endeavor to become qualified for a significant surety credit program. It’s even more challenging if your business is a fledgling contractor at the start-up stage. Most of the surety prequalification process is based on a proven track record of successful and profitable completion of projects. So, how do you best represent your company when pursuing surety credit if your company is new and your track record has yet to be established?
Start small and grow
It’s not unreasonable to suggest a new construction company should walk before it can run. Even though a new owner may want to do bonded work right away, it’s advisable to win and complete a few private jobs before pursuing public work because the administrative load is lighter. It helps to establish that the new company can successfully complete a contract at a profit. Perhaps even more important, earning some revenue in the new business entity will generate an actual financial statement rather than a pro forma projection.
It is also possible to secure smaller bonds under small- and emerging-contractor surety programs that are based on the personal credit scores of the owners. Nearly all of these programs have significant limitations to the single and aggregate limits of the surety program. In addition, other underwriting considerations such as the complexity of the scope of work and the construction duration under the bonded contract may be limited.
The best thing a new construction company can do to bolster its profile for surety credit is to assemble a team of advisors, including a surety professional agent, a construction-oriented CPA and a construction-oriented bank representative. Each has a role in helping you launch your new company.
Have a good resume for owners and key employees
When it comes to closely held construction companies, sureties provide surety credit to the people who own and manage the companies that sureties underwrite. Representing who you are and what your experience in construction has been, well and truthfully, is of paramount importance. The same is true for the key employees who will be the backbone of the new company. Good resumes for yourself and all your key employees must be part of the submission. It should detail what your education was, including any licenses or certifications you hold, what companies you worked for, and what your progression of responsibilities were that led you to strike out on your own to start a new company.
One of the ways you can gain more credibility with a surety is to have a personal financial statement that actually makes sense. Surety underwriters are often confronted with some handwritten numbers on a form from a bank or the surety agent that don’t come close to balancing and are obviously incomplete. It isn’t a matter of showing the surety just enough to get a bond. It is also a matter of representing yourself well to the surety. Transparency is a characteristic highly valued by surety underwriters.
It’s personal
You should ask to meet with the surety representative and your commercial loan officer in person to tell your story. Part of telling your story is knowing your numbers. If you, as the company’s owner, have to defer to your controller or accounting team to answer significant financial questions about your balance sheet or project performance, it will be off-putting to underwriters who have taken the time to fully understand the information you provide.
You should consider a dry run with your agent as devil’s advocate before your first surety meeting. Be prepared to explain your experience and that of your key employees, and answer any questions the representative may have about your team’s expertise. At the same time, be prepared to evaluate the surety representative you meet with. The meeting should be your interview as much as the surety’s interview. Do your homework on the surety company and ask questions regarding their appetite for risk and what requirements they have or guidance they can provide to support the growth and success of your company.
As much as numbers and financial statements drive surety, it is still, at its core, a relationship business. You will be sharing a great deal of personal and professional information with your surety. If you don’t care for the underwriter who comes to your meeting, you need to work with your agent to interview others.
You may be turned down for surety credit, but you should continue to work with your surety professional agent who can add value. If you are initially rejected, you should ask what changes or improvements you can make to qualify. Your agent can help you hone your presentation and advise you on your strengths and weaknesses with regard to qualifying for surety credit.
It may take more time than you wish to build a balance sheet and business plan that qualifies for a significant surety program. However, it is worth the effort to understand the scale of what is feasible with your new company and what can be accomplished short term and long term with a well-thought-out approach. With the help of your team, you can avoid early pitfalls resulting from an overly aggressive entry to bonded work.
Even if you have a great story, the way you manage your personal finances will reflect heavily on a surety underwriter’s perception of how you may run your new company. Pay your taxes on time. Keep the number of credit cards to a minimum and all payments current. Although it seems obvious, make sure all your other bills, such as utilities and mortgages, are paid on time. Speaking of the obvious, do not run up a tab at a casino. You will need a good personal credit score, but the entries on your credit report that make up the score are what will draw the surety writer’s attention.
Have a written business plan
You also should have a written business plan. People often commit ideas and abilities to paper, believing it’s a plan, but that isn’t enough to win over a surety underwriter. A business plan needs to be based in reality. It should include an examination of the portion of the construction market you intend to pursue and respond to the following:
- What is the public funding budgeted for the work you want to pursue?
- What are the upcoming project opportunities?
- Who are your competitors?
- Why is there space for your new company to compete?
- What is a realistic estimate of the market share you could capture over time?
- What are the specific steps you intend to take to win the business?
- How will the company manage the cash flow for the projects won?
The plan should include a projection of the project pipeline for at least three years with an evaluation of the likelihood of winning the projects in the pipeline. You must be prepared to answer probing questions about your plan and your resources.
One of the realities of starting a new company is starting from scratch. It may be frustrating to step away from a larger construction company where surety credit was well-established and find it difficult to get surety credit for a new company. A new company rarely begins business with an abundance of capital. The amount of surety credit granted to a company is scaled to the analyzed net worth of the company. So, if the company is starting on a shoestring, it will take some time for profitable operations to qualify it for a significant surety program.
During this time, the company needs to show judicious use of debt. Start-up financing by notes payable held by the company’s owners is generally viewed more favorably than debt to financial institutions as start-up capital. Securing a formal working capital line of credit with a bank is also helpful for short-term financing; however, due to its short-term nature, it should not be the source of start-up capital for a new company.
The company’s owners will likely have to sign personally for the working capital line of credit with the bank. Although taking out credit cards initially may be easier, the terms and conditions of a bank line of credit are less onerous overall. In addition, while the amount of credit you qualify for with the bank may be modest, the banking relationship will be beneficial when you need a more significant amount of credit than a credit card may provide.
Establishing this relationship sooner rather than later will pay off in the long run. The surety will require the same security and guarantees as the bank for the line of credit. The new company’s owners must be prepared to personally indemnify the surety company for losses at the outset.
Engaging the services of a construction-oriented CPA is paramount in assembling the building blocks of a well-run construction company. Contractors use track hoes, cranes and scaffolding as the tools of their trade. Sureties use CPA-prepared audit or review-quality financial statements as one of their most important tools. Accordingly, engaging a construction-oriented CPA who can produce a timely, high-quality financial statement with the appropriate schedules and disclosures in the footnotes is an important initial step in founding a company. A good CPA will be invaluable in helping a new company implement effective internal accounting and cost controls, as well as helping set up internal systems that will produce accurate internal financial information for the company’s management and interim information for the surety company.
Again, surety underwriters highly value transparency. It is a proven axiom in surety underwriting that bad news travels more slowly than good news. If your internal accounting system can’t provide accurate and timely information when requested by your surety, the underwriter is left guessing whether it will be good or bad news when it does arrive. It’s even worse if your CPA-prepared fiscal yearend statement is not timely.
Beyond the team of construction professionals, a new company should look to memberships in construction organizations that are both national and local. Organizations such as the Associated General Contractors of America (AGC), Associated Builders and Contractors (ABC) or the Construction Financial Management Association (CFMA), for example, can provide a broader perspective and context. These organizations also provide resources, networking and, often, formal training opportunities that can enhance the abilities of company owners new to running their own businesses. You should talk to other members in these organizations to gather their experience in starting a company and ask for pointers or market intelligence about choosing a good surety agent, construction-savvy bank and construction-oriented CPA.
With some careful preparation, start-up construction companies can have a good relationship with a surety underwriter — an important component of their long-term growth and success.
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