3/28/2017

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Surety Bond

A surety bond is a contract between three parties, the principal, which is the prime contractor, the project owner, and the surety company. The surety company issues a bond that guarantees payment by the contractor to the other parties that are involved with the project such as the subcontractors and suppliers. The surety bond also guarantees the performance of the contractor. The sub-contractor will also have to obtain a surety bond for itself.

Surety bonding can add up to $25,000 or more to a contractors administrative costs. To obtain a surety bond, there are several important factors involved that may require specialized expertise from sources such as a Certified Public Accountant (CPA).

  • The CPA should have knowledge about financial aspects of the construction industry that are vital to a contractor who wants to place a bid, no matter the dollar amount, on a project that requires a surety bond.
  • The CPA should know how to prepare the required financial statements that will be needed and how to give an accurate estimation of costs and overruns.
  • Adequate insurance coverage has to be factored into the equation.
  • The CPA should know how to establish a continuity plan that is funded by life insurance.
  • It is vital to have job-cost accounting software for job tracking progress and keeping necessary data.

For small businesses, a surety company may approve a bond up to $350,000 based on a contractor's personal credit score. It may also have no requirement for a CPA prepared financial statement. For projects over $350,000, a CPA prepared financial statement is needed and personal credit scores will be reviewed along with PayDex scores which rate how a business pays it's invoices.

Bonding Capacity is the remaining costs required to the completion of on all jobs whether they are bonded or unbonded. A CPA should know all the limit qualifications for bonding. In most cases, a surety company will only extend bonding credit up to one and a half times the largest project the contractor has completed. Since general contractors usually finance very little of the work, surety companies extend less capacity. For subcontractors who finance most of the work, a surety company will extend less capacity--usually about ten times working capital.

In certain cases, some bonding companies will provide bonding capacity for a small business if it teams with a stronger, more financially secure contractor. In this scenario, the teaming partner would be subcontractor to the smaller prime contractor.

The Small Business Administration (SBA) offers an alternative surety resource for small business contractors. It guarantees up to 90 percent of the bonded risk. The SBA offers two plans:

  • Plan A--the Prior Approval Plan requires that the bond account be submitted to both the corporate surety and SBA for approval.
  • Plan B--The Preferred Surety Bond program is for corporate sureties that maintain, underwrite, and approve bonds on the SBA's behalf.

If you are a contractor thinking of bidding on a construction project, no matter the size, you should enlist the help of an experienced Certified Public Accountant (CPA) who has an understanding of what it takes to secure surety bonding and is knowledgeable of construction accounting.

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