Well-capitalized construction companies are given preferred bonding programs over those whose equity has to "stretch" to achieve a desired program.
Equity can be low for several reasons:
Bad year(s) or project(s)
Two of these are typically out of the contractor's hands. Losing bonding because of distributions can be avoided.
Through the years, we have had many contractors distribute funds not knowing how it affects their bonding. Though we have annual meetings with them to discuss our bonding programs, sometimes it is not understood how important a solid equity position is for their bonding until they may make a large distribution.
Reasons for the distribution can be anywhere from paying taxes for S corp profits, personal reasons, starting other businesses or any number of reasons. Distributions to pay taxes are always assumed by the surety company. Other substantial distributions should always be consulted with the bonding agent first.
For example, if a contractor is being underwritten on a 10% case (bonding equity is typically 10%+/- for MEP contractors), they can bond a $10 backlog for every $1 within the company. So if a contractor keeps $1 in the business, they can bond $10 worth of bonding. If they can work that off twice in a year, then that $1 gives them $20 in bonding capacity. If the contractor's net profit is 10%, then they made $2 just for leaving $1 in. Then if they keep that $2 in the company, then they will start out the next year with $3, can do $60 worth of work, and end the year with $6 in profit and $9 in the business.
We often get asked why personal equity does not count toward bonding. Well, it does and can. Oftentimes, it can get over a hump but the bonding company can't usually make a case on it. Though some sureties count personal equity more than others, a contractor can get pigeonholed into a situation. In our opinion, it's best to have a lot of suitors.
It's very important to build equity during the good years and be overcapitalized in case of an emergency. During the annual meetings, an agent will be able to let the contractor know when they hold enough equity for their bonding needs.
Interested in getting a surety bond quote today? The team here at Shorewest Surety would love to help. For the last 20+ years, we’ve been exclusively focused on helping construction contractors get the best rates, expertise, and service possible. We truly care about our clients' success and are honored to partner with them and share our bonding expertise so they can bid on the projects that matter most. Give us a call today at (800) 264-1634 and talk with an agent who will give you a personalized quote.