016 Construction Bonds for Dummies

On this 16th episode of the Construction Industry Podcast we bring you the topic of bonds in construction.

In it I interviewed Luann Cole of SIA Group. I learned quite a lot from talking to her and if you always had questions about bonds and how they can help you, this interview is a great introduction.

And in the tech tip section, I spoke with Tom Buechel, creator of the iScrap smartphone app. iScrap helps you find scrapyards that are close to you so you can sell your scrap easily and get good money for it.

Take a listen by clicking the orange “play” button above.

Episode Links

Listen to the entire episode by clicking the orange “play” button above. Or you can check out the entire text transcription of the discussion by clicking here: [spoiler]Cesar Abeid: Hello Luann. How are you?

Luann Cole: I’m good. How are you?

Cesar Abeid: I’m good. We were just talking about this before we started the interview here. Well, first of all, thank you for participating on this episode of the Construction Industry Podcast.

Luann Cole: Oh, you’re very welcome.

Cesar Abeid: Great. And we were talking about how a portion of my audience here, they’re not necessarily familiar with a lot of things that are day to day topics or everyday topics for construction people such as bonds and that’s why I decided to cover this.

A lot of our audience is made up of construction owners and investors and I just recently learned that people that are not even in the construction sector have been listening to the show. So I think this would be a good topic to cover and I myself know very little about this because I’m not in this kind of – in this line of business but – so this is more for my own learning than anything else. I hope the audience will pick up something too. Fair enough?

Luann Cole: OK. Very fair.

Cesar Abeid: OK. So, as I said, a lot of the listeners of this show and our clients here at Remontech are construction project owners. OK. And they may not be familiar with bonds. Can you give us a bird’s eye view or an explanation of what a bond is?

Luann Cole: Well, a bond is a guarantee of some sort. Usually in the construction industry, we deal with bid bonds and performance and payment bonds and what they do is they are guaranteeing to the owner of the project that the contract is going to be performed as the contract sets out and also pay bills associated with that contract whether it is a subcontractor, a supplier, anything that is directly associated with that contract. So it guarantees to the owner that if the contractor either did not finish the job or is not doing the job properly, that they can make a claim on that bond. It could get the project finished.

Cesar Abeid: I see. Now, to me this sounds a lot like insurance but there’s a difference, right? What’s the difference between insurance and bonds?

Luann Cole: Well, insurance companies of course charge premiums with the thought of, there’s going to be a potential claim. So they of course regulate the premiums accordingly. With bonds, we do not want claims. Claims are a no-no and therefore that’s why the bonding companies will verify financial stability, financial strength. They do background checks as far as, “Does this contractor do good work? Do they finish their projects? Do they work well with others? Is their credit good?” So they know that they are not going to be entering into a claim and that’s really the most important part of the underwriting guidelines for bonds.

Cesar Abeid: So, it sounds like you’re basically vouching for that company …

Luann Cole: That’s …

Cesar Abeid: OK.

Luann Cole: Yes, bonding companies are considered kind of like a cosigner with the contractor because their name is on the bond and they are guaranteeing their contractor is going to fill that contract.

Cesar Abeid: I see. Very good. That makes sense. And how does surety bonding – how can it be beneficial to let’s say a new company or let’s say a company that has recently struggled with finances?

Luann Cole: Well, the one thing that owners of projects look for is the fact that a contractor is bondable because they know the bonding company has checked them out financially. They checked them out as far as their work ethics. Do they finish jobs?

So for a new contractor that comes into the bonding arena, it’s a little bit more difficult because there is nothing to compare it to. We don’t have previous jobs that they’ve done necessarily to compare it to. A lot of startup contractors are usually – they might have been a superintendent for another contractor and they decided to go out on their own. They don’t have the financial background to look at, to see if they are financially stable.

We do have market for those contractors who are fairly new or who have financially struggled. It is very important especially in this day and time for a contractor to pay his bills and have that good credit standing because even the smaller contractors who might not be able to start off in a standard market, we do have smaller programs that run off personal credit. The credit and the creditworthiness of a contractor is major.

Cesar Abeid: In a way, I think you’re taking on a risk when you issue a bond, I guess. And would it cost more for a company that has less of an experience record?

Luann Cole: Initially, yes.

Cesar Abeid: OK.

Luann Cole: A lot of – especially if somebody did have financial difficulties. We do have broker markets that sometimes will require collateral, to write bonds for them and they will charge a higher rate. Our small bonds programs start off with that higher rate just because of the fact that they don’t require all the three-year financials and the questionnaires and the personals and all of that initially.

So there are opportunities out there for the new contractors, the ones who might have struggled financially who don’t go get CPA-prepared statements and they can’t give us the quality information that we need to get them in a standard market but if they only need periodically a small bond, we don’t want them to go out and pay for a CPA statement and spend all that money just for one bond a year that they might need. So there are a lot of different avenues that you can go down.

Cesar Abeid: I see. Now, I just thought about this now. From the perspective of the project owner who is trying to build something and trying to hire a contractor, does it matter what company provides the bond, like your company as opposed to another company?

Luann Cole: Well, we actually represent a few bonding companies. I know a lot of the project owners are getting very specific as to the rating of a company simply because there are some companies that have gone out of business and their rating reflects this financial strength.

So they will every once in a while ask for a letter with the bonding company, how long we’ve had them bonded and what their rating is through AM Best. So that does play a part in what – especially like with GCs and their subs. They want to make sure that they have an A-rated company that is bonding them just because they want to make sure that that bonding company has nothing to go under and they’re going to have a bond that is pretty much useless.

Cesar Abeid: I see. It’s almost like a bond for the bonding company, so kind of those infinite loops. OK. So let’s say a contractor is going to work with a bonding company for the first time. What do they need to know?

Luann Cole: Well, they need to know that initially, it is kind of tedious to get set up. We do – especially in the standard markets. We initially require three-year financials, personals on all owners. We have a questionnaire that gives us some background information on previous jobs they’ve done, suppliers, GCs they’ve worked for because they like to make reference calls just to check them out and see how well they do their job and they keep on the schedules and they don’t make jobs fall behind and we get bank reference letters because their relationship with their bank is very important. We need to know that if push comes to shove, they’re having a cash flow problem, that their bank is going to be there to back them up.

That’s very important too. We have a lot of contractors that have line of credit, working lines of credit with the banks just in case they need that extra money to help out with the job, that maybe they are getting paid or some items. There was additional work that was added that they have to purchase new items or whatever.

So if it is a company who is needing a lot of bonds or substantial-sized bonds and they’ve been in business, initially it’s a lot of paperwork that we need to gather to do our homework. If it’s a small contractor, it’s just a matter of getting some applications completed and signed and the bonding company will then a run personal credit to see if they qualify for the small bond programs.

Cesar Abeid: I see. OK. So that’s from a contractor’s perspective. Now for the project manager that’s involved in the project, how does bonding help the surety owner and the investor that they are going to receive the highest quality of construction at all levels?

Luann Cole: Well, knowing that a contractor is bonded first of all lets them know that the bonding company has checked them out, has made sure that they are somewhat financially stable depending on what avenue they took. There are safeguards as far as that bond is going to guarantee to the owner that there is – somebody is going to finish that job and somebody is going to pay the bills associated with that job, whether it be the contractor that handed the contract in or if that contractor fails to do their obligation. They can ask the bonding company to step in with that bond. So it pretty much guarantees that that contract is going to be performed one way or another.

So we do our homework. The bonding company does their homework. They get a bond and that is ensuring that owner or whoever they’re contracted with that that contract will be finished.

Cesar Abeid: OK. So we talked about the contractor’s point of view, the project manager. Now what about the project sponsor or owner? What advice can you give them if they haven’t worked with bonds before? What do they need to look for? How should they look at this and what steps to take to make sure that they’re getting what they should get when they ask for a bond from a contractor?

Luann Cole: Well, I know some of my contractors when they’re jobs will run D & B reports on their subs to check them out that way. Owners can do that on contractors to see what their bill-paying abilities are, what their financial strength is. Not all of the reports are going to give them the same information. What they need to know about bonds is they need to make sure that the bonding company is credible, which they can check that out. They can go online and look up the treasury-listed bonding companies. If they’re treasury-listed, it will show what their bonding capacities are. They can look them up on AM Best, see what they’re rated which gives them the financial strength of the company. Other than that, I wouldn’t even begin to know what they need to look for.

Cesar Abeid: OK. No, that’s perfect. That’s exactly what I was looking for and I will put on the show notes. This is for the listeners. A couple of links on what Luann just talked about, treasury list and bonding companies and AM Best, I guess. Is that the other resource you mentioned?

Luann Cole: Yes. AM Best, yes.

Cesar Abeid: OK.

Luann Cole: And also they might even just send a verification to – if it’s a large job, they can always send a verification to the actual bonding company to verify that it is a legitimate bond. We have that a lot of times with our right here, government facility that we have a lot of contractors do work on and they will actually send a notice directly to the bonding company to verify bonds. So that’s another way that they can guarantee that that is a legitimate bond and it is with who it says it’s with.

Cesar Abeid: OK. Well no, this is great information. And thank you again. Now if our listeners want to learn more about you Luann and your organization, where should they go?

Luann Cole: Well, our website is www.SIAGroup.net or they can reach me at 910-478-3363.

Cesar Abeid: Perfect. Well, thank you very much.

Luann Cole: All right.

Cesar Abeid: OK. Bye-bye.

Luann Cole: All right. Bye. [/spoiler]