BID BOND

PERFORMANCE BOND

This is a written guarantee from a third party guarantor which is submitted to the principal by the contractor of a winning bid. A Performance Bond ensures payment of a sum of money in the event that the contractor fails in the full performance of the contract.
The Performance Bond is a guarantee that the job will be completed according to the terms of the contract.

The bond provides security that should the principal fail to perform the contract, the surety will either:

1. Complete the contract
2. Pay for the cost of completion of the contract in excess of the contract price
3. Pay the bond penalty.

For contractors, a bond is a valuable tool, because it assures clients that they will be protected financially in the event that there is a problem with the job. Clients prefer to work with contractors who hold bonds as a form of financial assurance, and subcontractors and suppliers may like to see proof of a contractor’s bond before agreeing to work on a job. Construction can get very costly, especially if things go wrong, making a contractor’s bond a critical tool to have.

How to Get Surety Bonds

Although most Surety Companies are also large Insurance Companies, qualifying for bonds is more like obtaining bank credit than purchasing Insurance. Like your bank, the Insurance Company wants to know you well before committing its assets. Most contractors find that it is necessary to spend a lot of time and effort establishing their first relationship with a surety company. Since the surety is guaranteeing the contractors performance, it needs to gather and carefully analyze much information about the firm before it will agree to provide bonds.

Prequalification

The Surety Underwriting process is focused on prequalifying the contractor. It takes time (sometimes a lot of time) to develop and present data, address questions the surety may have, and verify information. Before issuing a bond the surety must be fully satisfied that the contractor is of good character, has the experience that matches the requirements of the projects to be undertaken, and has, or can obtain, the equipment necessary to perform the work.
The surety also wants to make sure that the contractor has the financial strength to support the desired work program, and has a history of paying subcontractors and suppliers promptly. It will want to see that the contractor is in good standing with a bank and has established a line of credit. In short, the surety wants to be satisfied that the contractor is a well-managed, profitable enterprise who keeps promises, deals fairly and performs obligations in a timely manner.
It is important to realize that each surety company has its own underwriting standards and requirements. But there are fundamentals that are common to underwriting surety bonds, and understanding these fundamentals is helpful to brokers who are guiding a contractor for the first time.

Your decision to seek surety bonds should be based on their own cost benefit analysis. To obtain bonds, even some changes in the way your firm does business may be necessary and these changes could have certain costs.

Here’s What You Need

Let’s take a look at the kind of information you will need to provide to the Insurance Company in order to prepare your case for bonds:

• An organizational chart that shows key employees and their responsibilities;
• Detailed resumes of principal owners and their key people;
• A business plan outlining the type of work the principal does, how jobs are obtained, the geographic area in which they operate, and growth and profit objectives;
• A description of some of the largest completed jobs, including the name and address of the owner, the contract price, the date completed and the gross profit earned;
• A plan outlining how the business will continue in the event of the owners death or disablement, or that of another key employee (surety agent may suggest that principals plan include life insurance on key people, with the company named as beneficiary);
• Subcontractor and supplier references including names, addresses and telephone numbers of persons to contact (the surety will probably also order an independent credit report on the firm);
• Evidence of a line of credit at the contractors bank (sureties generally look for an unsecured line of credit that can be used when needed to meet short-term cash requirements; an additional secured line of credit obtained through the long-term financing of equipment or real estate may help to strengthen your case); and
• Letters of recommendation from owners, architects and engineers.

Financial Statements

Financial statements are vital to any business that grants credit, and sureties are no exception. Depending on how long you have been in business, the surety will want to see fiscal year-end statements for the last three years.
Financial statements should include the following:
• The Accountant’s Opinion Page, which discloses whether the statements were prepared according to audit, review or compilation/notice standards.
• The Balance Sheet, which shows the assets, liabilities and net worth of your business as of the date of the statement. This helps the surety assess the working capital and your overall financial condition.
• An Income Statement, which measures how well the business performed. The surety will assess each item, including gross profit on contracts, operating profit and net profit before and after tax provisions.
• A Statement of Cash Flow, which discloses the cash flow movements from operating, investing and financing activities.
• Schedules of Contracts in Progress and Contracts Completed, which show the financial performance of each contract and provide insight into the potential for future earnings from contracts in progress.
• A Schedule of General and Administrative Expenses, which may reveal how well overhead expenses are controlled and managed.
• Any Explanatory Notes that the accountant may have included with the statements.
The surety may also require aging schedules of accounts receivables and payables, as well as schedules for any other items on the statements that might need such support.

Quality of Financial Statements

Accountants prepare financial statements on three levels: an audit, a review, or a compilation. Sureties prefer audited fiscal year-end statements, but there are occasions when a surety may accept a review statement, which is far less comprehensive than an audit. A review statement consists principally of inquiries of the contractor’s people and the application of certain analytical procedures to the financial data. Although far narrower in scope than a full audit, the review does provide some limited assurance about the financial statements. A compilation, however, provides no assurance, or very limited assurance, as to the credibility of the figures presented because the accountant is not required to follow normal audit procedures or acceptable accounting principles.
In general, neither a statement prepared by a bookkeeper or accounting service is acceptable to sureties, because they are difficult to verify and lack the stamp of approval of an independent auditor. The Insurance Company will occasionally offer a modest bond program with statements that are completed on less than a review basis.

Accounting Methods

Complete and accurate cost recording and accounting systems are extremely important to surety companies. Without these systems, the contractor may not be able to identify and correct problems before they become too severe.
Although there are a number of accounting methods available for contractors, in most instances the Canadian Institute of Chartered Accountants recommends a method called percentage of completion. This method is also preferred, and in some cases required, by sureties. Generally, the percentage of completion method best represents a contractor’s financial condition and most accurately measures results of work performed during the accounting period.
Depending on the time elapsed since the last fiscal year-end statement, the surety may ask for an interim financial statement to show how the current year is progressing. While the requirement for interim statements varies, a six-month statement is usually minimum.
You will also need to prepare a schedule of work in progress, probably quarterly. This schedule should list each job by name and indicate the total contract price, including:
• change orders;
• amount billed to date;
• cost incurred to date;
• revised estimate of the cost to complete;
• estimated gross profit; and the
• anticipated completion date.

Submitting Your Case to the Surety

Once we have gathered the necessary documents we will present it to the Surety Company for review. The company’s underwriter may ask to meet with you and their key people.

Personal Indemnity

Because surety bonds guarantee a firm’s performance and payment of bills, the surety fully expects that the contractor will live up to those obligations. Therefore, you may be asked by the underwriter to sign an indemnity agreement. This indemnity will be required of the contracting firm and is usually required of the firm’s owners and their spouses.
The indemnity agreement obligates the named indemnitors to protect the surety from any loss or expense, thus assuring that they will stand fast in the face of problems and use their talents and financial resources to resolve any difficulties that may arise in the performance of the bonded work.
After the bonds are written, the surety will continuously reevaluate the overall performance and financial position of the contractor. Adverse changes may cause the surety to reduce or terminate the bonding program, while positive results may serve as the basis for an increase in the amount of bonds available.

Allow Sufficient Time

It is important to realize that sufficient lead-time should be allowed when seeking bonds-especially for the first time. The amount of time required varies on the credit requirements and cannot be accurately estimated until the underwriter has actually reviewed the submission.

In Conclusion

We have generally discussed the type of information an Insurance Company requires for a first bond. Even then, there is no guarantee that submitting all of the requested information will result in an approval. The bond will be given only if the surety feels the contractor is qualified to successfully perform the contract.