Necessary evils of doing business Bonding and Financing
Bonding Just another expense, or a reassuring safety net?
Bonding – A Definition Performance Bond – assures the contractor will perform the work for the owner (or prime contractor in case of a sub-contractor). Payment Bond – assures the contractor will pay for the materials and labor used on the project. Bid Bond – assures the owner the job will be done for the price of the lowest bid. All bonds provide a safety net for the owner or prime contractor.
Bonding – What is it? • Construction contractors are required to be bonded for governmental work. • The prime contractors will have a bond that covers the owner in the case that the prime doesn’t complete the job. • The prime may require you to have a bond also. • The bond allows the owner to have the project finished without incurring additional expenses. • It’s insurance for the owner.
Bonding – Where do I get it? Many business insurance companies provide performance/payment bonds. Check with your current insurance carrier – if they don’t issues bonds, they may have a referral. Insurance brokers can help to find lower rates trough shopping your needs to various bonding companies.
Bonding – How do I get a bond? The bonding company will require several different pieces of information prior to issuing a bond. The bonding company will want to see that your work history and credit rating are good. If you have a history of poor quality or incomplete work, it will be difficult or impossible to obtain an uncollateralized bond.
Bonding – How do I get a bond? • The bonding company will want to get to know you and your company. • If you are a new client, expect a general questionnaire. • A broker may have one questionnaire that he will use for multiple bonding agencies.
Bonding – How do I get a bond? • The bonding company will want to see what work you have in progress. • They will want to see what work you’ve completed. • The bonding company will want to determine your “bonding capacity.”
Bonding – How do I get a bond? • The company issuing the bond will look the following items: • Your credit rating and financial history • Your company’s credit and financial history • The size of the jobs you’ve completed • The size of the jobs on which you’re desiring to bid • Any previous bonding. • Bad credit or past bonding problems may result in a rejection.
Bonding – How do I get a bond? A poor background may force you to seek a bond from a second tier bonding company. These companies will likely have higher fees for bonding. The SBA may also be useful in securing bonding, but again there may be fees.
Bonding – What else? You can obtain a prequalification that allows you to obtain bonds up to the maximum amount. You can obtain a job specific bond which only covers the job for which it is issued. Bond costs may range from .5% to 3.5% of the bond issued (ex. $2.0 mill bond may cost between $10k and $70k). You should know your bond costs when preparing your bids.
Bonding – What else? Some bonds may be small enough to allow a more streamlined application process. You will likely need to successfully obtain smaller bonds before you will be able to obtain a large bond. The normal bonding process may take three weeks to place – DO NOT WAIT.
Bonding – What else? • Depending on the size of bond you may be required to have a CPA audit or review your financial statements. • Collateral may be required. • Depending on the size of bond requested and your past history, you may have to post collateral. • Examples of collateral include – irrevocable letter of credit, certified check, or funds control.
Bonding – Some final words. • Your credit is important. • Complete your jobs. • Know your bonding costs when preparing your bids. • Get preapproved with a bonding company. There may be a small annual fee, but the process is streamlined.
Bonding – Some final words. • Develop collateral that will be useful if needed. • Use a broker to help shop for the best bonding rates. • As your company strengthens, let the bonding company see your progress.
Financing The good, the bad, and the ugly.
Financing – Why do I need it? • Financing can impact your business in various capacities. • Financing will be useful in a long-term and a short-term manner. • Financing can only be obtained if you and your company are creditworthy.
Financing – Why do I need it? • Long-term needs – • New (or used) construction equipment can cost several hundred thousand dollars. • Contractors may need vehicles, buildings, job trailers, and office equipment which will cost significant amounts of money. • Most companies don’t have enough excess cash available to make the needed operational purchases required for their business. • Long-term loans may allow for a repayment length ranging from 5 to 30 years.
Financing – Why do I need it? • Short-term needs - • Many contracts are percentage of completion or completed contract payment terms. • Construction materials, rent, and wages will all have to be paid to your employees/suppliers before you get paid by the owner/prime contractor. • A revolving line of credit will likely last for one year, and it will allow you the cash flow to make the advance payments you are required to make. • You will borrow from the line of credit as you make payments, and then you will pay down the line of credit as you receive payments.
Financing – Why do I need it? • Properly leveraging assets can allow you to grow your business. • Real estate is one of the best forms of collateral to use when borrowing money. • Proper use of debt can allow you to expand into new lines of work • Using debt may allow you to build a cash reserve rather than using current cash for long-term purchases.
Financing – Why do I need it? • Carrying a manageable amount of debt allows you to build credit in the case you need a major purchase. • A manageable debt load also shows stability to your bonding company.
Financing, How do I get it? • You must develop good credit. • Your company must develop good credit. • Some easy ways to develop good credit – • Pay your bills in a timely manner • Properly utilize credit cards • Lease equipment • Have someone co-sign on a loan with you
Financing, How do I get it? • Develop a business plan. • The lender will want to know the company. • Utilize the SBA business plan tool to get started. • http://www.sba.gov/smallbusinessplanner/index.html
Financing, How do I get it? • Talk to several lenders. • Develop good relationships with lenders. • Be fully prepared before approaching a lender. • Compile a loan package – • Business plan • Historical financial statements • Company tax returns • References
Financing, How do I get it? • Keep business and personal assets separate. • Even a sole proprietorship must have separate banking relationships. • Make sure the business has the proper insurance. • Build collateral! • Leave profits in the company for future use. • Show stability in your market.
Business Plan Basics • Tell the bank who you are – give a brief company history • Tell the bank where you are going – what are your objectives? • What is your company mission statement? • What makes you different? • Why will you succeed? • Why should they lend you money?
Business Plan Basics • Who are the owners? • Where are you located? • Do you plan to open new locations? • What do you do? • Do you plan to add new services? • How are you better at what you do than your competition? • What is your marketing plan and how will you implement it? • What forms of marketing will you utilize?
Business Plan Basics • How will you utilize technology, and how will it impact your field? • What is your target market? • Are there specific market segments that you will be pursuing? • Who is your competition? • As you grow, will you face new competition? • Perform a SWOT analysis. • What is your pricing strategy?
Business Plan Basics • What are the milestones you will be tracking? • How will you track them? • Who is your team? • Provide a bio on each key employee. • Let the bank see you have the business and financial experience to succeed. • What is your financial plan? • Provide financial projections. • Make the projections reasonable!
Business Plan Basics • Include a complete set of basic financial statements in your projections. • Balance Sheet • Income Statement • Statement of Cash Flows • What assumptions are you using? • You assume large growth in your industry. • You assume a loan in the amount of $xx.xx and a repayment term of y. • You assume XX number of new contacts and clients.
Compile a Loan Package • Balance Sheet – • List current and long-term assets. • List liabilities – current and long-term • Final section is the equity in the company (assets minus liabilities).
Compile a Loan Package • Income Statement • Start with Gross Revenue • Deduct Cost of Goods Sold • Deduct Operating Expenses • Add/Deduct Other Items • Net Income
Compile a Loan Package • Statement of Cash Flows • Shows changes in assets • Shows where your cash came from / went to • Only needed if NOT using cash basis of accounting
Other Thoughts About Debt • Using debt may have tax ramifications – • Lease vs. buy analysis for equipment acquisitions. • Some leases may be handled the same as a loan from a bank. • Possible income if debt is forgiven. • Possible income if interest rate is below market from a related party. • You CANNOT deduct the principal payment as an expense on your tax return.
Other Thoughts About Debt • Pay attention to your lender. • Banks fail, know your bank. • Watch closely if your bank is acquired – a new lender may view things differently.
Other Thoughts About Debt • Don’t wait until the deadline to renew a loan. • Communicate quickly with your bank if you anticipate repayment problems. • Be prepared to explain why debt covenants are broken. • Keep projections used for the bank conservative.
Financing – Some final words. • Do not use your short-term financing to make long-term purchases. • Do not use your short-term financing to make “shareholder distributions.” • Do not max out your short-term financing.
Financing – Some final words. • Watch carefully the covenants placed into your loan agreements by your bank. • Communicate regularly with your bank. • Let your bank know in advance if you see problems arising. • Let your bank know when you see successes achieved. • Do not hesitate to utilize an attorney or accountant if you do not understand the loan agreement.
Financing – Some final words. • Do not allow your debt load to become unmanageable. • Do not become a slave to your debt. • Do not look at credit cards as a means of short-term or long-term financing. • Talk to multiple lenders when seeking financing help. • Watch your interest rates closely, and try to pay down the highest interest rate loan first. • Leasing equipment can also be a useful tool for financing an equipment acquisition. • Don’t ignore the tax ramifications of lease vs. buy.
Contact Information • Mark E. Vaughn, CPA 3555 College Avenue Alton, IL 62002 (618) 433-9229 firstname.lastname@example.org