Finance & Bonding Relationship - Pt. 1

1. The Relationship BetweenBonding & Finance What are the financial drivers behind bonding? Part I Explanation and Examples

Purpose of bonding

Ensure that the project continues on or near schedule despite issues with performance or payment.

Provide assurance to the owner or general contractor that your company can and will fulfill its obligations as contracted.

If the bond is utilized, the bonding company expects full repayment.

What do bond companies need/expect?

10% + equity on the balance sheet.

In order to show this, a company MUST retain a portion of its earnings each year.

This retention is shown in theStockholders Equitysection of the balance sheet.

If you have not retained earnings, shore up the balance sheet by injecting capital (paid-in-capital). Or, if you have an outstanding Shareholders Loan, convert that loan to equity.

Check with your accountant and attorney to make sure you document the conversion properly.

Bond companies also want:

5-10% of the revenues in a line of credit (LOC).

If you encounter a hiccup cost overruns, slow payment by the owner or general contractor, disputed work, then you have access to funding above and beyond your operational cash flow.

This LOC will help you complete the work as contracted, thus reducing the risk that any use of the bond will be necessary .

Banks & others willnotlend against bonded receivables.

Bonded receivables- accounts receivables (A/Rs) generated from contracts that required bonds .

Why wont banks lend against these?

Banks place liens on A/Rs as collateral for the LOC. Must be in 1 stposition. With bonded receivables, bond company is in 1 st .

How do construction companies get around this?

Most companies do not have 100% bonded contracts. The non-bonded receivables make good collateral for an LOC.

Companies may utilize equipment, property, or other collateral or strong personal guarantees by its management to obtain or increase its LOC.

Company A has $12 million in annual sales generated from two large $6 million projects.

Project 1 yields $6 million for the January June period.

Project 2 yields $6 million for the July December period.

Assuming both jobs/projects are fully bonded$6 million bond program.

$6 million is the per project max. bonding capacity.

Company B also makes $12 million in annual sales.

Revenue generated from small jobs with an average size of $150,000 - $300,000.

In any month, projects are beginning and ending, with most jobs lasting 3-4 weeks.

Average monthly revenue is $1 million.

Assuming all jobs are fully bonded$1 million bond program.

$1 million is the per project max. bonding capacity.

Acompleteprogram is typically denoted as per project maximum over aggregate bonding program.

I.e., a 2 over 4 program would be as follows: per project maximum of $2 million; aggregate bonding of $4 million.

Aggregate bonding- the maximum amount in total outstanding bonds the company can have.

Remember, as a project is completed, the exposure decreases and the bonding required for that project decreases.

Additional Information:

Solving the CapitalEquation:

Financing Solutions for Small Businesses

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Finance & Bonding Relationship - Pt. 1

Business

Transcript of Finance & Bonding Relationship - Pt. 1