For many small and emerging contractors, obtaining mandatory surety bonds required by public and municipal contracts can be difficult. These required bonds are underwritten by surety companies, each of which has its own appetite for risk, underwriting criteria and area(s) of specialty.
Thanks to the Miller Act, a federal regulation that was passed in 1935, principal contractors on federal construction projects of $150,000 or more must provide performance and payment bonds. States and municipalities may also require surety bonds on public projects. These bonds guarantee the contractor’s performance and payment to subcontractors and material suppliers. The guarantee can often find its way onto private commercial jobs as well, depending on the owner’s or lender’s demands.
In practice, there is a lot of variation in terms of what surety companies look for prior to issuing a bond. Certain contractor characteristics, however, consistently make receiving approval challenging. Examples of these limiting characteristics include prior bankruptcies, existing liens, negative net income, “thin” working capital and limited experience with a particular size or type of project.
In many cases, and even if a bond is approved under these circumstances, surety companies may apply higher premiums or require other conditions, such as funds control or collateral. These extras add time and cost, potentially making the contractor less competitive when bidding for bonded jobs.
The Surety Bond Guarantee Program Levels the Playing Field
Launched in 1958 by the Small Business Administration, the Surety Bond Guarantee Program (SBG) is intended to “provide bonding assistance, in partnership with surety companies, to qualified small businesses.”
Under this program, the SBA guarantees a percentage of the bond (typically 80% or more) for certain surety companies. This acts as a type of secondary insurance, reducing the surety company’s risk and, as a result, opening up more opportunities for small and emerging contractors. The fee to the SBA is small – approximately 0.6% of the contract value – and is paid by the contractor.
It’s important to understand that the existence of the SBA Program does not guarantee approval; the SBA will consider a number of factors in determining entry. It will also require that certain minimum standards for both the contractor and project are met. These include:
- the contract or subcontract cannot be larger than $6.5 million for public and private prime contracts and all subcontracts;
- the contract or subcontract cannot be larger than $10 million for federal projects; and
- the contractor must meet the definition of a “small business” under federal regulation.
To apply for the SBA Program, the contractor will typically work through a surety bond agent. These professionals guide the contractor in assembling the required financial documentation and in submitting the completed bond application to the surety underwriter. Because of both the amount of detail required and the sensitive information involved, it’s important to choose an experienced and trustworthy surety bond agent.
From there, the surety underwriter will complete the necessary due diligence, with the understanding that the SBA will guarantee a portion of the bond. Once satisfied, approval is granted subject to acceptance by the SBA.
A Helping Hand for Small Contractors
Without question, the SBA program is a valuable and effective tool for helping small and emerging contractors jumpstart their respective business and remain competitive in the public and municipal sectors.
The SBA’s objective in offering this program is not for contractors to remain within it indefinitely. Rather, the expectation is that the contractor will “graduate out” of the program and become bondable without the SBA’s assistance. For this reason, it’s essential that the contractor and surety bond wholesaler are a good fit. This way, when the time comes to move on from SBA-backed bonds, there is an opportunity for a strong ongoing relationship.
