If you are a contractor in the public works sector, you likely know about bid, performance, and payment bonds. You also likely know that qualifying for bonds depend on the financial condition of your company, personal finances, and experience as a contractor. Bonding is a lot like applying for a loan. Similar to lending, a contractor qualifies up to a maximum amount. But what happens when a contractor cannot qualify for a bond needed for an upcoming project? Do they have to pass on the job? Not necessarily. You may qualify thorough the Small Business Administration’s – SBA Bond Guaranty Program.
For contractors who cannot qualify for bonding, the SBA Bond Guarantee Program steps in (administered by the Small Business Administration). Here’s how it works: the surety company approves and writes the contractor’s bond with SBA backing it. The surety receives an 80-90% collateral guaranty from the SBA, removing most of the surety company’s liability. The guaranty provides an incentive to the surety to approve bonds they would otherwise decline.
The SBA offers 3 programs:
The Prior Approval Program offers a 90% collateral guaranty to the surety company. The contract must be $100,000 or less, or the company is owned by one of the following: socially or economically disadvantaged individuals, veterans and service disabled veterans, 8(a) certified companies and certified HUBZone companies. All other guarantees are 80%.
As of September 20th, 2017, this program offers the same guaranty as the Prior Approval program. Before September, it only offered a 70% collateral guarantee to the surety company. The surety company decided to approve or decline a bond, rather than the SBA. Because of this, the SBA chose to offer a lower guarantee than the Prior Approval Program. The difference to you? Nothing. Your bond agent may choose the Prior Approval Program or the Preferred Surety Bond Program.
This is a subset of the Prior Approval program. The SBA designed this program for companies with infrequent bond requirements. It dramatically reduces the underwriting and paperwork requirements, streamlining the process. The program has some limitations, such as no environmental work, multi-year contracts, and excessive warranty and liquidated damages provisions.
Regardless of the program, the SBA can offer guarantees on contracts up to $6.5 million, and up to $10 million on federal projects (with a federal contracting officer’s certification).
A huge benefit of the SBA bond guaranty program is the minimum working capital requirement. The SBA will go to 20 times working capital of the total (bonded and unbounded) costs to complete work on hand. This is fairly aggressive; the standard industry caps at 10 times. Additionally, the SBA will also count unused credit lines toward working capital. Here is an example to show the benefit:
Example: Need-a-Break Construction Company has no current work on hand but has $100,000 in working capital, and an unused $100,000 line of credit.
This would likely result in $1,000,000 of aggregate bond capacity.
$100,000 (working capital) x 10 = $1,000,000
This could result in $4,000,000 of aggregate bond capacity. Add $100,000 of unused credit to the $100,000 of working capital. The SBA counts 20 times $200,000 to come up with available aggregate bonding of $4,000,000.
($100,000 + $100,000) x 20 = $4,000,000
In reality, a surety would not likely extend $4 million worth of surety credit based on these figures. But it would most certainly go higher than $1 million with an 80% to 90% guaranty. The surety company, the agent’s recommendation, SBA approval, and many other factors determine just how much bond capacity can increase.
In the right scenario for the right contractor, the SBA bond guarantee program can be extremely valuable. Many contractors benefit greatly, growing their businesses more than ever possible without the program.
If you have any comments or questions, you can reach us at 877-654-2327 or email us at [email protected].
By: Ryan Tash