Bonding Capacity as a Driver of Construction Company Value? | Meaden & Moore

Can increasing bonding capacity raise your company’s value? 

A construction company’s bonding capacity can signal different things to different stakeholders. If a construction company shows that they’re able to obtain the required bonding:

• Banks see it as a sign that the company is creditworthy.
• Project owners gain confidence that the contractor they just hired has the financial resources to get the job done.
• Joint venture partners trust that the company has the financial strength to meet the needs of the contract without placing financial stress on the partnership.

One metric can certainly say a lot. But do you know what it says about your business’s value in the marketplace?

Construction companies hoping to undergo a business transaction, whether that’s a sale, merger, acquisition, or ownership transition, need to understand both how and why bonding capacity plays into a company’s value.

If you want a refresher on what bonds and bonding capacity are, skip to the FAQ section below. Otherwise, let’s jump right to the issue at hand.

Does bonding company affect business value?

Business valuations are built on many different factors. Labor availability, industry trends, interest rates, and the economic landscape all matter. But every valuation starts with the business itself — and a company’s bonding capacity can tell you a lot a business.

Bonding capacity reflects overall financial health.

A contractor’s bonding capacity is directly linked with financial metrics like working capital, liquidity, debt to equity ratios, and revenue trends. Because these factors are also central to a business valuation, assessors can use bonding capacity as yet another indicator that the company is doing well.

Bonding capacity is an independent validation of the company’s financial health.

Sureties perform extensive due diligence before they issue bonds. Business valuators know this. So a construction company’s bonding capacity is effectively a third-party, independent verification of financial stability. Yes, evaluators will do their own due diligence, but bonding capacity can provide a bit of extra assurance.

Bonding capacity reflects growth potential.

Sureties will only approve a strong bonding capacity if they’re confident the company can manage additional projects. This growth potential is a quality that buyers want to see.

Bonding capacity is an indicator of risk.

Contractors that have a healthy bonding capacity may be seen as lower risk because it signals financial discipline and operational stability. And when that capacity is maintained over many years, it reduces perceived risk further.

Should you increase bonding capacity to raise your business value?

If you’re looking to increase bonding capacity as a way to increase your company’s valuation, you may be thinking about it the wrong way. Bonding capacity isn’t the driver of a successful business; it’s simply a reflection of financial success. It’s more direct to focus on strengthening the underlying business. Here are some things you can do to increase both your business’s value and your bonding capacity.

• Diversify your projects. It can be appealing to focus on just a few types of projects, but concentrating in only one industry can be risky if that market takes a downturn. Diverse portfolios tend to be seen as less risky.
• Stay on top of finances. It may sound simple, but understanding your costs can go a long way. If you know what drives your costs and how they’ve been changing over the years, you are empowered to make changes that can improve your bottom line.
• Grow your backlog. Maintain a healthy backlog so prospects can see that you’re in demand, and so buyers have an idea for future revenues.
• Review your subcontractor qualification process. If your vetting process is robust, you’ll work with subs that are more reliable, which will help make projects more efficient.
• Keep good records. Keep well-maintained financial statements, but you should also: formalize change orders; track safety incident reports; obtain and maintain licenses; keep proof of insurance; and organize files for warranties, lien waivers, permits, and inspection results.
• Revisit long-term strategies. It can be worthwhile to take a second look at your strategies — for financing, capital investment, succession planning, taxes, etc. — to see if there’s anything you could change that would make you more competitive.

Bonding capacity isn’t a driver, but rather an indicator of a healthy business.

Bonding capacity isn’t what makes a construction company more valuable in the M&A market, but it is certainly used to help determine that value. If your goal is to increase your company’s value, focus on strengthening underlying operations. Over time, your business will become more valuable, and you’ll likely earn greater bonding capacity as a result.

Construction Bonds FAQs

What is a surety bond?

In the construction industry, a surety bond is a legal instrument that guarantees that the contractor will meet its contractual obligations on the project.

What is bonding capacity?

Bonding capacity is the maximum amount of bonded work a surety company is willing to guarantee in support of that contractor. This typically includes both single-project limits and a total limit for all bonded projects.

Why do contractors need surety bonds?

Many project owners require bonds to protect against financial losses if the contractor runs out of money or doesn’t complete the job according to the contract’s specifications.

Who issues bonds?

Surety companies issue bonds.

What’s the process of getting a bond?

Project owners often require contractors to obtain surety bonds before work begins. To get that bond, the contractor establishes a relationship with a surety company to see what their total bonding capacity might be. The surety company determines bonding capacity by looking at the contractor’s financial strength, track record, operations, staffing availability, backlog, and more. When the contractor wins a project, the surety determines if there’s sufficient bonding capacity to issue a bond.

What kinds of construction bonds are there?

The three most common types of construction surety bonds are:

• Performance bonds — A guarantee that the contractor will complete the job as stated in the contract, according to the proposed schedule.
• Payment bonds — A guarantee that the contractor will pay its suppliers and its workforce so that debt doesn’t fall to the project owner.
• Bid bonds — A guarantee that the contractor’s bid is accurate.

What happens if a contractor defaults on a job?

If the contractor defaults, the surety company will step in and satisfy the bond’s obligations. Depending on the bond or the circumstances, they may finance the completion of the project, hire another contractor to complete the work, or compensate the project owner financially. Looking to strengthen your bonding capacity and position your construction company for future growth? Contact our team to learn how we can help. 

Co-Authored By:
Jennifer A. Myers – Vice President, Meaden & Moore, Ltd. and Meaden & Moore Advisors, LLC
Lloyd W. W. Bell III – Director, Meaden & Moore Advisors, LLC