What you Need to Know About Surety Bond Underwriting
This week, Surety Underwriting Specialist Joel Cannon is giving us an inside look at what goes into bond underwriting decisions for contractors.
Topics we cover in this episode include:
- The importance of good year-end financial statements for bonds
- What creative underwriting means and which factors beyond working capital go into bond decisions
- Common mistakes contractors make when getting bonded for the first time
- The “sweet spot” for contractor success
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Kelly Finnell, ESOP Coach | https://execfin.com
Rob Williams, Profit Strategist | https://IronGateESS.com
Wade Carpenter, CPA, CGMA | https://CarpenterCPAs.com
Stephen Brown, Bonding Expert | https://McWins.com
TRANSCRIPT
[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today, we have Joel Cannon with us, with Philadelphia Surety Companies, and he is the Senior Surety Underwriting Specialist. Wow. What a title, man! This is great. And we are the Contractor Success Forum where we discuss financial strategies for running a more profitable, successful construction business.
And we have in one corner Stephen Brown, a construction bond agent with McDaniel-Whitley bonding and insurance agency with over 30 years, three decades guys, more than that, underwriting and placing bonds for you as a contractor. And in the other corner, we have Wade Carpenter, Carpenter and Company CPAs, and he has been helping contractors nationwide to become permanently profitable also for over three decades.
And I am Rob Williams, your profit strategist with IronGate Entrepreneurial Support Systems. And I am driving profit in your businesses with decades of vertical integration as a contractor myself, a manufacturer, an aviator, and a financial strategist in the construction industry.
Today we are talking to Joel Cannon about being a surety bond underwriting specialist and what they look for. Welcome, Joel. And right now. You’re a contractor yourself. We’re looking at his beautiful, shiny trim. He’s contracting his own house redo himself right now. So how’s that going?
[00:01:48] Joel Cannon: It’s going pretty well. I’m getting firsthand experience in project management and everything is going well, but I can appreciate the challenges that our contractors are going through in the marketplaces. I’m experiencing all of them right now.
[00:02:00] Rob Williams: Yeah.
[00:02:01] Stephen Brown: Rob. I want to explain to our listeners that Joel was one of our surety underwriters that we we rely on. in our agency. as an agency, we represent a bunch of different companies, Joel of course being one of the very best. That’s why he’s on the show.
[00:02:16] Rob Williams: Great, man. That’s great. And we’re excited to have him. Wade, we’ve been talking about having him on for a while and to have both you as a CPA preparing all this information for the Joels of the world to see how we can help our contractors. Do we have any questions for…?
[00:02:35] Wade Carpenter: I appreciate you coming on, Joel. We recently did a podcast on dressing up your financial statements for year end. And I didn’t know if you could kind of speak to that in general. This is the time of year people should- I feel, should be really paying attention to the numbers and seeing how we can dress up those financial statements.
[00:02:55] Joel Cannon: Absolutely. I really liked the idea of being forward thinking, that end of the year planning, recognizing the different partners that the contractor has on their team, which is critical. the insurance and bonding agent, the CPA, the banker, the attorneys, the surety company, all of these partners that are all striving to help the contractor succeed. We all wear different hats, but if you have the right team and the team knows what’s important for the other teammates, you can make sure that that planning aligns with the long-term goals of your company and the ability to, in my case, secure the bonding credit that you need to prosecute your business plan.
So, as far as the end of the year tax planning, there are some CPAs out there that are singularly focused on tax strategies. That may not be the best the best thing for the surety underwriter. What we really want to see with the year end statement, we’re definitely focused on liquidity. We’re focused on working capital. We’re focused on the composition of the working capital. Retention of profits, understanding that pay the contractor. It’s his money. He’s earned it. but at the same time, enough money needs to be left in the kitty to prosecute the business plan that the contractor has for the coming year.
It all really rolls into a forward looking strategy for the contractor. What do they see in the next six to 12 months? And what does that financial statement need to look like for the bonding company to be able to just be easily doing this every time they need a bond?
[00:04:33] Rob Williams: Yeah, that’s great. Stephen, we were talking earlier about the different kind of underwriters and how Joel can be different sometimes in looking at the companies. Do you have any questions for him on that?
[00:04:47] Stephen Brown: Well, one thing I wanted to comment is that Joel’s a really, really good underwriter. He’s been doing this for a long time. The longer you do it, you do get better. Not that the new underwriters can’t make decision on bonds, but Joel’s been through a lot. He understands that character is a key underwriting issue. He does it by the book, but at the same time, he understands the intricacies of how things should change in the construction industry. And that’s why Joel is such a great underwriter. And one thing about Philadelphia is that it’s an insurance company. They have a surety division. Joel is part of that surety division, but he didn’t start off–
He was at Hartford before that. He got his training different ways, just like all of us do to get to where he is today. But, that’s the key thing about surety companies. They’re the same, but they’re different. Wouldn’t you say, Joel?
[00:05:43] Joel Cannon: Absolutely. I remember early in my career, a mentor of mine once said that, surety companies are like flavors of ice cream. Everybody likes something different. And this is true about insurers. There are some surety companies, some of the larger, more established companies, you know, the standard market surety companies, they’re looking for, let’s say large general contractors. That’s their forte.
Some, some really like the sub contractor realm. Some like the middle market. Some really catered to the small and emerging contractors and those oftentimes are the best fit for contractors getting out and getting started in business as they’re starting to build their balance sheets.
And then quite frankly, there are other markets that we call the substandard markets, and that’s not a pejorative. They have a role in this industry. They tend to handle the more challenging cases, cases that oftentimes require collateral and usually command a higher rate. So depending on where you are as a contractor in that spectrum, somebody like Stephen who sees a lot of different types of contractors and represents different markets is in a really good position to match the contractor to the appropriate market.
[00:06:52] Wade Carpenter: Great.
[00:06:53] Rob Williams: You know, I have a question for Joel, because as a contractor myself, we always thought that was pretty much just a hard, fast rule. We didn’t realize that it’s kind of humans in this and making decisions. We thought, you have to have this percent of money sitting in the bank. And if you don’t have say, I remember 10% was this rule that we had, you know, and then we thought that was the only thing you really looked at and just how to get this 10%.
And, tell me more about how you can underwrite and the different ways you look at it and the different factors. And what’s outside of the box.
[00:07:29] Joel Cannon: Yeah, absolutely. And that’s one of the things I like about the company that I work for right now, Philadelphia Insurance Companies. It’s a very creative underwriting culture, looking at the business case first. We follow up and see how the metrics then can match up with our business case.
But you’re spot on. I mean, there’s the standard 10% rule, you or, you 5% working capital case. These are all fairly standard things that you hear in the marketplace. But what I really like to do, and I kind of feel I’m a creative underwriter, I like to put together interesting, complicated deals. But you know, we, we can take a look at Philadelphia. We don’t necessarily have to focus in on that script, 5% working capital case or 10% net worth case.
Experience of the contractor means an awful lot, understanding the contract terms and conditions means an awful lot. if we have to layer in some partial collateral to sweeten the deal, we can do that at Philadelphia. We can also take payment risk out of the equation. We do funds control at Philadelphia Surety, and we do it all in house.
But these tools that we have, and our ability to kind of get under the skin of the deal, enables us to not get so hung up on these 5% and 10% rules that are so common in the industry and really craft a creative deal that enables us to do some things on a thinner case than maybe we would ordinarily do.
I’ll give you one example. I was able to help an industrial contractor who typically does not bond. They would rather walk away from a job if it requires a bond than take the job. But occasionally they’ll see something that is really, really in their wheelhouse and they really want to do. So I had an opportunity on a $30 million contract and quite frankly, this is a very, very successful contractor.
He makes a lot of money year over a year, but he doesn’t want to leave it in the company. So, you look at the year end statement and it’s, you know, less than a million dollars in equity and very little working capital, not much bank support, but the contractor has been very successful and he’s got a very nice personal balance sheet. But we were really able to get in under the skin of the contract and figure out ways that we can mitigate the risk. Took a little bit of collateral on the deal and he didn’t really want to personally indemnify, but we got them convinced to at least give us a little limited personal indemnity. And lo and behold, we were able to convince the owner to take a percentage bond and it all ended up working out great.
But if you went by the 5% and 10% rules of the world, A $30 million bond on top of probably $60 billion worth of work didn’t make a whole lot of sense. But we made it work and it was a very, very successful project. And everybody was very happy with the result.
[00:10:20] Wade Carpenter: That’s great. I know some of our listeners may be trying to get bonded for the first time. From your perspective, what are some of the mistakes that contractors make when trying to get bonded for the first time?
[00:10:31] Joel Cannon: Probably the primary mistake, I like to call it a crawl before you walk and a walk before you run approach, particularly in a market that we’ve been in in the last couple of years where there’s been an availability of work. We see too many contractors that want to get over their skis. They want to swing for the fences and take advantage of all that work.
Maybe they’re coming out of larger companies where they’ve managed larger projects, but they don’t appreciate the risks fully that they’re taking in terms of the cash flow requirements that this abundance of work may demand on them, the need to have secondary support with their bank. And they get over their skis and they tend to kind of blow themselves up right out of the gate. So I’d say that’s probably the fundamental thing. So, have a plan where you can grow smartly and take on additional risk as your company is able to handle that risk.
[00:11:31] Wade Carpenter: So I guess, sometimes it’s this time of year when I’m planning with a contractor, it seems like sometimes things are not going well with a contractor. So from your perspective, when a contractor has got bad news, what’s your recommendation for communicating that to Stephen or, underwriting, that kind of stuff?
[00:11:51] Joel Cannon: Time it. Don’t hide it. Get in front of it. If there’s bad news, particularly if it’s bad news on a bonded project, get your surety company involved early. We’re not the enemy. We can help. We have arguably the best claims team in the business. At least we like to think so.
They’re crackerjack. They’re top notch. Get the surety company involved early, get your partners involved early because keeping it under wraps is the worst thing you can do. Because everybody’s here to try to help. Wade, from the CPA perspective, you have a role to play in that.
Stephen you have a role, the surety company has a role, the banker has a role. Your legal counsel has a roll. But get your team involved first.
[00:12:34] Stephen Brown: No one of your key advisors wants to lose your business. You know, the more time you have invested with one of your clients, the more important they are to you. And all of us, you know, it would be your professionals, are here through the good times and bad times. That’s what we do. If things get a little challenging, you’ve got a problem, that’s something that we want to help you through.
[00:12:56] Joel Cannon: Absolutely.
[00:12:57] Stephen Brown: A lot of times, Wade, when I get a financial statement that’s in April, May, June, July, August, I can just tell you that by the time Joel has followed up to see where that financial statement is, we all assume that there’s going to be bad news on there. You know, I had a situation where a contractor presented me with a large bond request and the year-end statement and all the money had been removed from the company. It was a great day for me.
[00:13:25] Wade Carpenter: I know you talked about the relationship a lot, and a lot of times when I’ve had the agent in, we talk from the CPA standpoint and all that stuff. But at times when they brought in the underwriter and sometimes the construction contractors should be introduced to the underwriter. And I don’t think I see that a lot.
[00:13:44] Stephen Brown: Well, one thing that is always really nice is when your accountant is a friend of yours and, you can get them on the phone with the underwriter say, hey, do you mind if Joel just asks you a few questions to clarify some things on the year end that he just got?
[00:13:59] Joel Cannon: And I don’t know how most underwriters are in the industry right now, but we like to be face-to-face with our customers. We like to at least have an annual meeting and we’re available anytime to have a conversation with our contractors.
We have a vested interest in their success because quite frankly, everybody here kind of is relying on the contractor’s success for our own success. And so, in the most crass terms, we’re feeding off the success of that contractor. But on top of that, we’re developing relationships and friendships, and we really, really want to see them succeed.
[00:14:33] Stephen Brown: Right. If you’re not meeting with your underwriter at least once a year, something’s wrong. Now, it may be a situation that you don’t need many bonds. It may not be a situation where the underwriter needs to visit, but if a bonding program is important to you, and the success of it, and you want it to grow, you want better terms, you want better rates, you want better conditions, you want Joel to understand your sweet spot and how he can help you.
[00:15:01] Joel Cannon: I’ll add one other thing to that too. And Stephen you’ve probably seen this as well. The surety relationship, your surety program is different from insurance. If you rely on bonded work, if that’s your bread and butter and the success of your business is dependent on your bond program, you really want a long-term relationship with that surety company. You want to develop a track record, a level of trust, you want to demonstrate your character. And what that does for you over time is when you do get into one of these rough patches or you want to bid on a stretch job or whatever is it is that’s a little outside the norm of the box, you’ve got the longevity of that relationship in your corner.
The surety relationship should not be viewed as a commodity. I think it’s just kind of real important and unfortunately it seems to be more and more so today, but that’s what you depend on, I would recommend that you develop that deep, long lasting relationship with your surety company.
[00:16:06] Rob Williams: Yeah, I like that. And I love the way that the word sweet spot has come up so much today. And I guess that’s important to you. I’m actually trying to remember exactly what we said during the show. We had a little conversation before we started it, which may have been bad because now I can’t remember which things we said during the show. So I may ask you to repeat yourself now. but that sweet spot, I know that’s important for us in our businesses. How important is that to you guys? Is that one of the main thing is you look at? I guess the cash is probably the main thing you look at.
[00:16:39] Joel Cannon: Well, you know, for that business play, that sweet spot that you were talking about. I think the story you were referring to, I got involved with a contractor quite a few years ago and, they, it was ego-driven they’d gotten out of their sweet spot. It was a very successful company. Typically doing about 35, $40 million a year in revenue. And you can almost predict year over a year, three and a half, $4 million in debt. It was just like a machine. But egos got involved. They got out of their sweet spot. They decided they wanted to ramp up. They just had a target. Hey, we want to be a hundred million dollar company.
Well, they became a hundred million dollar company. But their net income dropped to virtually nil. I mean, they were just barely breaking, even taking on all that additional risk, working harder, not working smarter. And ultimately the result was not what they wanted. Nobody wants to be breaking even on a hundred million revenue.
So they had an opportunity on a large job that they couldn’t find anybody else willing to take a chance on them. I got to meet with them. But part of it was the plan. What were they planning to do moving forward? And it was to return to the sweet spot and we bought into the plan. We supported the large stretch job.
Sure enough, they right sized the company back to about a $35, $40 million a year company. They started banking three and a half, $4 million net year over year. They found their sweet spot. You know, different ways you can think of that, stay in your lane, work within a familiar geography, take on the kinds of projects that are best suited for your company. There are so many different elements to that, but “sweet spot” kind of sums it up.
[00:18:20] Rob Williams: That’s great. Because we talk a lot about looking at the profit, and the cash that you generate rather than looking at a goal of revenue. So many people that come to us, their first goal is, it’s almost always Wade, isn’t it, it’s a revenue goal instead of a profit goal because revenues, we actually talk a lot about, more revenue is more headaches. If you can make the same profit at a third of the revenue with a third of the headaches– you really don’t even have a third of the headaches, you have a tenth of the headaches or a hundredth of the headaches as you do, when you’re doing the revenue goals.
I know I was, when you were bonding me, Stephen, I know I was big into my revenue goals. We were trying to grow, and I support growth. But are you growing your revenue, or are you growing your profits? That’s a big thing that we like to look at, and I’m so glad to hear that coming from you, Joel, on the side.
[00:19:11] Joel Cannon: Well, and it even translates into my job, right? So I could go out there and chase revenue. It’s easy to write business right now. I could go out there and pick up a ton of new accounts. No problem. But my focus is on the bottom line. I don’t necessarily want to beat the biggest player on the block, but I do want to be the most profitable.
I think the contractor should have the same mindset. He’s like, what do I need to do to maximize my profitability? And why should I take on all this additional risk, all this additional work, all these additional headaches if it’s not going to translate into maximizing profit?
[00:19:47] Rob Williams: Boy, and guys that is coming from somebody that knows. Our surety underwriting specialist. So listen to those words. So that’s, that’s great. Well, we’re coming up with, gosh, I didn’t even look at the time. We’ve gone past our time again. When we have great guests like this, we do that. Any other big things? Joel, is there any one thing that you love to let your contractors know?
[00:20:12] Joel Cannon: Well, we like to form partnerships with our contractors. I don’t want my contractors to ever think that when they are looking at a deal that makes sense to them that, you know, hey, our surety company is not going to support something like this. It’s outside the box. Hey, if it makes sense to the contractor and they can articulate it to me, more often than not, it ends up making sense to me. And then the question is how do we structure the deal? So open communications, please. You know, we’re here to help. So, open up that line through your bonding agent, through the Stephens of the world.
And let’s talk about what you see out there and what we can do to assist you.
[00:20:53] Stephen Brown: Fantastic. One other thing I wanted Joel to comment about is Joel, what is the number one advice you would give to a contractor out there to help them become successful in your experience? Things you’ve seen from all your best contractors?
[00:21:10] Joel Cannon: The best contractors, they have a plan. They surround themselves with good people. It’s all the things we’ve been talking about. They stay within their lane and they go out and execute. If you keep your word, if you’re a man of good character, or a woman of good character, and you go out there and you do all the right things, focus on your cashflow, building your company, building it smartly, you’re going to have a long career. I think you’re setting yourself up for success. And what we like to see as underwriters is we like to see that steady, year over year profitability, profit retention to the company, building an adequate working capital base to do what you want to do.
And not to say that hiccups don’t happen along the lines. I mean, this is the real world, they do. But if that trend is always arcing in the positive direction, you’re going to have the surety support you need to be successful in this business.
[00:22:09] Rob Williams: Yeah, I don’t think we can hear that enough times. So valuable. We just need to hear it over and over again because we’re bombarded by the wrong messages so often on what we should be working on. All right, guys. Well, thanks. Wade, we good?
[00:22:25] Wade Carpenter: Yeah, I think so. I appreciate the relationship I can have when I can actually get to the underwriter and I’ll know a lot of CPAs are sometimes afraid to talk to the agent or the underwriter, because they’re afraid they’re going to get sued or something like that. But I think that’s the best way to help a contractor is if we can all communicate.
[00:22:46] Stephen Brown: Yeah, that’s crazy. We’ve all got the same goal in mind.
[00:22:51] Rob Williams: Yep. Yeah. Communication and stuff. As a contractor, I definitely felt sometimes the imposter syndrome. Like I used to be a little home builder. What am I doing out here in the commercial world? I kinda felt like sometimes I should hide in the corner and kind of hide myself from that because am I really a commercial contractor? Man, hold on! It was nerve wracking a little bit to put it all out there. So, well, great.
Well, thanks guys. This is just a huge thing and hopefully our listeners can listen to this over and over again and give us a great rating on the bottom of the show, the big five stars for this great show.
If it’s one star don’t, don’t bother about rating us, but thank you anyway for listening. So give us those big five-star ratings because we are the Contractor Success Forum. Lots of good information at ContractorSuccessForum.Com. And our surety bonding agent, Joel Cannon, we usually say how do we contact you. I guess they contact you through their bonding underwriter. They don’t contact you directly, do they?
[00:23:58] Joel Cannon: Well, the primary relationship is always that bond agent and that’s Stephen would be the quarterback in this situation. And Stephen would know then to reach out to me and get me involved and develop that partnership.
[00:24:11] Rob Williams: All right. So, we are Contractor Success Forum again, and we have Stephen Brown, our construction bond agent with McDaniel-Whitley bonding and insurance company, Wade Carpenter, Carpenter and Company, CPAs, and I am Rob Williams with IronGate Entrepreneurial Support Systems, and we have Joel Cannon with Philadelphia Surety Companies. Thank you for listening today, and we’ll see you on the next show.