As private equity firms increasingly target construction contractors for acquisition, maintaining a surety program post-acquisition is crucial. Surety bonds are essential lifelines for contractors, ensuring financial stability and trust in the industry.
What is Surety?
Surety is a form of unsecured credit, with decisions based on the company’s financial health. When evaluating financial statements, surety companies focus on leverage and liquidity ratios, and require tangible working capital and net worth to support the total backlog.
Key Points:
- Tangible working capital and net worth should be at least 5%, preferably 10% of total backlog (bonded and non bonded and calculated on a cost to complete basis).
- Post-acquisition, goodwill isn’t a tangible asset, leading to deficit net worth.
- Deficit net worth prompts sureties to examine liquidity and leverage ratios, affected by transaction debt.
- Contractors’ operational debt, usually equipment debt, is understood by sureties as it generates revenue.
- Sureties focus on profitability, needing positive net income after taxes, depreciation, amortization, and interest.
- Sureties prioritize net profit over EBITDA, as net profit grows equity, essential for surety support.
- PE firms and sureties often clash on the need to show net profit for bond-requiring firms.
Indemnity Concerns:
Surety companies rely on both healthy corporate financials and the owner’s personal indemnity. This guarantee is crucial for securing bonds on large or difficult projects. Sureties may waive personal indemnity only if the company is highly liquid with strong tangible capital or is a large publicly traded company, still requiring tangible equity and strong liquidity.
Growth and Acquisitions:
Post-acquisition, managing multiple locations is challenging for sureties, relying on PE firms’ expertise. Operating in different areas can cause failures and surety losses. Revenue growth expectations from PE firms can be problematic due to labor shortages and challenging projects. Sureties prioritize bottom-line profitability over top-line revenue growth.
Coexisting with Surety:
Surety and private equity can coexist if PE firms work closely with sureties. PE firms must demonstrate adequate liquidity, engage in the business, retain existing management, and inform sureties of future acquisitions with detailed projections for approval. Transparency and communication are key. PE firms should ask potential acquisitions about existing or future bond needs and consult a surety expert to maintain the bond program post-acquisition, preventing bond program issues and deal failures. Treat your Surety as if they were part of your Cap Table!
At Smith Brothers, our Surety team is ready to assist with your needs. Connect with us today for more information.