Private Equity continues to make significant investments in the construction industry both in the U.S. and globally. These investments can be great for the industry, but they also create challenges for companies needing Contract Surety Bonds such as Performance Bonds, Payment Bonds and Bid Bonds. Learn more about what contract bond underwriters look for in these transactions and how to make obtaining these bonds easier.
Private Equity is an investment in a company or companies in exchange for ownership in the company. These investments are often made by an investment group or fund on behalf of a group of owners. You can read more about private equity here.
Contract bond underwriters will be very interested in how the company is managed after the transaction takes place. Will the former owners and management team stay around to run the company or will the PE firm install new managers? Bond underwriters typically favor keeping key people on board for a period of time.
If new management is put in place, do they have experience running this type of company? Construction is a challenging industry, even for the best managers. Bond underwriters will be hesitant to support company management without deep industry experience.
Even if the top management changes, keeping experienced estimators, project managers, superintendents, and accounting staff is key to a successful transition and support from a bond company.
One of the biggest challenges for getting Contract Surety Bonds after a private equity investment is the indemnity Package. Surety Bonds are written on The Principle of Indemnity and are a credit product. This means, the company and or owners need the financial ability to reimburse the contract bond company if there is a loss.
The problem for contractors purchased by private equity is that the new structure often makes this difficult. In many cases, the construction company is rolled up under the parent firm. The parent firm will often refuse to indemnity, creating a challenge for the bond company.
Another possibility is that the PE parent company pulls out all the cash, creating a construction company with negative net worth. Again, without indemnity of the parent, this creates a challenging situation for the contract bond company.
Finally, the new management may have no ownership in the construction company. Therefore, they will usually not provide their personal indemnity. This creates a situation where the bond company struggles to get any meaningful indemnity Package.
One option for contractors with private equity ownership to obtain bonding is to post collateral. Because the PE firms and owners may be unwilling to indemnity, collateral gives the contract bond company some security. The amount of collateral necessary depends on the bond company but 20% of the requested Surety program is standard.
Getting indemnity of the parental PE firm can be a challenge and take time. However, once they understand the reasoning, it is often doable. First of all, this is the cheapest option. Getting parental company indemnity allows the contractor to get better bond rates and terms. Additionally, the company avoids the extra costs associated with collateral.
Although many bond companies focus on working capital and net worth, some put an emphasis on Cash Flow. In cases where the company has solid cash flow and profitability, this can be a great option for obtaining bonding.
Contract bond underwriters may be very interested in the prospectus and history of the PE firm. Firms that intend to hold and operate companies for long periods of time will find it easier to secure Surety bond credit. Alternatively, a PE firm with a history of flipping companies quickly may find it more difficult to get Surety.
Contract Bond Companies will want to understand the distributions required by the PE firm. It is not uncommon for all profit to be distributed back to the PE group. However, distributing all profits will lead back to discussions on indemnity.
Private Equity transactions can create challenges for contractors needing Construction Surety Bonds. However, Axcess Surety had the expertise and bond markets to place such risks. Contact our experts anytime. You can also visit our FAQ Page for more information on Surety Bonds.