Funds Control is a tool that helps contract bond underwriters write performance bonds and payment bonds for contractors. From a contractor perspective, there are positives and negatives to using funds control. Learn more about what funds control is, how much it costs and when it may be needed.
In surety, funds control is the process of having a third party take control of a contractor’s earned revenue on a given project and paying the appropriate subcontractors and suppliers on that project with the earned revenue. Funds control is a special tool that helps contract bond underwriters provide contractors with performance and payment bonds when they may not be able to qualify without it. Funds control can also be called escrow or Funds Administration. You can see a chart showing the funds control process below:
Funds control services are very specialized. There are a number of companies that perform these services for the surety bond companies. However, some surety bond companies do have their own funds control company. In return for a fee, the company sets up a bank account for the Principal Contractor. The bank account is usually in the contractor’s name. The funds control company then has both the Contractor (Principal) and Project Owner (Obligee) sign an agreement that assigns the contract proceeds owned to the Principle over to the Fund Control company.
The funds that are earned and paid to the contractor go into the funds control bank account. Then monies owed to suppliers and subcontractors are paid and lien waivers are collected. The remaining funds for each check are then released to the Principal for their overhead and profit.
Construction Bond underwriters may require funds control in a few different scenarios.
One scenario is when the contractor has had some financial difficulty. Often, when contractors are having cash flow issues, there is a tendency to constantly take proceeds from one project to pay subcontractors, suppliers and overhead from other projects. This juggling of cash can help contractors stay afloat but it is a major risk to contract bond companies. A contractor may take the contract proceeds from a bonded project and pay bills from an unbonded project. This may put a bonded project that would otherwise be profitable into a claim situation. Funds Control can help with this problem.
By having a third party manage the collection and payment of the contract proceeds, a bond underwriter can be confident that the funds will stay within that project and a contractor will not use the proceeds from the bonded contract to pay for other bills. This significantly reduces the Payment Bond Claim exposures for the surety bond company.
Funds Control may also be required when a contractor is completing a project larger than they have done in the past. Contractor’s can have issues when they take on a project that is significantly larger than the ones they have completed in the past. Larger projects often require more supervision, more subcontractors and suppliers. Coordinating more parties can lead to less time monitoring lien waivers and payments. By turning this over to a third party, it reduces the risk of payment bond claims and frees up more of the contractor’s time to focus on other aspects of the project.
Contrary to popular belief, contractors often have bond claims when they have too much work instead of not enough. Construction is a cash intensive business and delay between when work is done and when money is collected, often creates a strain on cash flow. More backlog increases this strain. Funds Control allows the surety bond company to protect themself from too much work. It helps ensure that the proceeds from bonded projects will be used to pay subcontractors and suppliers on those projects.
Funds control usually costs between 0.5% - 1.00% of the project amount. For example, a $1,000,000 project requiring funds control will cost $5,000 - $10,000 for the funds control only. This is the fee paid to the funds control company. Normally this amount must be paid out of the first submittal. This amount is in addition to the performance and payment bond cost.
There are both advantages and disadvantages to using funds control from a contractor perspective.
For contractors the biggest advantage to using funds control is that it enables you to get a performance bond or payment bond that you could not get without it. However, another advantage is that somebody else takes care of the project accounting and lien waivers for you. Many contractors have poor processes for these things and having a third party handle this is a welcome relief for some contractors.
The biggest disadvantage for many contractors is that the process is different. Having another party control your money is not ideal for many contractors. Some contractors are also worried about what the Owner will think. However, many Owners like this set up as it protects their project funds. Finally, there is a delay in receiving the funds. Usually the contractor can get their part of the payment within forty eight hours, but this is still slower than they would receive the funds otherwise.
Funds Control is a helpful tool for getting performance bonds and payment bonds when a contractor cannot obtain them without it. However, in some circumstances, a surety bond underwriter may want to use other surety bond tools in addition to funds control. These could include collateral and/or SBA Bond Guarantee support. The amount of tools is related to the contractor’s financial condition and the project being bonded.
Funds Control is a way to help contractors get surety bonds when they cannot otherwise. The process may be different but is probably not as bad as many contractors think. At Axcess Surety, we try to avoid using funds control for most contractors. We can often find a viable alternative. Contact us anytime for questions on funds control or any surety bond questions.