Subcontractor Prequalification

While the U.S. economy has turned around, landing construction projects for subcontractors remains as competitive as ever. Whether you are an excavator or an HVAC specialist, general contractors will look closely at your company to judge your fiscal health, reputability and reliability. One of the primary methods general contractors use to evaluate potential partners is subcontractor prequalification.

But what is prequalification? Shelly Sullivan, Director of PreQualification for SureTec, a surety bond company, offers this textbook definition: Prequalification is an initial evaluation of a potential borrower’s credit worthiness. It’s used to determine the estimated amount that a person or company can afford to borrow. “In the construction industry, prequalification entails being approved for a certain job given a specific set of parameters that needs to be met or maintained,” says Sullivan.

That may sound simple, but subcontractors navigating the prequalification landscape can easily get sidetracked. So it’s important to understand the basic principles of prequalification and the attributes for which companies who offer insurance or bonds are looking.

“When most people think of prequalification, they usually associate it with a surety company or bank,” says Sullivan, who has 18 years of experience in the surety industry. “However, with the introduction of subcontractor default insurance (SDI) a little over a decade ago, many general contractors have taken on prequalification with their own workforces. They’re assuming a lot of risk, so they need to ensure they are doing business with financially sound, experienced companies.”

In addition to banks, surety companies, and the general contractors themselves, prequalification is also performed by brokers, SDI providers, and independent third-party providers. “No matter who is doing the prequalifying, the basis of what we’re looking SUBCONTRACTOR PREQUALIFICATION: 2 2 for is the same,” says Sullivan. “We’re considering financial stability, experience, current workload, payment and legal history, and safety records.” Those findings determine if a subcontractor is a good candidate for insurance or a surety bond.

Sullivan says “three Cs” form the basis of underwriting—capital, character, and capacity. Capital relates to the financial strength of the subcontractor. Underwriters look at the following:

  • Annual financial reports and interim financial information
  • Working capital
  • Net worth
  • Total debt structure
  • Cash flow
  • Bank and credit relationships

“All of these factors affect the ability of the contractor to perform and keep the business moving forward,” says Sullivan.

Character refers to the reputation of the company and takes references into consideration. Underwriters consider these areas:

  • Relationships between general contractors, subcontractors, and suppliers
  • Credit history
  • Legal filings

“If references say the subcontractor is difficult to get along with or can’t man the job, this can be problematic,” says Sullivan.

Capacity is the overall ability of the subcontractor to perform the job. Underwriters examine the following:

  • Organizational structure
  • Past performance and experience
  • Work systems and schedules
  • Current work in progress

Sullivan says surety companies ask a lot of questions to determine capacity: How long have management team members been in their current positions? What’s the largest job the company ever completed? What’s the amount of backlog they can handle? Do they have proper internal tracking processes to know how jobs are going? Can the company keep jobs staffed properly and complete work on time?

The Surety & Fidelity Association of America compiles data on why contractors fail. The most common reason is unrealistic growth. “They grow too fast, and more is not always better,” says Sullivan. The second biggest reason is performance issues, which often occur when companies take on jobs substantially larger than they’ve ever done before. Other top reasons for failure include character issues, poor internal accounting, and management issues.

DURING THE PREQUALIFICATION PROCESS, companies look at many areas— financial strength, character, experience, equipment, credit history, and banking relationships. “We take all of this information—good and bad—and formulate a decision,” says Sullivan.

She offers the following advice to subcontractors for looking their best:

  • Keep money in the company. “We call it ‘keeping some skin in the game,’” says Sullivan.
  • Invest in your financial presentation. “This doesn’t mean you need to get an audit,” she says. “But as your company grows, make an investment in your company: Engage a CPA to mentor you as you grow.”
  • Monitor your payment history and credit scores. “A poor business credit score can be deadly because sometimes it’s the only thing people use to rate your company,” says Sullivan.
  • Remain in good standing with the bank and have a standing line of credit. “Get a line of credit even if you don’t think you need it,” she says. “The fact that a bank is willing to provide you one shows a level of confidence. And when you really need that line of credit and don’t have one, you probably won’t qualify because you are overextended everywhere else.”
  • Be open to controls. “If there are any deficiencies in our evaluation—it could be lack of capital or some past credit issues—being open to some controls shows a willingness to do what’s needed and shows you are flexible,” says Sullivan. Controls may vary from a joint check to more frequent meetings with project managers or a personal guarantee on a job.
  • Make sure you can cash flow your projects
  • Keep tabs on equipment and people. “Have the appropriate equipment to perform the work and competent people to handle the job size or particular scope of work,” says Sullivan.
  • Keep abreast of current backlogs and jobs in the pipeline. “If you can’t handle the work you currently have in front of you, you certainly don’t want to add a whole lot more on top of that,” says Sullivan. “Being responsible and growing at a steady pace is the best success strategy I’ve seen with smaller and newer contractors.”
  • Be able to provide meaningful internal information. This includes internal balance sheets, profit and loss statements, work in progress reports, insurance information, and safety data.
  • Maintain good safety ratings. Have a solid safety program in place and monitor your safety numbers.
  • Get involved in local organizations. Whether it’s a trade association that is particular to your subcontractor trade or the Better Business Bureau. “This allows you to know your competitors as well as build new relationships,” says Sullivan.

Understanding the basics of prequalification and adhering to the advice above can help subcontractors put their best foot forward and gain business in the competitive construction industry

This article was prepared by Assurex Global in collaboration with SureTec—a leading contract and commercial surety company.