Also known as escrow or funds administration, funds control is a concept somewhat similar to residential-side construction loans. This process is a part of surety bonding where a third party processes the payments on behalf of a bonded contractor by handling proceeds.
There are two companies involved – the surety bond company and the one handling funds control. Typically, a General Indemnity Agreement (GIA) is made between the contractor and each of the two companies.
This document is important as it outlines details regarding the submission of draw requests, how and when to pay the funds, etc. The funds’ control company will then open a new bank account in the contractor’s name to ease out payment handling.
In this article, we will delve deeper into the risk-mitigating tool of surety bond funds control.
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When and Why Does Surety Bond Funds Control Make Sense?
The surety bond company may ask for funds control at any time. However, using this tool makes the most sense when the contractor is going through a financial crisis.
It may also be called for if the contractor is stretching out a backlog or a single project. Finally, this tool is useful for projects that may be beyond the scope of the contractor’s normal expertise. Now, the more important question is why funds control is even used in such scenarios.
According to the North American Construction Services (NACS), funds control is a tool that helps the surety bond company mitigate project risk. In other words, the bond company can rest assured that a contract’s proceeds will be used for a given project only. A contractor cannot defraud one project by using its funds for another.
It often happens that contractors may run short of cash. This has a kind of domino effect as one bad project robs funds from other successful ones. Through funds control, a surety bond company can alleviate such contract-related risks.
Upsides of Funds Control in Surety Bonding
Now, let’s learn more about fund control by understanding its major benefits in mitigating project risks.
Surety Bonds Procurement
Funds control is like any other specialty tool in the market. This means it is often used by the surety bond company as a last resort. Since the company is only likely to use it when all other options are exhausted, it may help the contractor get surety bonds or stretch their bond capacity.
However, there are certain conditions attached to it that protect the interests of the surety bond company. For instance – the contractor must stay within their area of expertise. Suppose the contractor’s area of expertise is building schools. The surety bond company may use funds control to stretch capacity for larger premises.
However, the same would meet some resistance if the contractor seeks to stretch capacity for a hospital building (outside their area of expertise).
No Unnecessary Burden
Some surety bond companies may ask for collateral to mitigate risks. These may include a bank letter of credit or cash. Funds control is a better alternative compared to the others because it does not bind the contractor’s funds.
As mentioned earlier, a contractor may fail a project if they run out of liquidity or cash. Construction is a highly cash-intensive business, and any delay in payments creates a strain that leads to a backlog. With their funds already tied up as collateral, the contractor’s borrowing capabilities become limited.
Once the project halts, even the surety bond company suffers the loss of time and effort. Through funds control, they can avoid unnecessary hassles as the tool will ensure all proceeds are used to pay suppliers and subcontractors.
Back Office Support
Not every contractor a surety bond company works with is well-established. According to IBISWorld, the number of construction businesses has increased by 4.2% in 2022 compared to the year prior. Currently, there are 3,919,352 construction companies across the US alone.
The new contractors joining the construction industry every year need time to prove their areas of expertise. Dedicated and ambitious as they may be, many do not have the required staff for cash management, project accounting, etc.
Funds control is a beneficial tool for administrative tasks that the contractor may not have the time or staff to perform.
A construction business is often riddled with cash flow challenges – the number one reason behind a failed project. Why do cash flow issues arise? Some major causes include inaccurate tendering or quoting, payroll, unforeseen changes in orders, and tediously long payment periods.
Through funds control, the surety bond company essentially dodges the payment risk. The funds control company does all the heavy lifting – setting up a separate bank account in the contractor’s name, overseeing payment disbursements, and delivering each drawer’s checks to vendors.
This lowers the risk of project failure, thereby being a win-win for the contractor and the surety bond company.