Surety: Contractor and Factor
Contractors today must learn to adapt and overcome many adverse situations. When general contractors pursue government-funded projects, that are several specific mandates they must adhere to, such as using a certain percentage of subcontractors who are WBE, MBE, and others. Those subcontractors chosen then must have working capital and surety line of credit to meet their obligations. If you’re an emerging contractor, it’s easy to fall short in one of these obligations, but there is a solution.
Surety: Contractor and Factor
If you fall short on your obligations, then your solution will require two extensions of credit: the surety company and a factor that specializes in construction. What is this factor? A factor that specializes in construction is a third party that purchases and agrees to pay a company’s invoices on billed projects.
Both surety and factors work together to provide the working capital and bond credit that a general contractor needs while waiting for payment. This partnership helps emerging contractors guarantee performance on a project, and ensures that subcontractors and suppliers will be paid for their work.
This is a simple, but effective way for contractors to ensure performance and payment, but why are there two different extensions of credit and what’s the difference?
Differences in Surety and Factor Underwriting
A significant difference between the surety company and the factor is their financial evaluation of a contractor’s working capital. If the contractor has adequate working capital, such as cash or adequate credit, then the surety company will usually approve the contractor for a surety line of credit.
If the contractor lacks the criteria needed for a surety, however, then the contractor may be required to provide collateral, such as an irrevocable letter of credit, or use a funds control administrator (which we’ll get to later) to be issued surety credit.
This is where factor underwriting comes in. If a contractor is needing to provide additional collateral but does not have it, employing the services of a specialized construction factor can work in conjunction with the surety. This means that the factor will be able to provide the working capital necessary for the contractor to work on the project, without needing additional collateral.
Keep in mind, the factor may have conditions needed when used by a contractor, such as using a professional employer organization (PEO) to provide a payroll service and an HR component so the contractor is compliant with all applicable employment laws. This helps ensure the contractor will fulfill the requirements for the job.
Funds Administration Program
As we mentioned earlier, contractors can use a funds control administrator if they do not meet the criteria when applying for a surety line of credit. What does this mean? A funds administration program is when a contractor outsources an accounts payable to a third party to provide assurance to the project owners, surety, lenders and others involved in the project. This third party assures everyone involved in the project that the proceeds will be used to pay for project expenses before any other type of expense.
Both the surety and the factor will typically approve this service, with the factor advancing the funds through a control program to make sure the money is used in accordance with the project’s budget. This funds control process acts similar for both the surety and the factor. A third party will enter all of the necessary project information into their system, and then a separate escrow account is established so that way no funds are intermingled in different project expenses. This helps force the contractor to use the provided funds in the way that it was meant to be used.
The major difference between the two is that, in the case of the surety, the third party waits for payment to be received from the owner or general contractor to pay job costs. For the factor, once the contractor submits an invoice for payment to the owner and is verified, the contractor can then hand the invoice back to the factor. The factor will then advance the funds to the third party administrator for them to disburse the money used to be job costs on the project.
Either way, going through a funds administrator allows the contractor to be given the funds necessary to perform the job required. It’s an effective method in growing your emerging business and proving that your company is responsible with credit. Of course, this program can only work if the surety and factor both agree to share interest in the project.
Joint Collateral Participation
There are a lot of behind-the-scenes details that goes into acquiring a funds administrator. When going through the process, a factor will only provide working capital on a project, they must have the first position on the lien. To accomplish that, they need to file a UCC-1. Since the surety company will have issued the payment and performance bonds, they will have implied first position.
This is something that the contractor will not normally need to worry about. As long as the surety and factor can work together, then you’ll be able to receive the funds to work on the project, and will also help your business grow smarter and faster in the long run.