How to Grow Bonding Capacity: Banking and Tax Moves for Contractors

0:00Kathe Barrington: Every construction company answers to three masters. The bank, the bonding company, and the taxman. Here's the problem. All three read the same financial statements, and all three want something different. You want to show the bonding company as much strength as you can, you want to show the bank you can always pay, and you want to show the taxman as little profit as the law allows. Same numbers, three different faces. So every move you make to keep one of them happy can quietly cost you with the other two. And most owners never feel it until the bond agent calls. If you don't have a vision and your own goals set, then you are going to be at the whim of them and what their recommendations are.

0:46My guest today stands in the middle of that triangle for a living.

0:52Kathe Barrington: This is Eric Anderton, and you're listening to Construction Genius, a leadership masterclass. Thomas Edison said that genius is 1 % inspiration and 99 % perspiration. If you're a construction leader, you know all about the perspiration, and this show is all about the 1 % inspiration that you can add to your hard work to help you to improve your leadership.

1:22Kathe Barrington: Kathy, welcome to Construction Genius. Good to be here. It's great to have you back. So an owner takes one set of books to his banker, his bond agent, and his CPA. Same numbers, same company. And he walks out with three different recommendations. So why does that happen? Are these three people actually disagreeing with each other? Or are they each just protecting against a different risk? So in that situation, they're definitely protecting against their risk and they're also giving you recommendations based off what they think. If you don't have a vision and your own goals set, then you are going to be at the whim of them and what their recommendations are.

2:10What you really need to start with is what your overall vision and goals are and what your timeline is to bring to them. So then they can give you the recommendations based off what your goals are instead of what they're just going to recommend from their aspect.

2:27Kathe Barrington: Okay. So for instance, the bonding company might come to you and be saying, you need to organize your books and the way that you're running things in a particular way so that you can bid on larger projects. But then in your mind, you may be thinking, I don't necessarily want to bid on those larger projects because I want to be able to manage my cash in a different way or manage my tax burden in a different way. Is that kind of what you're saying? Yeah, I mean, bonding is looking at certain things. They want to see if you have a line of credit. If you don't have a line of credit, they want to see a certain level of equity.

3:05They want to see a certain level of cash. So the bonding agent is looking for something in particular. When you're saying you want a certain bonding capacity, they have to check certain boxes. So it really comes at what you want and how big you want to get and the scale you want to get to in the timeframe. And they're just going to tell you, this is what we need. Okay.

3:29Kathe Barrington: So it's interesting because you talked about the contractor being clear on their visions, their vision, their goals, and their timeline. Is this where the contractor can then begin to work through any disagreements or conflicting advice that those three entities may give him or her? Yeah, absolutely. Because if you want certain goals with your bonding company, you want to get to a certain bonding capacity, you want to get to$100 million in revenue and that sort of thing, but yet you don't want to pay anything in taxes, that's going to be very difficult for you to build up your equity to where you need to.

4:05So you've got to have a vision that you have where you bring all these things together. Yeah.

4:12Kathe Barrington: Yeah. So there's a real push pull here and it's incumbent upon the advisors to help a contractor to see this clearly. Yes, absolutely. And when you actually have that clear vision, you will be surprised at how much more in alignment those three bodies will be because they're all part of your team. Yeah, so that's really interesting, right? Because the tendency can be for a contractor just to think of themselves as I'm the builder, and these guys give me their expert advice, and I'm just going to default to them, instead of taking the time to clarify what my visions, goals and timeline are, and then to think through the implications of those things as it relates to the bonding.

5:02Kathe Barrington: and to the CPA and to the bank. Exactly, exactly. That requires some work then. I mean, it does. And it requires people getting uncomfortable and really working hard to understand those things in more than a superficial way so that they're actually coming to these advisors with their own ideas as opposed to just letting the advisors impose their ideas upon them. Yes, absolutely. Okay, so then if different risks exist persist, whose risks should win when they truly collide? Well, I mean, it's definitely one of those things where you have to figure out what the risks are, and then you have to abide by those risks.

5:45So you don't really have a choice in that aspect. You have to decide which one is the bigger priority. So if you need a certain bonding capacity, and the bonding agent is telling you, well, you need a certain amount of equity and you need a certain line of credit and you go to your bank and they won't give you a line of credit balance for what your bonding person wants. Now you're at the whim of the banker, right? You need to appease the banker first because then that will get you to your bonding goal. Right.

6:17Kathe Barrington: So this is the way I think. And tell me if this is the way contractors generally think or if it just depends. My first thought is I want to minimize my taxes as much as possible because I just don't like giving money to the government. Who does? But I know who does, right? But at the same time, I don't want to jeopardize my business in the sense that, yeah, the bonding company and the banking company, banker may have a problem with me, but the tax guy can put me in jail, right? The IRS can put me in jail or, you know, there's much more jeopardy involved there. Am I thinking about that the right way?

6:55Yeah. All those things are part of it. But what I find with a lot of contractors is they don't necessarily see all of these people and groups as part of their team. They see it as almost like an outsider thing, right? Like the thing we talked about before, field versus accounting. It's almost a little bit of that mindset of like, oh, well, you know, my bonding guy or my banker. And it's like, well, but they're part of your team. They might not be on your payroll, but they are part of the team, so they need to be involved in this process, so everybody's kind of on the same page.

7:31Kathe Barrington: Okay. All right, quick break to talk about my book, Construction Genius. This is what I want you to do. Go to Amazon, search for the book, read all of the five-star reviews, because there's a ton of them. Over 50, to be precise. and the reason I want you to read them is because real people wrote those reviews who've actually read the book and it'll give you an idea of why you should go and buy a copy right now on Amazon and here's the deal if you purchase 10 or more copies for your company and then send me an email eric at constructiongenius.com I'll come in via zoom and do a one-hour Q &A and a bonus training session with your team at no charge.

8:15Kathe Barrington: I normally charge$4 ,500 for an hour of my time. And again, for you, I'll do it at no charge if you buy 10 or more copies of my book. And the reason you should buy it is all in the title. It's effective, hands-on, practical, simple, no BS, leadership, strategy, sales, and marketing advice for construction companies. So if you're in the construction industry, this book is for you. So you can get it on Amazon. You can also get it on audible in the audio version as well, narrated by yours truly. And I know you'll really enjoy it. So go out and get the book. And now back to the interview. So let's talk about this a little bit more then.

8:53Kathe Barrington: How do banks and bonding companies evaluate your financial statements differently? Well, like you said before, the bank is one, their main priority is to making sure you can pay them. So, you know, besides personal guarantees and seeing what you have going on personally, so you can sign everything away to them. You want to be able to make sure you pay the line of credit and that sort of thing. So they're looking at their own risk in that respect. The bonding agent, same thing. They're looking at their risk from a job perspective. So they want to make sure that you have good practices in place.

9:28You can cover your bills to your subcontractors. You also won't let the job get out of control with a bad subcontractor if you're a GC or whatever it is. So they're definitely protecting their side of things, which the tax guy, the only thing that they're making sure is that, you know, there's no fraud or anything that they can be kind of held responsible for. So the tax guy doesn't really have the same risks. They're just going to recommend you pay the minimum tax and how to do that. Okay.

10:01Kathe Barrington: So with the bank and bonding companies, what's one line item that they'd react to in opposite directions? Well, I don't know if they really do, to be honest with you. I think the bank and bonding agents are pretty much in more alignment than you would expect. Okay. So how does a year-end tax strategy affect bonding and banking capacity? So if you're trying to pay the least amount of taxes as possible, and you're getting down your bottom line, or whatever you need to do to try to get that tax liability down, then you're not building your equity. and most of the time bank and bonding are looking at equity.

10:40They want to see you retaining, retained earnings. They want to see you retaining the money in the company to build it, keep your cash up. You know, if you're taking a ton of distributions at your end and you've wiped out your cash balance, where's your working capital?

10:55Kathe Barrington: Yeah. And again, that goes back to the visions, the goals and the timeline. Yeah. So if I'm thinking long-term, I want to build my business to$100 million, dollars, 200 million, whatever the case is. To do that, I have my books look a certain way so that I can get that bonding capacity. With that in mind, that's going to cause me then to have to pay more in terms of my taxes in the short term to get there. Yeah, exactly. Exactly. You're less in distributions to yourself, right? So now you've got a plan possibly personally that you can't take as much out of the company. Yeah. So you just need to be clear eyed on that so that you're not being reactive in your decision-making.

11:34Exactly. And you're not at the mercy of them. They should be working with you on your goals, not the other way around.

11:43Kathe Barrington: Yeah. It's really interesting. What's a smart rhythm for engaging each of these stakeholders? One, having that vision as number one, figuring out what you want to do and that sort of thing. So then that way you can bring them into the conversation of, hey, this is what we want to do. can I get there? And how do I get there? How do you think I can get there? What do I need to do? What do I need to change? And they will help you in that. They want to support you because it benefits them for you to grow because they get more in bank fees. They get more in interest. They get more in bonding fees, right?

12:21They want you to succeed. Yep.

12:24Kathe Barrington: So we've touched on it. We've mentioned it, but this risk of optimizing for short-term tax savings over long-term stability. How often do you see contractors falling into this trap? A lot. A lot. If they don't have a true vision of where they want to be, then usually they're at the mercy of their tax liability. Yeah. Because they see that, right? And if they haven't been disciplined in terms of how they manage their cash, and they've got a decision to make in terms of how they're going to do their taxes that has a significant enough impact, it's going to cause them to be reactive on an ongoing basis, which will hinder them from long-term stability and reaching the goals that they say that they want to achieve.

13:09Yeah. Yeah. It's really the taking the time spent on working on your business and not in your business.

13:17Kathe Barrington: Yeah. No, it's really good. So I know we've talked about overbuildings, underbuildings, and the whip in previous episodes. How does the accuracy of those numbers influence outside trust? It's very important because a lot of times when you have certain things that the bonding agent is looking for, they maybe are going to be more concerned with you having too many jobs on your job schedule. Backlog is looked at very closely. the shifts in what's happening with the jobs is looked at. So you want to be able to establish trust. So there's integrity in your financial statements and they don't want to see huge swings in your jobs because they want to see that when you said you were going to make 20 % on a job, you're making 20, maybe a little bit better.

14:11You know, if you like to keep it more conservative and you do better. You never want a situation where you have either a roller coaster situation with your jobs, meaning one month they're 15%, next month it's 25%, and then you're back to 18%. Consistency is so important. So that's one thing. And then also nobody wants to see constant fate on your jobs. So if you estimate your jobs at 10 % and they all finish at like 6%, you're going to be discounted from the very beginning. So you want consistency and integrity in your reporting.

14:50Kathe Barrington: How often have you, as one of your clients, and you're a CPA, how often has one of your clients brought you into the room at the same time with the bonding and the banking, and you guys have all had a strategy session together with the contractor? In 20 years, maybe once or twice. In that situation, you don't have to disclose details. Was that helpful? Absolutely. Absolutely. And it's one of my contract, I don't work with them anymore, because they outgrew me. And, you know, they ended up with a full time controller and CFO along the way, and they've grown exponentially. So like they had a very clear vision of what they wanted.

15:30Kathe Barrington: So that's really interesting. In that conversation, what were you guys discussing? If you remember? I mean, it's definitely one, what is the vision? What is the timeline? And then working backwards, like you would normal goal setting, right? Like, okay, this is where it is that we want to be. And then where are we now? And how do we bridge that gap? And what are the action steps we need to start doing from today to get us to that point? That would seem to be like a very wise thing to do, right? Why doesn't it happen more often? I think what ends up happening a lot of times is people are working in the business so much more.

16:10And especially if it's a contractor that has kind of built up from being a contractor to being a contractor owner, evolving and learning and constant growth and having to understand that you're not going to be working in the business and you shouldn't be. That's not where you need to be if you plan on getting to a certain place. You have to work on the business.

16:35Kathe Barrington: So that's one possible takeaway for folks listening here today. As you're setting up those visions and goals and timeline, getting a meeting where you can bring all three of those folks, your bank, your bonding, and your tax person in a room and really discuss it through with them, that would be something it seems like that would have potentially a tremendously positive impact. It should. It does. So obviously you haven't done that a lot, which is interesting, but, and yet you're, as a CPA, you're very conscious of what the bonding and the banking are looking for. How do you actually serve as a bridge between the bank and the bonding agent for your clients, even if you're not in the same room at the same time with everyone?

17:16Communication, just communicating with the banker, with the bonding agent, making sure that we're all in communication and obviously the tax person as well. So making sure that the communication exists, even if you don't have one meeting where everybody's there at the same time.

17:32Kathe Barrington: Yeah. And having the common vision. Sorry. So having that vision. That's good. Yeah. What are the most damaging financial mistakes contractors make in this triangle that you see over and over again? Not having a vision, being reactive. Yeah, so interesting, isn't it? Because it's interesting how the technicalities of the tax strategy, the bonding and the banking, they can be overwhelming. But I think if you sat down with most contractors and just had a conversation with them and said, where would you like to be 20 years from now? They would do a pretty good job of coming up with that and being able to articulate that?

18:15I think a high level, yes.

18:17Kathe Barrington: Yeah, that's what I mean, at a high level. Yeah, yeah. They may not necessarily know how to get there. I mean, they may know how to get there in terms of the construction side of it, but in terms of what we're talking about, they may not know how to get there, but they would know how to articulate that. They'd be able to do that. And then from that end point, begin to work backwards to what that means for the tax and for the bonding and for the banking. Right, exactly. So that would seem to be that first step. Strategizing, having a vision. Absolutely. Think about the last time you promoted someone into a leadership role and it failed.

18:54Kathe Barrington: Why did it fail? I can tell you one reason. People know how to build projects, but they don't know how to build and lead teams of people. Construction comes with its challenges that only insiders truly understand. Generic leadership training doesn't cut it. You need a program to train your leaders built specifically for construction professionals led by an industry expert. And my online course, The Shift, is exactly that course. It has five modules. It'll teach your people how to control their calendars and reduce stress and embrace chaos and accomplish their critical tasks. It will teach them the three essential messages they have to communicate every day in order to motivate and lead their team effectively.

19:40Kathe Barrington: It'll show them how to build and lead a high-performing team, give them a framework for running effective meetings so they'll be able to solve problems in less than an hour, and also give them a higher perspective on their leadership that will enable them to work on the business and on their teams and not get stuck in the weeds micromanaging. So go out to my website, theshift.constructiongenius.com, read all about the course, and then enroll yourself and your leaders in the course. And I guarantee that it will transform your leadership. If it does not, you take the whole course and you didn't get benefit from it.

20:17Kathe Barrington: You just send me an email, eric at constructiongenius.com and I will cheerfully refund you 100 % of your money. I'm really confident this course will transform your leadership. So again, go out to the website, theshift.constructiongenius.com, learn more about the course and start taking it today. So when you're sitting down with your clients and they're working through this, what are some of the questions that you ask them that help them to get clarity in terms of this vision? I mean, the first thing I honestly would ask is why, like, what is your intent? Because sometimes what ends up happening is you're chasing a revenue number, but then your gross profit suffers.

21:02So why are you going to work harder for less money in essence? Right. So like, what is your why? What's kind of your ultimate goal? So we can kind of work towards that because you have to have a vision that makes sense.

21:16Kathe Barrington: Yeah. Okay. So let's say I want to bring my, these three aspects of the business together in harmony, working towards my long-term goals. and I want to be as thoughtful and methodical and intentional as possible. And I'm sitting face-to-face with my CPA. What are some of the questions I need to be asking my CPA in order to help me with this clarity process? There's certain changes that might affect you if you're at a certain size before you get to a certain size. Like if you're a smaller contractor, you might be completed contract for your tax basis. So you don't actually pay. When you say smaller contract or what number are you thinking?

21:59I don't know what it is off the top of my head. 10, 25 million. There's a number. I'm not the tax person. So don't quote me on these numbers. I'd have to look into them. But there's certain thresholds where you now become a certain size contractor and you have to change your tax practices. So you can't be cash and completed contract anymore. You have to be accrual and percent complete. when does that shift happen for you in the timeline that you're looking at and what does that do you know am i going to have a huge tax liability in year three that i need to think about and assess so like figuring out what those different components are and what size you are

22:40Kathe Barrington: are going to be really important with the tax person okay excellent excellent so kathy remind us a little bit more about yourself and how people can get in touch with you i am a cpa who does not do taxes. I focus on the construction side in terms of the accounting practices, getting your book set up. We do month-end and quarter-end, year-end closes. So I help assist where people basically need a controller CFO type level work, but they don't need a full-time person at that point. So I kind of bridge that gap for them and help them get to a certain level. And then hopefully they can get a full-time controller CFO that helps them through the rest of the way.

23:21Kathe Barrington: Yeah. So fly bird. Yeah. Yeah. Fly birdie. But LinkedIn is a great place to get ahold of me. So yeah, that's probably the best place. But I, my website is kbcpa.biz. You can check out kind of what I do and I have my podcasts there too. So they can watch the previous ones as well. Awesome. Yeah. We have a whole series. This is episode six and we'll link to the other episodes in the show notes, as well as to Kathy's LinkedIn page, and you can get in touch with her. And I think my biggest takeaway here is get your CPA, get your tax advisor, get someone like Kathy, get your bonding and get your banking person in the same room with clear vision of where you want to be and start to talk through some of these technicalities so that you can have a greater understanding of what you need to do to get to where you want to go.

24:12None of it should be a surprise if you know where you're going, right? How do you get to where you want to go if you don't know where it is? You have to know where you want to go.

24:21Kathe Barrington: Beautiful. Very well said. Very clearly said. Kathy, thanks again for coming on the show. Thanks for having me. So your bank, your bonding agent, and your CPA are on your team, but they can't help you get where you want to go until you decide where that actually is. So your first step is to get clear on your vision. Your second step is to do something that seems like is pretty unusual. And that is get those three parties in a room with a clear vision and begin to work with them from their perspective on how to get to where you want to go from where you are right now. It's only happened a couple of times in 20 years in Kathy's practice, but she told us that when it did happen, the contractors experienced a tremendous amount of success.

25:11Kathe Barrington: So thanks to Kathy for coming back on the show. Her LinkedIn and her website are in the show notes. This is episode six of our series with Kathy. The first five episodes are well worth checking out and they're linked in the show notes. So if you're new to the series, go back to the start of it and go from there because they do build on each other. If you've got something out of this episode, please subscribe so you can catch the rest and also pass it along to a contractor who'd find it useful. That's how the show reaches more people. Appreciate you listening. I'll catch you next time. Thank you for listening to this episode of Construction Genius.

25:54Kathe Barrington: Hope you found that 1 % of inspiration to help you in the next few days. If you like the show, please give us a five-star review on iTunes. share it with other construction leaders who you think would benefit and always remember that the show is brought to you by kick-ass meetings i've been working with construction leaders since 2004 teaching them how to run extremely effective problem-solving meetings that gets their people collaborating taps into their creativity and to get yourself a free copy of the kick-ass meeting report, go to www.ericanderton.com slash kickassmeetings. Grab yourself that free report, read it, use it in your business.

26:37Kathe Barrington: You'll find it extremely useful. And thanks again for listening.