How To Free Up Capital Using Performance Bonds

Yes, performance bonds really can free up working capital enabling your company to take on larger contracts and to grow more rapidly and securely.

Introduction

Performance Bonds are widely used in the renewable energy construction and infrastructure sectors. They act as a guarantee that a contractor, supplier or service provider will fulfil their contractual obligations. But, Performance Bonds also play a crucial financial function, they free up capital for contractors and suppliers, enabling them to compete for more projects, grow more rapidly, improve cash flow, and operate more efficiently. For contractors seeking to thrive in dynamic and capital-intensive industries, performance bonds offer a flexible and efficient alternative to traditional forms of project security.

Providing Security, Without Tying Up Capital

Project owners / clients will always require contractors and suppliers to provide some form of monetary security. The three main ways of providing this security are cash deposits, bank guarantees, and performance bonds. While cash deposits and bank guarantees can tie up significant capital, performance bonds offer a more capital friendly alternative.

  1. Cash Deposits: Contractors must set aside a certain percentage of the project value in cash, held by the client or in an escrow account. This locks up valuable working capital, making it unavailable for other projects or operational needs.
  2. Bank Guarantees/Letters of Credit: Here, a bank promises to pay the beneficiary if the contractor defaults. However, banks typically require collateral from contractors, such as cash or liquid assets, tying up your balance sheet capacity and reducing the amount you can borrow for other purposes.

As you can see, both these approaches can severely restrict the contractors’ ability to grow, bid for new projects, or weather unforeseen financial challenges, as a substantial portion of their resources are locked away.

3. Performance bonds, on the other hand, offer a fundamentally different but equally secure approach. Instead of requiring cash or heavy collateral, the contractor typically pays a relatively small premium.

Key Ways Performance Bonds Free Up Capital

  • Reduced or no Collateral Requirements: Surety providers, unlike banks, usually do not require 100% collateral. In many cases, contractors may not have to post any collateral at all. This arrangement allows contractors to retain more cash and assets for ongoing operations and investments.
  • Preservation of Bank Credit Lines: Since performance bonds are not loans, they do not use up a contractor’s borrowing capacity or appear as liabilities on the balance sheet. This leaves the contractor’s bank credit lines open for use in other areas, such as acquiring equipment, covering payroll, or funding expansions.
  • Improved Cash Flow: By paying only a premium for the bond rather than tying up cash, contractors maintain liquidity. This flexibility allows them to respond quickly to new opportunities and manage project costs more effectively.
  • Facilitating Multiple Projects: With no need to tie up large sums of money as security, contractors can bid for multiple projects simultaneously. The capital they would otherwise have to commit as collateral remains available for project mobilisation and operational expenses.
  • Lower Opportunity Cost: The opportunity cost of tying up cash or assets as security is high. By using performance bonds, contractors can invest their available funds in other areas that may offer higher returns or strategic value.

Performance Bonds Enable Growth and Competitiveness

The capital efficiency offered by performance bonds can transform a contractor’s operational model:

  • Enhanced Bidding Capability: By freeing up capital, contractors can compete for larger and more numerous projects without overextending their resources.
  • Faster Project Mobilisation: Readily available capital allows for prompt acquisition of materials, equipment, and talent, accelerating project delivery.
  • Resilience and Stability: Contractors retain greater flexibility to manage unexpected expenses, economic downturns, or changes in client requirements.
  • Attracting Investment: Strong liquidity positions resulting from efficient use of performance bonds can make contractors more attractive to investors and financial partners.