Using performance bonds
If you rent property, you’ll already be familiar with the concept of a bond, the money you pay upfront as assurance that you won’t destroy the place, or skip off without paying your rent. You could say it’s the landlord’s way of keeping you honest.
A performance bond follows much the same concept, acting as a kind of insurance for the buyer that you will do the job that you have been contracted to do. But this can be a problem, especially for small to medium exporters who either don’t have that kind of money, or could better use the cash elsewhere in their business. This is where financial institutions can step in, fronting up the performance bond for a fee, so that you can complete the job, get paid and grow your business.
Essentially, you don’t touch the money, says Andrea Govaert, executive director for SMEs at the Export Finance and Insurance Corporation (EFIC). “It’s a bond that has been issued by a third party on behalf of an exporter in favour of an overseas buyer. And it is an assurance for the buyer that if the exporter doesn’t perform the contract, the buyer has a ability to call on the bond and reduce their losses.”
Time to bond
Most bonding products require a robust balance sheet so the financial institution knows you’re able to pay back the money for which they’re covering you. Every bank provides a facility like this, says Govaert.
However, there may be situations where the bank perceives the credit risk as too high, which is where a guarantee can help. “We provide a bond or a guarantee in situations where the bank doesn’t want to. We tend to be more of a risk-taker,” remarks Govaert. “EFIC will provide a back-to-back guarantee where we provide the guarantee and the bank will issue the bond. Also, if a foreign buyer isn’t familiar with EFIC, then they may not be willing to take a bond from us, but they’ll take one from a bank and EFIC will guarantee it.”
In providing both direct bonds and guarantees, EFIC understandably takes a wider view of exporters that may be suitable for this facility. “We do not look at it from the balance sheet, what we look at primarily is the ability of the exporter to comply with the contractual requirements, if they are technically competent to deliver under the contract,” Govaert explains.
The assessment starts with an application form, where the exporter needs to explain the tender, nature of the contract, how much they need, and who is the counterparty. It helps if the exporter has a proven track record in the industry and has a list of successfully completed transactions.
EFIC will then indicate the price of the bond, based on the strength and nature of the business, as well as taking into account the contract. “Clearly a six-month bond is a very different concept to a five-year bond,” says Govaert. “We also take the risk profile of the country into account.”
The contract is another key aspect of the bonding process. The parties need to specify milestones, and set realistic expectations in a realistic contractual period, she explains. “Usually the bond reduces with time, but you need a trigger point that needs to be clearly defined in the contract, otherwise there will be grounds for dispute.”
Who bonds?
Exporters that need bonds tend to be in the construction, engineering, oil and gas, cleantech, or mining industry. Sometimes they are in the process of commercialising technology, so the buyer needs a guarantee that the product will be delivered. Most are medium-sized businesses looking to grow; often the need for a third party to cover the performance bond indicates their first big contract. “Typically it’s the mid-sized companies. The bonding facility enables companies that are technically competent to undertake contracts that are much larger than their balance sheet than their normal circumstances allow them to do,” says Govaert.
Ironically, the companies that are big enough to afford bond money don’t tend to need it. Mature businesses such as BHP Billiton or Leightons have strong enough reputations that allow them to dictate the terms of a contract.
Got something to say? Join the export forum here at DynamicExport.com.au.
