The following guest post (our first) is from Danielle Rodabaugh, Director of Educational Outreach at SuretyBonds.com. Their name, like ours, pretty much says it all. SuretyBonds.com is a nationwide surety bond producer that helps contractors fulfill their bonding requirements.
Starting a construction company requires more than an interest in building practices and a knowledge of the local market. As with other industries, the government recognizes that not everybody is cut out to be a business owner, so it enforces numerous requirements that protect consumers from fraudulent or inexperienced construction professionals. Aspiring contractors sometimes struggle to fulfill these requirements, and, as a result, some simply won’t qualify for business ownership. As such, these requirements might seem to be nothing more than legal hoops that must be jumped through.
With a full understanding of legal expectations from the get-go, however, aspiring business owners will better appreciate the reasoning behind the laws that regulate California’s construction industry. This article will function as a basic guide to starting a construction company in California; it will also address some pitfalls individuals should prepare themselves for during the process. The California Contractors State License Board (CSLB) regulates the state’s construction industry, so if you have any questions along the way, you should look to this agency for help.
Step 1: Gain work experience in the construction industry.
You might find this to be an odd first step, but the CLSB requires that contractors demonstrate at least four years of experience/education in the trade for which they wish to be licensed. Furthermore, without much experience working in the construction industry, contractors can have trouble getting people — from loan officers to insurance companies to clients — to trust them. Whether you’re speaking with a government agency or a potential client, they’ll want to be sure you know what you’re doing. Fulfilling this step is paramount to your company’s initial success.
Step 2: Draft a legal team.
This step is crucial because your legal team can help you make important decisions from the beginning. If you intend to operate a small construction firm with few employees, you’ll need trusted legal counsel so you don’t have to figure everything out on your own. If you want to operate a large construction firm with many employees, you’ll need trusted legal counsel to help you keep everything straight.
You’ll at least want to get in touch with an attorney and an accountant who have a working knowledge of the laws that regulate California’s construction industry. Their assistance will limit the risk for oversight, which helps you avoid legal problems.
Step 3: Plan a budget that includes funding for bonds.
Planning an operating budget from the get-go is crucial for a number of reasons, both obvious and not. One of the biggest budget busters new contractors find themselves facing is ongoing proof of financial security. Contractors typically file surety bonds because they pay just a fraction of the required protection, but cash or certificates of deposit can also be filed with the state. The CLSB requires every contractor to file $12,500 of financial security with the state as a part of the licensing process. Applicants with good credit could pay just $110 for annual license bond protection while those with bad credit could pay as much as $1,350 for annual license bond protection.
Furthermore, most publicly funded projects in California require performance bonds to be issued for 1/2 of the contract price. And, all public works projects contracted for more than $25,000 require payment bonds issued for full contract price. Surety underwriters typically charge premiums calculated at 1-4% of the bond amount. So, if you need a $50,000 performance bond for a $100,000 project, your premium would likely be between $500 and $2,000.
Without the appropriate surety bond(s) in place, the project developer won’t allow you to begin work on the project. If you plan to work on multiple public projects contracted for more than $25,000 each year, you’ll need to have enough cash on hand to pay for your bond premiums up front and in full. (Also note that while surety bonds aren’t legally required for privately funded projects, the developer can still choose to require them.) If you can’t afford to get bonded, you won’t be approved to work on projects. The costs associated with bonding is one factor that can limit the reach of small contracting firms.
Step 4: Determine your business structure.
Depending on your construction company’s size and focus (roofing, concrete, electrical, etc.), one business structure might have an advantage over others. Your business structure will also affect how you pay taxes and license your business.
For example, in 2012 the CLSB began issuing contractor licenses to limited liability companies (LLCs). This gave contractors more flexibility when establishing businesses. However, LLCs must provide proof of two additional assets before being licensed:
- liability insurance worth $1,000,000 to $5,000,000 (depending on the number of employees that work for the company)
- a $100,000 surety bond (in addition to the $12,500 bond already required of all contractor licensees in the state)
Step 5: Get licensed.
In addition to being bonded, individuals seeking a California contractor license must be fingerprinted and undergo an FBI background check. In all, there are 43 specific types of contract licenses available in California. All licensing documents can be accessed on the CLSB website here. To put it simply, though, contractor licensing in California can be broken down into three major categories:
- general engineering contractor
- general building contractor
- specialty contractor
If you plan to work in California’s construction industry, setting up a legitimately licensed business through the state is of paramount concern. Contractors caught working “underground” without a legitimate license face a Notice to Appear (NTA) for misdemeanor charges of contracting without a license or illegal advertising, and that’s just for their first offense. The NTA carries a maximum penalty of six months in jail and/or up to a $5,000 fine. Additional convictions result in a $10,000 fine and mandatory 90-day jail sentence. Fortunately, you can avoid legal trouble by doing plenty of research before you open your construction business.
Danielle Rodabaugh is the director of educational outreach at SuretyBonds.com, a nationwide surety bond producer that helps contractors fulfill their bonding requirements. Danielle writes to help leading industry professionals better understand the legal aspect of managing successful construction operations, including those related to contractor licensing. You can keep up with Danielle on Google+.