The Earnout Dilemma: Challenges Bonded Contractors Face When Selling to Private Equity

When a bonded contractor decides to sell their company, especially to a private equity (PE) buyer, one of the most overlooked yet critical issues that can arise post-transaction is related to surety bonding. While earnouts are often used as a way to bridge valuation gaps and align incentives between buyer and seller, contractors operating in the bonding world must carefully consider how the sale and subsequent changes to bonding relationships can impact both the earnout and future business success.

Earnouts and the Shift in Risk

Earnouts are commonly used in private equity acquisitions of construction companies. These arrangements tie a portion of the seller’s proceeds to the future performance of the business, often based on revenue, EBITDA, or specific project milestones. In theory, this allows the seller to “prove” the business’s value and reap additional compensation.

However, for bonded contractors, earnouts introduce a major risk: the ability to perform and win future work may be jeopardized by bonding complications after the sale.

Surety Relationships Change Post-Sale

One of the first moves a PE firm typically makes after acquiring a bonded contractor is to restructure the company’s bonding program. This may involve:

• Replacing the existing surety company with one that aligns with the PE firm's broader portfolio or strategy.

• Removing personal guarantees from the seller or prior ownership group.

• Restructuring the indemnity agreement to reflect the new ownership entity.

While these changes are logical from the buyer's perspective, they can severely impact the contractor’s ability to win new bonded work. Without personal guarantees or a longstanding surety relationship, the bonding company may reduce bonding capacity or increase bond premiums significantly.

Increased Bond Costs and Perceived Risk

Higher bond premiums can often be absorbed into the cost of doing business. However, the optics to potential clients are much harder to control. In the eyes of project owners, increased bond costs or switching sureties may signal instability or a history of claims, even if that’s not the case. This perceived risk can result in:

• Lost bids on competitive projects

• Strained relationships with long-standing clients

• Difficulty securing larger or more complex jobs, which are often critical to meeting earnout targets

Implications for the Earnout

Here’s where the trouble truly sets in: if the company can’t secure the same level of work or must take lower-margin jobs due to bonding limitations, hitting the earnout metrics becomes significantly harder. The seller, who is now out of control operationally but still financially tied to performance, may watch helplessly as the opportunity to realize full value slips away.

How to Protect Yourself

Contractors considering a sale to private equity must:

1. Bring bonding agents into the process early. Make sure your bonding company understands the transaction structure and is comfortable with the buyer.

2. Negotiate protections into the LOI and purchase agreement. Consider clauses that protect the earnout if bonding capacity is reduced due to changes initiated by the buyer.

3. Structure earnouts thoughtfully. Avoid tying all contingent payments to revenue or project wins if bonding disruptions are likely.

4. Explore transitional support. In some cases, the seller may agree to maintain personal guarantees for a limited time to support bonding, in exchange for earnout security.

Trust the Experts at Golden Shield Business Brokers

At Golden Shield Business Brokers, we understand the unique challenges bonded contractors face, especially when dealing with earnouts and private equity buyers. We work closely with surety professionals, attorneys, and financial advisors to structure deals that protect your bonding capacity, safeguard your earnout, and preserve your company’s ability to win the work needed to meet future milestones.

If you're a bonded contractor considering a sale, reach out to Golden Shield today. We'll help you navigate the complexities of the deal and ensure you're set up for success, both at closing and long after.