What Entrepreneurs Must Know About Surety Bonds

If you are an entrepreneur, you might be having a hard time dealing with all the details involved with running a new business. There is a lot to take into account and most of us simply do not have the time to think about every small thing that needs our attention. However, some of those seemingly minor things can make or break your business — surety bonds, for example.

Getting your business bonded might be the difference between getting a customer and not landing that contract. On top of that, depending on your industry, you might not qualify for public bids and projects. A surety bond also does wonders for the integrity, credibility, and reputation of any business.

In this article, we will explain all you need to know about surety bonds. You will learn how they work, where to get one, and what costs to expect.

An Overview of Surety Bonds

A surety bond is a financial guarantee that your business will deliver results as per contractual obligations, industry standards and best practices. It is designed to protect customers, project owners, and government entities in case a business fails to produce results. Even though it has some similarities to insurance, a surety bond only covers contracts — not damage claims from third parties. Surety bonds are a requirement for many major industries, including construction, travel, auto dealerships, etc.

Without a surety bond, your business will not be able to participate in public tenders in those industries. A business that is bonded is seen as credible and willing to guarantee its services. Sometimes that is the difference between getting a client or not.

How Do Surety Bonds Work?

Surety bonds are three-party contracts that are issued by a neutral guarantor, also known as a surety. The surety company agrees to pay out if the bonded business fails to meet the contract requirements. If a bond is successfully filed against, the bonded business needs to pay out the surety in full — which is another major difference between surety bonds and insurance.

The bonded business is known as the principal. The party that is protected by the bond is referred to as the obligee. An obligee can be a government body, or an organization that runs public bids. The obligee can file against a bond and get financially reimbursed in case the principal violates a contract or any associated state and local rules.

What Types of Surety Bonds Are There?

A surety bond is an umbrella term that covers a wide variety of specific bonds. Depending on the industry, there are many surety bonds that you can get, each designed to provide protection for a specific stage of a project. For example, in construction, there are bonds that cover each phase — from initial bidding and suppliers to execution and post-construction maintenance.

As an entrepreneur, you need to familiarize yourself with the regulations in your industry. Learn what specific bonds apply to your business and the types of projects you are working on.

What’s more, there are some basic types of surety bonds that apply to almost any industry and are the basis upon which more specific surety bonds are designed. If you are in the construction industry, for example, you may need to get one or more of the following specific bond types:

  • Payment bonds ensure that you will pay what is necessary to subcontractors, suppliers, temporary workers, etc.
  • Bid bonds guarantee that you will execute the project at the price you offered at the initial stage of a public tender
  • Maintenance bonds guarantee the quality of materials and craftsmanship used for a certain period after the completion of a project
  • Performance bonds ensure that all work on a project will be completed as per contract and will adhere to all industry standards and best practices.

How to Acquire a Surety Bond

Once you have decided what types of surety bonds are necessary for your business, you need to acquire them. Keep in mind that getting bonded does carry some upfront costs, so plan your finances ahead. If you are short on cash, you can always use a credit card for financing the full premium. Look at surety bonds as a necessary investment. Depending on the industry, they might make or break your business.

In order to get bonded, you need to find a surety company and apply for the bonds you need. The process is relatively simple. The surety will run a variety of background checks on you and your business. Your credit rating, financial strength, and business history will be looked at in detail. The cost of your surety bonds depends on the outcome of those checks.

For entrepreneurs, it might be hard to find a good business history and financial capital. As a result, you can expect your premiums to be a bit higher than the industry average. However, your application is highly unlikely to be rejected, even if you have a bad credit rating.

What Do Surety Bonds Cost?

As we already mentioned, the surety bond cost you will have to pay depends on the results of your background check. Keep in mind that the amount you will have to pay can vary significantly based on your past performance and credit rating. Generally, you are looking at a premium that is 1%-10% of the value of the surety bond you are getting. It all depends on whether or not the surety views you as a high-risk client.