What SMB Owners should know about Surety Bonds

While many business owners consider sureties an unwanted necessity, the government requires them to buy surety bonds as a pre-requisite to getting their licenses or bidding on federally funded construction projects. This is a brief introduction to surety bonds.

Surety bonds for starters

Unlike regular insurance that includes two separate parties, a surety is a type of guarantee that involves three. The three parties are:

• The principal – a small or medium business.
• The obligee – the customer (the government, other business or an individual client).
• The surety – the company that issues the bond.

The guarantee is issued by the guarantor (the surety) to the party that is conducting business (the principal). In basics, surety guarantees that the principal will fulfill the terms of the contract they have signed with the third party (the obligee). If the obligee needs something done and wants to make sure the contractor will do the job according to certain standards, laws, and regulations, the surety is the guarantee that the job will be executed. If the contractor fails to meet the terms of the agreement, the surety reimburses the obligee, and the principal pays the surety.

Types of surety bonds

There are three main types of surety bonds: contract surety bonds, business service bonds, and commercial surety bonds.

• Contract surety bonds – are often used in the construction business. More accurately, they are mandatory when any branch of government awards projects to a construction company, whether it is federal, state or local. Three types of contract surety bonds are bid, payment, performance, and maintenance bonds.
• Business service bonds – protect customers from theft by companies who have access to their homes or business property. For example, someone who runs a home health care business will need to buy one of these bonds in order to protect their clients in case one of the employees steals something from clients’ home.
• Commercial surety bonds – are required by the state as a proof that a company will provide the services according to laws and regulations, together with following certain professional standards. Businesses that often require these bonds are plumbers, electricians, brokers, car dealers, and insurance and mortgage agents. Sometimes the government requires elected official like judges, commissioners and treasurers to obtain commercial surety bonds that guarantee their incorruptibility.

Other than contract, business service and commercial surety bonds, there are other types of sureties that protect the interests of different obligees. The most popular types are court bonds, that guarantee that the accused party will make the presence in court; and title bonds, that guarantee the ownership of the vehicle, and are used by car owners whose titles are lost or stolen.

Benefits for business owners

The layout is clear – surety bonds are invented to protect the customer. They are the means of making sure that a business owner (that is, you) will provide proper service. On the other hand, surety bonds can also protect a business owner, primarily from false claims. If a customer (obligee) makes a claim, your surety will challenge the claim relying on their lawyers and their experience.

Not unlike insurance companies, surety agency will be protecting their assets and prevent any false claims from costing them money. In turn, it also means that your business is protected from false claims. There are alternatives to surety bonds, like irrevocable letter or credit, but sureties are far cheaper. Eventually, surety bonds can separate honest businesses from those who operate out of regulations and kill prices.

The cost of surety bonds

With so many different types and subtypes of surety bonds, it’s extremely difficult to cover all the information about the costs of surety bonds in one brief article. Surety bonds are not one-size-fits-all financial instruments. Their price range is wide, and they are paid for on an annual basis as a percentage of the total bond amount. The applicant can pay one lump sum up front for an entire year’s worth of surety coverage.

Surety bonds are an inseparable part of the contracting business. At one level, they provide the same level of protection to both the obligee and the principal. They protect obligee’s money but also make sure that every project terms are met and that contractor’s reputation is spotless. As an SMB owner, it is in your best interest to be bonded if you want to compete and land government projects.