What do huge corporations with decades of experience and successful business practices have in common with startups that just got public a week or so ago? We’ll give you a hint. It’s the same thing that nearly every single business in the modern market has. Yes, that includes construction, marketing, manufacturing, and even insurance sales. Well, all of these businesses, big and small, want to be secure when dealing on the open market. And one way to have that kind of security is to get surety bonds .
As a young, up-and-coming entrepreneur, this term is one you will want to remember. So, in this article, we’ve decided to share with you the basic information about surety bonds. You will learn what they are, who exactly needs them, and why they might just be the most important part of any business out there.
Surety Bonds 101
A surety bond is an agreement between three parties : the obligee, the principal, and the surety. Generally speaking, if there’s a project, the obligee will require a bond as coverage in case something goes wrong. The principal is the party that has to get bonded. The surety is the body that issues the bond and also backs it financially during the agreement.
Basically, a surety bond is put in place to make sure that all three parties deal in good faith. For instance, if a principal fails to honor the agreement, the surety provides compensation to the damaged party in the event of a valid claim.
Different Types of Surety Bonds
Listing all of the different types of surety bonds is an impossible task. That’s because each and every agreement requires a specific type of bond that covers every single aspect of it. Potentially hundreds of thousands of various surety bonds might exist in the US alone.
However, we can still classify them into several different groups, based on what exactly they cover. The classifications vary, but the most accepted number of said groups is four. Those groups include the following:
- Contract bonds
- Commercial bonds
- Court bonds
Surety Bond Groups Explained
Let’s get in-depth with each group. Contract bonds exist to make sure a contract you have in place is honored. If a principal doesn’t have the means to follow the contract through to the end, the obligee will either get monetary compensation or some sort of means to finish the project. The documents that go into contract bonds have to cover everything from payment to performance, and anyone involved with the project gets coverage. That includes contractors, subcontractors, and other parties concerned.
Some subvariants of contract bonds include:
- Bid bonds
- Performance bonds
- Payment bonds (also known as labor and materials bonds)
Commercial bonds tend to cover an entire market. Their primary purpose is regulation. To put it simply, you get a commercial bond if you want to prevent individuals or companies from engaging in harmful practices. Naturally, they have their own various subtypes. The most common ones include:
- Sales tax bonds
- Auto dealer bonds
- Business service bonds
- Customs and excise bonds
- Administration, property, and guardianship bonds
- Lost document bonds
- License and permit bonds
Court bonds are exactly what their name suggests they are. With this bond, you can reach a court-specific goal during a proceeding. These primarily deal with estate settlements and other civil affairs that are not applicable to a startup business.
Who Requires Surety Bonds?
One of the most frequently asked questions about surety bonds is who exactly needs one. After all, they are mandatory in some fields, but not in others.
Getting a surety bond will let your peers and potential investors know that you’re a serious business owner. What’s more, it shows that you are committed to ethical business practices and that you’re financially and fiscally responsible.
A small sample of different parties that acquire surety bonds includes:
- Mortgage brokers
- Insurance brokers
- Auto dealers
- Public insurance adjusters
- Health club owners
- Importers and exporters
- Notaries public
- Private investigators
- Credit repair servicepeople
- Medical suppliers
- Loan originators
Newcomers to the business world will be happy to know that obtaining a surety bond isn’t particularly hard to do. You will have to pay a premium before you can acquire one, however, though we will cover that a little later.
But more importantly, all you have to do is provide the insurance company underwriters the necessary info about you and your business and they’ll let you know what kind of bond you require. In fact, they will provide you with the documents to sign on the very same day you requested a bond. That’s right, you can acquire surety bonds within literal hours after submitting your documentation!
The Average Cost of Bonds
Discussing the cost of a surety bond is difficult if you don’t know what kind of bond you require. Generally speaking, you will never have to pay the total bond amount in advance. You normally only pay a percentage, known as the bond premium. If your credit score is spotless and your company has a reputation, you will normally pay around 1-3% of the total sum.
However, if you’re new or have a spotty record, that premium might be hiked up to as much as 10%. To put it in raw numbers, the riskiest of businesses will have to pay $2,500 if their total bond sum equals $25,000.
For commercial bond prices, the surety will normally have to take into consideration the owner’s personal credit score and financial strength, as well as the financial risk of the enterprise.
Contract bonds are typically broken into two categories: Fast Track and Full Bond Line. Fast Track is used when the job is $500k or less, and your company has limited experience and has a strong credit score. These cost about 3% of the bond amount. Full Bond Lines are for more experienced contractors and require a more thorough underwriting process, including a review of financials and work-on-hand schedule, among other things. Typically, the larger the job, the smaller the bond rate will be.
Final Thoughts
Surety bonds have a ton of advantages, especially when compared to insurance or letters of credit . Hopefully, this article has helped you understand just how important it is to acquire one for your business and why so many different companies and individuals continue to do so.
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