Surety bonds are essential for small business owners who work on a contract that requires a performance guarantee (e.g. the delivery of goods or services). Take some time to learn about these third-party promises to pay and how they may help you gain more business.
The Purpose of a Surety Bond
A surety bond provides protection between the first party who takes on an obligation (principal). They promise to make good on the contract to a second party (obligee) who needs the work done. A third party, the issuer of the surety bond, guarantees that the first party will perform the terms of the contract for the second party. Otherwise, compensation will result.
Common Types of Surety Bonds and Their Characteristics
There are different types of surety bonds available depending on the contractual situation. For example, a business involved in contracting work might use the following:
Other types of situational surety bonds include commercial, fidelity, and court bonds.
- Bid Bond: Used to guarantee that the first party will enter the contract on behalf of the second party.
- Performance Bond: Provides a guarantee that the first party will perform the terms of the contract as agreed.
- Payment Bond: Provides a guarantee that the first party will pay for all associated work in connection with the contract. It will also pay for any subcontractors and for all materials and supplies required.
- Ancillary Bond: All other bonds incidental to completing the contract such as a maintenance bond. This bond guarantees that the first party stands by their work. It shows that they will provide maintenance or corrections in a timely manner
All types of surety bonds have certain common characteristics:
- Bonded amount: A cap on the first party’s equity interest (amount invested plus retained earnings).
- Working capital requirement: This equals current assets minus current liabilities. It equals a percentage of the bonded amount.
- Bonding capital: The maximum bonded amount available to the first party.
- Bond premium: A fee paid by the first party for the surety bond.
- Bond term: The term of years the bond assists your business.
How a Surety Bond Benefits Your Business
Companies performing any type of work, especially contract work, typically must carry bonds. This is particularly true for businesses bidding on government contracts. This guarantee provides the government (obligee) with the assurance that you have the financial capacity to perform the work on its behalf. This could lead to huge opportunities for your business.
There may be obstacles to obtaining a surety bond. Often, this occurs if your business lacks some of the financial capacity necessary to be underwritten for a bond. The Small Business Administration provides a surety bond guarantee program to assist you in obtaining a bond, however. This guarantee makes your business competitive and can lead to greater opportunities and financial success.