Surety bonds provide financial guarantees that contracts and other business deals will be completed in accordance with mutual terms. Many lines of business are required to be bonded before they can perform jobs.
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Surety bonds provide financial guarantees that business deals will be completed on mutual terms. Plenty of people never hear of surety bonds until they learn they need one.
They cover what business insurance often does not, providing protection and peace of mind for the individuals and organizations that hire you to work with them.
What are surety bonds and what do they cover?
A surety bond is a guarantee or promise to cover another’s debts. It is an agreement between three parties to ensure that costs are covered in the event of an unforeseen occurrence.
There are a few terms that are helpful to understand before digging into what surety bonds are and how they work.
- The Obligee: The individual or organization requiring the bond. This may often be a government agency.
- The Principal: The individual or organization that needs to acquire the bond. This is likely you as the contractor.
- The Surety: The third party that ensures that if the principal (you) runs into a financial roadblock, the obligee (the one hiring your services) will be covered from any potential losses.
- Indemnity agreement: This agreement includes your business and all owners saying that any corporate or personal assets can be pledged to cover debts and legal costs.
A surety bond is designed to protect the obligee from financial harm and ensure that contracts established by both the obligee and the principal are held up, ensuring that the obligee can recoup any losses incurred.
Does my business need surety bonds?
You may be wondering if your business needs surety bonds or someone you plan to do business with may have requested that you get a surety bond.
First understand that surety bonds are not an alternative to business insurance. Business insurance is an agreement between two groups (the business and the insurer).
A surety bond is not designed to protect your business. It is designed to protect whoever has contracted work with your business. Consider it insurance for your client.
Surety bonds provide you and your client with many benefits. There are a number of ways in which having a surety bond is a far more financially resourceful tool than alternatives, including the following:
- Less expensive than a line of credit: The rates on a surety bond are generally cheaper for the consumer than establishing a line of credit.
- No need to provide 100% collateral: When you have a bond, you don’t need to pay the entire amount that you are being covered for up front. You pay for a percentage and the bond is only used if you don’t cover the obligation.
- Greater liquidity: Because the bond doesn’t require you to have the full amount you are covered for immediately available, you are able to use your financial resources for other expenses.
- Protection from false claims: When a surety bond is used, there is an investigation that is done before any claims are paid out to ensure that any payments made are a result of legitimate claims.
Common types of surety bonds
Understanding the types of surety bonds, and what they do is instrumental in finding the right bond for you and your needs. There are several different kinds of bonds. This includes some primarily for construction needs, or if you are the owner of a car dealership. There are also bonds for brewer’s and private schools, among other types of organizations.
The two common types of surety bonds are contract surety and commercial surety.
- Contract Surety: This is designed to protect the customer from financial loss if the contractor fails to fulfill the terms or agreement of the job.
- Commercial Surety: These are designed to protect government and public entities from legal risk, satisfying security requirements.
In the construction industry there are a number of bonds that are commonly used, including the following:
- Bid Bonds: Some government organizations require this to ensure that any business bids are made in good faith.
- Performance Bonds: These are required to ensure that any work is completed on time and done to an acceptable level.
- Payment Bonds: This is to make sure that any subcontractors are protected and paid on time and in full for any work or materials that may have been provided.
How do you get surety bonds?
A surety bond can be obtained if a principal or the one who needs to acquire the bond can provide evidence that they have the credit and collateral to cover any incurred costs paid out by the surety. It also means that you will abide by obligations and regulations of your industry.
Once you’ve established that you do need surety bonds, you’ll need to apply for one. Understand that credit rating is a factor in determining the cost of your bond.
How much do they cost?
Not having to have the full amount of cash available is one of the advantages of a bond. Generally speaking a surety bond requires a payment of 1% to 15% of the total bond amount. The rate is determined by several factors including the risk of the bond.
You will also have to sign an indemnity agreement during this time. This is a signed document between the principal, or the one creating the bond, and the surety, or the one issuing the bond, promising that if a claim is made, the principal will pay back the surety.
How Frost & Remer can help
The unexpected can happen at any time. Making sure that all of your business needs are covered and protected, while providing the peace of mind for you and your clients is where preparation counts.
This is why Frost & Remer is here to help with our knowledge and experience. Contact Frost & Remer today to schedule an appointment for your full risk assessment. Ask about our Worker’s Compensation Insurance and Builders Risk Insurance.