How can surety bonds benefit small businesses

If you are a small business owner who is competing for contracts, you will need to demonstrate that you are qualified to perform the work that will be required under the contracts. Depending on your type of business, you might also be required by the state to obtain a license to legally operate. A common state requirement for licenses to operate different types of businesses is a surety bond. These are state-specific, so if you live in Florida, you’ll be required to get a Florida surety bond. Even if your business is not required to get a license, purchasing a surety bond is a good way to demonstrate that you are capable of performing work and can be trusted to meet your contractual obligations.

What Are Business Bonds?

Business bonds or commercial bonds are types of surety bonds that might be required for licensing or for entering into a contract. They are legally enforceable agreements between the following three parties:

Principal – The business that is required to purchase the bond
Obligee – The party requiring the principal to purchase a bond, which can be the government or a private party
Surety – The company that issues the surety bond and guarantees the principal’s performance and legal compliance

Surety bonds are required for many different types of businesses to obtain licenses and legally operate. If the small business that purchases a surety bond fails to complete the work or violates the law, a claim can be filed against the surety bond. The surety company will then pay any valid claim, but the principal will ultimately be responsible for the costs and will be required to reimburse the surety company.

Common Types of Businesses for Which Surety Bonds Are Required

Many different types of businesses are required to purchase surety bonds to obtain licenses. Some of the common types of businesses for which surety bonds might be required include the following:

Auctioneers
Notary public services
Auto dealers and dealerships
Travel agents
Construction contractors
Mortgage brokers

According to the U.S. Bureau of Labor Statistics, 21.8% of adults employed in the U.S. had licenses from their respective states in 2018. Since bonds are a licensing requirement for many different types of businesses, this demonstrates how common bonding requirements may be.

Construction bonds are particularly common. Congress passed the Miller Act in 1935. This law requires contractors who want to perform work on construction projects on federal buildings to have surety bonds for any project worth more than $100,000. At a minimum, contractors that want to perform work on federal buildings must have performance and payment bonds. States also have laws that are similar to the Miller Act and establish different state thresholds for public projects.

Common Types of Bonds for Small Businesses

Some of the common types of bonds small businesses might need include the following:

License bond – Bond required by the state for licensure
Permit bond – Bond required by a municipality to obtain a permit
Bid bond – Bond required by the government in order for contractors to submit bids on projects
Performance bond – Bond required by public or private project owners to guarantee a contractor will perform its contractual duties
Fidelity bond – Bond a small business owner might purchase to protect the business from losses caused by employee theft or fraud
Auto dealer bond – Bond required for auto dealers that intend to sell more than a minimal number of vehicles per year
Business service bond – Bond that protects a small business’s customers from employee theft or fraud

How Surety Bonds Work

Business owners who are required to purchase surety bonds can apply through a surety company. The business will be required to submit multiple documents with the bond application to allow the surety company to evaluate the business and its risk.

Surety bonds are not insurance and instead function as a form of credit. This means that you will need to go through an underwriting process before the surety company will issue a bond to you. The surety company will review information about your financials, including your business’s audited financial statements, profit and loss schedules, the resumes of key stakeholders, your business’s organizational chart, and your business and personal assets and liabilities. It will also look at your credit score and compare the size and value of past projects to the one that your business wants to bid on.

If the surety company believes that your business poses too great a risk because of problematic credit, poor performance in the past, or evidence of poor character, it will likely deny your bond application. This makes it important for you to operate your business in an above-board manner and keep your credit in good standing.

The surety company will provide you with a free quote if you pass the underwriting process. The quote is for the bond premium, which is the amount you will have to pay to purchase the bond. The bond premium is typically a percentage of the total bond amount and can range from 1% for experienced business owners with excellent credit to 15% for businesses with little experience or problematic credit.

If you accept the free quote and pay the bond premium, you will also have to sign an indemnity agreement. This means you agree to indemnify the surety company for any valid claims that might be filed against your bond.

Benefits of a Surety Bond for a Small Business

Surety bonds offer several benefits for small businesses. When you are approved for a bond, it functions as a prequalification and demonstrates that your business is stable and able to perform the work as promised and in compliance with the law. Having a surety bond might demonstrate that your business is trustworthy and encourage others to contract with you.

Surety bonds also protect other parties beyond the obligee. For example, if you own a construction business, your bond will also protect the suppliers and subcontractors that you contract with, so it might be easier for you to find subcontractors and suppliers that are willing to work with you. Surety bonds also provide you with access to more valuable projects.

Many businesses are required to purchase surety bonds by the state to get licenses to legally operate. Others may be required to purchase bonds to perform work on specific types of projects. While purchasing a surety bond is another expense for small businesses, doing so can help you to demonstrate that your company can be trusted to perform its work ethically and legally.