Surety bonds

What Entrepreneurs Need to Know About Surety Bonds

Latest posts by Mike Herranen (see all)

Startups involve a lot of planning and organizing before you get to the fun of actually running a business, meeting new clients and connecting with peers in your industry. With all of the money, investments and infrastructure that go into setting up a startup, one thing you might miss is the requirement of obtaining a surety bond. Let’s take a look at what surety bonds are and why they are often needed in order to get your business off the ground.

Understanding surety bonds

Most startups mistake surety bonds for insurance, and while they have their similarities, surety bonds are instead an extension of credit. They involve three different parties:

  • The principal, or the party becoming licensed
  • The obligee, who is usually a State or Federal entity requiring the principal to become bonded as a condition of becoming licensed
  • The surety company that backs the bond (generally a division of an insurance company)

Surety bonds are designed to protect customers financially, ensuring that you follow through on obligations of your license. Essentially, if you fail to deliver on what a contract stipulates or violate local laws and regulations, the obligee can file against your bond, or in many cases, the consumer files directly against your bond.

For example, say you’ve just started a new construction company. In many states you will need a contractor license bond in order to simply operate. Once you begin bidding on projects, you will encounter other bond requirements. In this situation, a city government puts a project out for bid. You provide a bid bond, and the city awards your bid to construct a new library for which you now would have to purchase a performance and payment bond. The payment bond ensures that any subcontractors, and material suppliers, still get paid for the project even if you run out of money. If you fail to pay, the subcontractors and suppliers may file claims against your bond. The performance bond covers the actual work on the project. The project must be completed properly, as bid, and within the time frame identified.

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When you require surety bonds

Depending on the industry or field of work, you may be required to obtain a surety bond to operate your startup. For example, construction workers and contractors usually need surety bonds to bid on public projects. Other businesses that often require surety bonds include:

  • Auto dealerships
  • Collection agencies
  • Travel agencies
  • Health clubs
  • Mortgage brokers
  • Auctioneers
  • Notary publics
  • Most providers of medical equipment when paid for by Medicare

Obtaining a surety bond

Your first step is to figure out if you require a surety bond for your project or business. We know that being a startup means being tight on money, but you have to pay for surety bonds upfront. If you don’t have the money to pay for the bond, you can finance it through your credit card company by putting the full premium charge on your card. If neither is an option for you, you won’t get the bond. Knowing if you require a surety bond beforehand gives you time to save up and set aside some money or line up proper credit availability.

The application process itself is fairly straightforward. Sureties will rely on underwriters to examine your credit, financial strength, and in some cases, your experience. From there, they’ll consider your application and process the paperwork. Many basic bonds can be processed on the same day and if premium and signed agreements are received by the surety agent, the bond can even be issued on the same day.

How much does a surety bond cost? It varies by the type of bond, and the strength of the applicant startup. Bonds are required in varying amounts. You’ll pay a percent of that bond amount in the form of a bond premium, which is normally 1 to 5 percent of the face value.

Applicants with bad credit or unsteady financial history may pay a higher premium. As a startup, you will probably have to pay more as you may not have strong financials or credit history. Thankfully, companies offer quotes for applicants even if they do have credit issues or limited financial ability. However, as mentioned, the cost will be higher.

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