What is a surety bond and how much does it cost?

Business owners, even experienced ones, are often puzzled when they hear their next project requires a surety bond. If you are one of them, naturally the first questions that spring to mind are: “What is a surety bond?” and “How much does a surety bond cost?”. In this article I will address these two questions and help you understand how to get bonded.

Cast a Line / Foter / CC BY-ND

Let's start with a definition. Broadly put, surety bonds are a three-party agreement involving a Principal (the one of whom the bond is required, or in other words, you), an Obligee (the one who requires the bond) and the Surety Bonds Company (the one backing the agreement).

What the surety bond will guarantee depends on the nature of your business and in which of the three major categories it falls.

Commercial Bonds

Of all three categories, commercial bonds (also known as license and permit bonds) are the biggest. Businesses such as auto dealers, freight brokers, mortgage brokers, telemarketers, alcohol manufacturers, and others, all fall under the commercial bonds category. They are put in place to ensure that your business will operate under the rules and regulations set out by your business license and your state.

Contract Bonds

Contract bonds are types of surety bonds required by contractors working on construction projects. They guarantee that you will stick to the terms of your contract and complete everything by the deadline. The most frequently required contract bonds are bid bonds (required for bidding on public projects), performance and payment bonds – the latter two are issued together and make sure you will not only keep the terms of the contract but will pay everyone you involved while working on the project.

Court Bonds

The last category is that of court bonds. There are different kinds of court bonds but they are all usually used as guarantees in trials and legal proceedings. Guardianship bonds also fall under this category to ensure legal guardians will fulfill their court-ordered legal duties.

How do surety bonds work?

So far you might think that surety bonds are a lot like insurances. But that's not the case. If something happens to your insured property, you pay a deductible, get the rest of the money and risk getting a higher premium next time you apply. A surety bond is more like credit given to your business. If you breach an agreement and get a claim, your surety bonds company will cover the losses and will then ask you to pay what you owe. It also has the right to cancel your surety bond if it deems it necessary.

How much will a surety bond cost me?

That's a very good question and the best answer to it is: it depends. The pricing process depends on a variety of factors – the type of bond, your credit history, size and location of your business and industry, etc. The good news is that you can apply for a surety bond online and get your quotes and approval in no time. Still, as a general rule, you will have to pay 1 – 3% of the total cost of the surety bond you are required. That is, if you are in good credit standing. Remember, a surety bond is credit given to your company and bonding companies assume a 0% loss rate. That doesn't mean that your business won't get bonded due to bad credit. It does mean, however, that you will have to pay a higher price for your bond – typically anywhere between 4% and 15% of the total cost.

401(K) 2013 / Foter / CC BY-SA

Can I save money on the bonding process?

Yes, you can. The easiest way to save money is when purchasing commercial bonds because the price of the bond depends on some characteristics of your business. Credit score, naturally, is one of them but not the only one. Providing a professional resume that shows relevant experience will definitely improve your chance of getting a better offer. Another way to demonstrate your company's credibility is by showing financial strength, i.e. a high net worth. Some people are unwilling to do it for tax reasons but a solid flow of cash will definitely be considered a plus when you apply for a surety bond. Keep in mind that money you are owed, but have not collected, does not count towards your financial statement so you might want to collect all overdue payments before you begin the application process.

I hope I managed to make surety bonds a bit clearer for you. If you still have questions, don't hesitate to call Lance Surety Bonds customer service. Good luck on your bonding process.