How To Start & Grow Your Business

Understanding Surety Bonds: The Very Basics

Marcus Jensen
May 18th, 2016
  • Estimated reading time: 5 min read
  • Hummy's
    Highlights

    1What are actually surety bonds 2Who needs surety bonds 3How are surety bonds used
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Finance Misc.

What is a surety bond Image: courtesy of https://www.suretybonds.org/what-is-a-surety-bond

Companies often consider a surety bond to be a form of an insurance. While this mistake is common, and even not entirely a mistake, the characteristics of this legal binding agreement, the differences and the benefits that the end users, or the public, can gain from this form of a contract, is what separates a bond surety from your typical insurance.

Opposite to an insurance, surety is the type of a guarantee that a company or a contractor has to offer to their clients in order to ensure that the contract between the two parties (company and the client), will be honored. In simple terms – when the obligee, or the entity that requires from a company to get a surety bond, asks a contractor to obtain this type of a bond, contractors are required to contact a bonding company, or the Surety company. This company then offers different type of bonds which can help with lowering the risk of the debt, and possibly even lower the debt for the borrower. The company pays the percentage of the total bond cost in order to ensure that their clients will be protected, and that the service provided will meet all regulations and laws.

If you are not familiar with the term, this explanation might seem somewhat confusing. So to simplify things, just think of your Surety Bond as an insurance that you are paying for your clients.  In a certain sense, this is what a surety bond actually is: an insurance and a credit. But let’s dissect this legal entity further so that you, a business owner, a contractor, or even a client, can understand this seemingly complex process thoroughly, and know how it functions.

Who are the Parties Involved?

Before we explain how the cost of a specific bond is determined, we have to understand how this bond affects all the parties involved, and who are the parties involved to begin with. There are a total of three entities that are crucial in this process:

The Principle

The principle presents the party that needs a surety bond. A certain company, or a contractor, is the one who is purchasing the bond. By purchasing a specific type of a surety bond, the one that meets all needs and requirements of the industry and the state government, the company, or the contractor, provides a financial guarantee that they will honor their agreement, and that they will follow all laws and regulations when they are servicing their clients.

The Obligee

The term Obligee represents the party that is demanding the surety bond. It is usually a governmental agency that is in charge of certain administrative functions. If the obligee asks for a surety bond, which is a generally common practice, they are simply asking from a company, or an individual contractor, to provide insurance to their own clients that the contract will be honored and all legal binding needs met.

The Surety Company

As a form of a curator between the two previously mentioned parties, the surety company is the organization which guarantees the bond. The principle pays the company a percentage of their bond, and in return, if the principle, or the company, is not following the agreement stated in that bond, the obligee has the right to claim reparations for damages. The most important thing that a contractor has to ensure when contacting a surety company, is that that company is on the list of the Department of the Treasury’s Listing of Approved Sureties.

The end user, or the client that the contractor is servicing, is not involved in any way in this process, except from being the party ensured by this agreement.

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How Much Does A Surety Bond Cost?

There are literally thousands of types of surety bonds. Depending on the industry, on the obligee, and on the credit score of the contractor – the price variates. It is almost like getting a loan. Your credit score determines the price, but in certain industries there are some standard practices and standard fees.

For instance, in public construction, we can determine the price and value of bid bonds easily. A bid bond is guarantees that the contractor will post an accurate bid proposal for the job, and that the contractor will post a performance bond. The performance bond ensures the contractor will complete the project according to the contract specifications. If the contract surpasses a figure of $350.000, some companies offer bid bonds free of charge. If it doesn’t, a standard fee is usually around $100 per bond.

Of course, this standard variates across industries. Whether you are looking for a surety bond that will address your licenses and permits, construction, court or commercial bonds etc. – the best source to inquire about these prices are your local surety bond companies and governments. The price also variates in accordance to the procedure, if you need a contract that is not standard – it will probably cost more.

Who needs a Surety Bond?

In case that you are a construction contractor, you will definitely need a surety bond. They are also mandatory for almost any company or institution that is tied to the federal resources and administration. While business owners consider this fee as an expanse, knowing that you are ensuring your customers is certainly comforting as well. Not to mention that it is  the law.

Featured image: courtesy of https://www.suretybonds.org/what-is-a-surety-bond

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