Like businesses buy insurance to protect themselves against potential losses, surety bonds provide obligees with a financial guarantee. In return, principals pay a premium linked to their risk.
The Small Business Administration guarantees small contractors bids, payments, and performance bonds. This removes a barrier to getting jobs and opens up more opportunities for entrepreneurs.
What is a Surety Bond?
A surety bond is a three-party contract where one party (the “surety” or “insurance company”) guarantees the performance and responsibility of another party (the “principal”) to a third party (“obligee”). There are two broad categories of bonds: contract and commercial (or miscellaneous).
Contract surety bonds guarantee that a principal will fulfill their contractual obligations. This can include a contractor’s promise to pay subcontractors and suppliers and the obligation to complete a project according to a contract.
Commercial surety bonds guarantee that a person or business will comply with a specific law, regulation, or court proceeding requirement. These bonds can be required for licensing and permit applications, such as a mortgage broker bond, or to protect against improprieties by fiduciaries like guardians. A court also often requires them to secure an international or large financial transaction. They are a cheaper alternative to bank guarantees and can free up assets that could be used for other purposes.
What is a Surety Bond Guarantee?
When you enter into a surety bond, you agree to a contract between three parties that guarantees a specific obligation will be fulfilled as promised. This obligation may involve meeting a contractual commitment, paying a debt, or fulfilling specific duties. Individuals purchase surety bonds to demonstrate their financial responsibility and reduce the risk of a claim against them.
A bonded principal will pay a premium to the issuing agent, usually an insurance company or specialist bond issuer. They must also sign an indemnity agreement that pledges company and personal assets to repay the surety in case of a valid claim.
The SBG program makes it easier for small and new contractors to obtain contract surety bonds they could not get through regular commercial channels. This includes bid, performance, payment bonds, and ancillary bonds that are incidental to the contract’s performance. The SBA guarantees payments on behalf of the obligee for amounts up to but not exceeding the bond amount.
How Can I Get a Surety Bond Guarantee?
The first step in getting a surety bond is to contact an insurance agent. They can assist you with determining what types of bonds your business requires and help you complete the application. The next step is to provide your business information and financial records. Your agent will use this information to compute a premium rate for the bond.
The SBA Surety Bond Guarantee program helps small businesses get the bid, performance, and payment bonds they need to take on projects. Typically, these companies would need help getting the bonds in the normal market due to poor credit or working capital issues.
What Are the Requirements for a Surety Bond?
This company issues the bond and guarantees it (surety), and an entity that requires a bond as part of a contract, law, or licensing requirement (obligee). The principal pays for the bond, often by credit. If the principal does not meet their responsibilities, the obligee can seek compensation from the surety by filing a claim against the bond.
Government agencies, industry regulators, and obligees require surety bonds for licensing, permits, contract work, and other business requirements. For example, auto dealerships and freight brokers must obtain a motor vehicle dealer bond and freight broker bond before they can sell or operate. The bond is a less expensive alternative to bank guarantees and allows businesses to meet compliance requirements without tying up assets. Unlike insurance, however, funds expended to settle claims against the bond must be recuperated from the principal. This is why having a trusted partner to assist with your bonding needs matters.