Surety bonds is basically a third-party guarantee required for signing certain types of contracts or for starting a business in various niches nationwide. These are in most cases issued by companies specialized in this kind of advocacy, also called surety companies. In this article we will explain you certain terms and procedures that are connected with surety bonding.

Insurance or credit?

Surety instruments stand somewhere in between insurance and credit. For obligees they represent insurance, because they can claim to get paid if the bond’s promise is not met, while from the contractor’s point of view they represent credit because they must be repaid and in some cases they require indemnity agreement to be signing.

surety bonds

How do surety bonds work?

Principals would never take surety bonds, if government or obligees didn’t force them to. In most states principals need to take these bonds for receiving a license for work in just about any niche or for signing a project contract for bids higher than $100,000.

Surety instruments are taken from surety companies who expect principals to pay the amount of the bond in full. In some cases principals also sign indemnity agreements that guarantee they will repaid the bonds. If principals don’t meet all contract terms, they need to pay every dollar as well as all legal costs. If they don’t do it, surety company can claim contractor’s money or pledged assets.

surety bonds

Different types of surety bonds

There are different types of bonds, since local, state and federal authorities require these documents for various business-related processes. These are some of the main categories of surety bonds:

  1. License and permit bonds– required for obtaining various business licenses and permits. Some of the license bonds are: contractor license bonds (for doing contractor’s work), health club bonds (for opening health clubs), mortgage broker bonds (for opening mortgage brokerages) etc.
  2. Contractor bonds– bonds for projects worth more than $100,000. There are several contractor bonds that relate to various phases of contracting projects. These are: bid bonds, performance bonds, payment bonds, maintenance bonds and supply bonds.
  3. Other commercial bonds– bonds can relate to various business processes and occurrences. There are fidelity bonds that protect companies and customers from employee theft, court bonds that guarantee that principal will fulfill all responsibilities ordered by the court.

What are the alternatives?

There are also several alternatives to surety bonds. Two of the most popular ones are irrevocable letter and Credit In Lieu. These alternative come with plenty of downsides. Some of them are:

  1. 100% Collateral– both above written option require 100% collateral, which contractors usually try to avoid.
  2. Higher costs– Irrevocable letter and Credit In Lieu are potentially much more expensive.
  3. Decreased Capital– Putting your assets as a guarantee can drastically limit your liquidity, which can also have an influence on project’s success.
  4. False Claims– this happens often and it comes as a result of providing obligees with money, which they can use for insurance claims.
  5. Bankruptcy– since all other alternatives are limiting your company’s capital and liquidity they can easily lead your company to bankruptcy.

Surety bonds’ benefits

Since they require only your signature and uses it as a collateral, it enables you to use and invest your assets in order to successfully finish the project you started. Surety companies are also much fairer when it comes to claims. In most cases they protect principals from false claims and offer representation when these occur.

 

Surety bonds are a necessity in order to make business less risky and more transparent. That’s why entrepreneurs shouldn’t view them as a burden, but as a guarantee that every project they start will be finished on time and in accordance with the contract.

Nate Vickery

Nate M. Vickery is a business and financial consultant from Sydney, Australia. He has years of experience in giving small businesses and entrepreneurs financial advice, as well as personal money making and saving advice.

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