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Many small business owners will eventually consider surety bonds while conducting their business operations. Some businesses are required to secure surety bonds before they can secure licenses. If you learn that you will need to secure a surety bond to enter into contracts or are required to obtain one to operate your business legally, you likely wonder whether a bond offers any financial benefits or if it is instead simply another hoop for you to jump through. Here is some information about surety bonds, their potential financial benefits, and the ramifications your company might face if you choose not to purchase one for your company.
Understanding Surety Bonds
A common misconception many business owners have about surety bonds is that they are a type of insurance. Surety bonds are not insurance but instead function more like an assurance that the business holding the bond will perform as promised and will comply with the law.
Bonds are legally enforceable contracts involving the following three parties:
- Obligee – The party that requires the bond, which could be the government or a private party
- Principal – The business that must purchase and maintain the bond
- Surety – The company guarantees the principal’s performance and legal compliance
Local, state, and federal government agencies frequently require bonds for contracts, bids, licenses, and other purposes to protect consumers from legal malfeasance or non-performance by the principal. The federal government has required contractors to be bonded to perform work on public projects since 1893. Project owners might also require bonds as a condition of contracting with businesses.
If people are harmed by the principal during the course of business, they can file claims against the surety company that bonded the business. The ability to file bond claims obviates the need to pursue mechanic’s liens. The surety company will investigate claims, and if they find the claims are valid, the surety will step in and pay the claims. However, the principal will be responsible for paying the surety any claim amounts the surety pays or face legal action.
To purchase a surety bond, you must go through an approval process.
The bonding process includes underwriting during which multiple factors will be considered, including the following:
- Business and personal credit
- The business’s available working capital
- Business and personal assets and liabilities
- Experience handling similar types of projects
- Reputation and moral character
The cost of a bond will depend on the surety’s evaluation of these and other factors. Once the surety determines the principal’s degree of risk, it will decide whether to approve the application or deny it.
If it is approved, the surety company will provide a free quote for the bond premium, which is how much the principal will have to pay to purchase the bond. The bond premium is a percentage of the bond’s maximum amount.
If a business has poor credit, it might not be able to purchase a bond or might be forced to apply for subpar credit bonds and pay a high percentage of the bond’s amount to secure it. If your business has excellent credit and a good history, you might expect to pay a low percentage of as little as 1%.
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Surety Bond Benefits
While surety bonds might seem like one more expense that your business has to absorb, there are some potential financial benefits to purchasing and maintaining a bond. If you include the fact that you are bonded in your advertisements, your bonding status might positively impact your sales and operations. Many consumers and businesses look for companies that are bonded to help to reduce their risks of loss and maximize their gains from their business transactions. When you choose to become bonded and licensed, it shows that your company is willing to comply with the law and work within the recognized channels of your industry.
Surety bonds provide your company with greater credibility. Since you have to go through the underwriting process to be approved for a bond, qualifying for a surety bond demonstrates that your business is stable and is likely to comply with the law and honor your contractual obligations. Being bonded may allow your business to take advantage of more opportunities than you might have access to if you are unbonded.
Surety bonds also offer financial benefits to consumers, clients, project owners, and the government. Since the bonds guarantee that your business will follow the law and engage in ethical business practices, consumers, clients, and others with whom your company enters into contracts have a remedy available if you engage in misconduct or fail to honor your contractual obligations.
People who are harmed by your actions while doing business with you can file claims against your surety bond. If their claims are validated, they can recover money for their losses. Since the surety company will step in and pay valid claims, people who are harmed by your actions as a bonded company can be assured that they will be protected even if you fail to honor your obligations. However, if you fail to pay a valid claim, the surety company will come after you in court. The indemnity agreement that you are required to sign as a part of the bonding process means that you are ultimately responsible for paying valid claims against your surety.
What Happens If You Do Not Purchase a Bond?
If you do not purchase a surety bond, you can encounter several problems. If you are in an industry that requires licenses, you might find that you cannot secure a license without purchasing a surety bond.
Consumers also view your bonding status as an indication of whether you will perform your work fairly and ethically. If you remain unbonded, it can harm your business’s reputation and your ability to legally operate.
While purchasing a surety bond for your business might seem like one more thing you have to do, being bonded can offer some benefits to both you and the parties with which you do business. Surety bonds normally will only cost you a few hundred dollars. By contrast, failing to carry a required bond can result in substantial penalties ranging into thousands of dollars and the potential closure of your business.
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