Surety Bond

What is a Surety Bond?

A surety bond is a three-party contract that provides financial protection and guarantees that a contractor will complete a project according to the contract terms. If the contractor fails to meet their obligations, the surety company compensates the project owner.

Unlike insurance (which protects the policyholder), surety bonds protect the project owner or client against contractor default, incomplete work, or contract violations.

The Three Parties

Principal: The contractor who purchases the bond and promises to fulfill the contract.

Obligee: The project owner, developer, or government agency requiring the bond.

Surety: The insurance company that backs the bond and guarantees the contractor's performance.

Types of Contractor Bonds

Bid Bond

Guarantees that if awarded the contract, the contractor will sign it and provide required performance bonds. Typically 5-10% of the bid amount.

Performance Bond

Ensures the contractor will complete the project according to contract specifications. Usually 100% of the contract value.

Payment Bond

Guarantees the contractor will pay subcontractors, suppliers, and laborers. Protects against mechanic's liens on the property.

License Bond

Required by many states and municipalities to obtain or maintain a contractor's license. Protects consumers against contractor fraud or code violations.

Maintenance Bond

Covers defects in workmanship or materials for a specified period after project completion, typically 1-2 years.

Why Bonds Are Required

Government Contracts

The Miller Act requires performance and payment bonds for all federal construction projects over $150,000. Most states have similar "Little Miller Acts."

Commercial Projects

Many private developers and commercial clients require bonds to reduce their financial risk on large projects.

Contractor Licensing

Most states require a license bond to protect consumers and ensure contractors meet minimum financial standards.

How to Get Bonded

1. Assess Your Bonding Capacity

Your bonding capacity depends on your company's financial strength, experience, and track record.

2. Prepare Financial Documentation

• Business and personal financial statements
• Tax returns (typically 3 years)
• Work-in-progress reports
• Bank references

3. Work with a Surety Agent

Find an agent who specializes in construction bonds and understands contractor businesses.

4. Build Your Bond Program

Start with smaller bonds and build your track record to increase capacity over time.

Factors Affecting Bond Approval

Financial Strength: Working capital, net worth, and liquidity ratios.

Experience: Years in business and successful completion of similar projects.

Credit History: Personal and business credit scores.

Character: Reputation in the industry and references.

Capacity: Current workload and ability to take on new projects.

Bond Costs

Premium Rates

Typically 1-3% of the bond amount for contractors with good credit and experience. Higher-risk contractors may pay 5-15% or more.

Example Costs

• $100,000 bond at 2% = $2,000 premium
• $500,000 bond at 1.5% = $7,500 premium
• $1,000,000 bond at 1% = $10,000 premium

Claims and What Happens

When a bond claim is filed:

1. Investigation: The surety investigates the claim
2. Resolution: The surety may help complete the project, pay the obligee, or defend the contractor
3. Reimbursement: Unlike insurance, the contractor must repay the surety for any claims paid

Tips for Maintaining Bondability

Keep Clean Financials: Maintain strong working capital and timely financial reporting.

Finish What You Start: Complete projects on time and within budget.

Manage Cash Flow: Avoid underbilling and maintain healthy accounts receivable.

Communicate with Your Surety: Report problems early and maintain a good relationship.

Build Your Track Record: Consistently successful projects increase bonding capacity.

The Bottom Line

Getting bonded opens doors to larger, more profitable projects. While the process requires financial transparency and patience, establishing a strong bond program is essential for contractors looking to grow their business and compete for commercial and government work.