Surety Bonds

What Entrepreneurs Need to Know About Surety Bonds

Whether an experienced business professional or a newcomer as an entrepreneur, operating a successful company requires owners to wear many different hats. Tasks including bookkeeping, hiring, marketing, and compliance with state and federal business regulations must either be managed internally or outsourced to an expert. One of the often overlooked components of operating a business is the need for a surety bond.

Many entrepreneurs confuse surety bonds and insurance, using the terms interchangeably. However, recognizing what a surety bond is, when it is required, and its cost can be incredibly beneficial in ensuring a business is complying with licensing and operation guidelines set by the state or federal governments.

What is a Surety Bond?

A surety bond is a contract between three distinct parties: the surety company providing the bond, the principal required to have a bond in place, and the obligee that mandates a bond. This contract ensures that if the principal of the bond does not perform business activities in line with the law or licensing guidelines, a claim can be made against the bond to cover financial losses. In this sense, a surety bond works similarly to an insurance policy for customers of the business. Unlike insurance, however, bond claims are paid to the impacted party, not the company.

Surety bonds come in many different categories, and the type of surety bond a business needs depends on the work being performed or the services offered. For example, a state or county may require a surety bond as part of the licensing or permit process, or when a bid is placed on a construction project. Surety bonds may also be necessary to protect customers and the public from dishonest employees, or due to a court mandate.

Businesses Requiring a Bond

Many businesses need to have a surety bond in place, but be sure to check with local business agencies to determine if one is necessary for a specific industry or company type. The most common businesses that need a surety bond include:

  • Auto dealers
  • Mortgage brokers
  • Money transmitters
  • Collection agencies
  • Travel agencies
  • Sports agents
  • Auctioneers
  • Contractors and construction professionals

Other companies may secure a bond based on the type of transactions they complete for customers, especially when employees are entrusted with managing the services provided.

Surety Bond Costs

Entrepreneurs should also be aware of the cost of a surety bond, as this represents an essential expense of the business. Surety bonds are priced as a percentage of the total bond amount required, not the full bond. The percentage an entrepreneur pays can range from 1 to 15% of the bond total, but it depends on the following factors:

  • The size of the bond
  • The personal credit history of the bondholder
  • The business financials of the company
  • The type of bond being put in place

One of the most influential components of surety bond pricing is personal credit. The surety company initially pays for claims against a bond, but the principal is required to repay this amount when a claim is successful. Given this structure, a surety bond works as a form of extended credit the bondholder. If personal credit of an entrepreneur is less than ideal, meaning negative marks like late payments, bankruptcy, court judgments, or liens are showing on a credit report, the cost of a bond will be higher.

Getting a Surety Bond

To ensure a business is able to obtain the bond it needs to comply with laws and regulations specific to its industry, entrepreneurs need to understand what’s required to get a bond. Many surety companies make the initial process of applying for a bond simple, requiring a brief online or phone application.

This process involves providing detailed information about the business owner, the business location and industry, and the type of bond needed. Once these details are received, the surety company reviews the application to determine if additional information is necessary, such as business financial documents or industry experience.

After an application and all required information is provided, the surety company determines the bond price and offers next steps for putting the bond in place. In many cases, bonds need to be renewed each year to stay compliant with licensing or business requirements.

Surety bonds are an essential aspect of doing business in many different industries throughout the country. Entrepreneurs can prepare for operating a successful company by understanding how a surety bond works, the price of a surety bond, and the process of putting a surety bond in place.