Securing a surety bond can be a major hurdle for commercial construction companies looking to land bigger projects and grow their businesses. This is especially true if bidding on a government contract.
What is a surety bond?
Bonding is similar to an insurance policy, in that a surety bond company will cover the cost to fix any problems that occur, such as failing to complete the project, once a claim is filed against the policyholder. Unlike an insurance company, however, the surety bond company can then charge the policyholder for any dollars they pay out if a claim is a made.
To protect against losses, surety bond companies require stringent and thorough underwriting processes. In many cases, a bond company will charge a Bond Premium upfront before issuing the bond you need to start work.
Securing a bond can be a trying experience, especially when you have a valuable project at stake. The best strategy is to be organized, persistent and thorough.
First, know what kind of bond you need.
The first step in securing a bond is understanding what type of bond your company is looking for, as well as the value of the bond. Here are some of the most common, though they can be combined depending on your contract and situation.
Performance Bonds are the most common type of bond. They are required by many large projects, both public and private. If for some reason your business is unable to complete the work it was hired to do, the bonding company will have to cover the cost of getting the work done by someone else.
Rather than performance bonds, which primarily protect the project owner, payment bonds largely protect subcontractors, vendors and material suppliers for jobs on public property. Lien laws that ensure subs, vendors and suppliers are paid cannot be applied to projects taking place on public property.
Typically limited to public projects, bid bonds are a strategy for a project owner to pre-qualify bidders. By awarding a bond, the surety company is endorsing the bidder’s ability to do the work. A bid bond also means that if the lowest bid is accepted and then the bidder backs out, the bonding company will ensure that a bond penalty is paid (between 5% and 20% of the bid price).
Know what bond companies are looking for.
Surety bond companies only issue bonds to businesses that prove they are able to complete a project according to the contract. That means having the financial means to cover the cost of things like materials, labor and equipment.
They often require documentation such as:
- Company financial statements
- Work history
- The owner’s personal financial statements
- Credit checks
- Resumes of each owner
- Professional recommendations
To navigate the complicated system, most business owners hire a professional bond agent to help prepare and educate them on preparing the company for the application and underwriting process, identifying surety bond companies and then working with the owner through the underwriting process to secure the bid itself.
Surety bond underwriters consider the following categories when considering whether or not a contractor should be granted a bond, according to ConstructionBusinessOwner.com.
Are the individuals who make up the construction firm of high moral character?
Does the construction firm have the people with the knowledge, experience and understanding to do the work?
Does the construction firm have the equipment and financial wherewithal to complete the projects they desire bonds on?
Know how your credit affects your surety bond.
Similar to applying for a business loan, company owners and their spouses are typically required to sign an “agreement of indemnity” or a personal guarantee.
The cost of the surety bond is dependent on the company and business owners’ credit worthiness. Good credit can result in a bond premium of about 1% of the bond amount, or two to three times that if they have poor credit. That cost will often be due in full before the bond can be issued.
Danielle Rodabaugh, the chief editor of SuretyBonds.com wrote that you should thoroughly check your bond before signing and especially before submitting it to the project owner to verify that your company name, business address, bond value are all accurate and free of typos. Otherwise you risk your bond being rejected and losing the job.