Running a small business involves wearing numerous hats, ensuring legal compliance, obtaining required licenses and many other things. Depending on your industry, you might be required to obtain a license to operate your business legally or might need a contractor bond to perform work on the types of projects you want to complete. It can be difficult for many entrepreneurs to grasp all of the details they need to understand to ensure their businesses will be successful.
One thing you might encounter as a small business owner is a surety bond. You might be required to purchase a surety bond as a condition of your license, or you might want to be bonded to build your company’s brand and reputation. Below are five important things you should understand about surety bonds from Bryant Surety Bonds as a small business owner.
1. Surety Bonds Are Not Insurance
A common misconception among small business owners is that surety bonds are another type of insurance. However, they do not protect the businesses that purchase them against liability and instead protect consumers and the state. Surety bonds are instead a form of credit extended by a surety company to the business that purchases the bond.
A surety bond is a contract between three parties and is legally enforceable. The following parties are involved in the surety bonding process:
• Principal – The entity that needs the bond
• Obligee – The agency or private party requiring the principal to purchase a surety bond
• Surety – The surety company that guarantees the principal’s legal compliance and ethical practice in conducting business and issues the bond
If you are approved for a bond, you will have to indemnify the surety company against any claims that might be filed against your surety. Surety companies ask business owners to sign indemnification agreements before they will issue bonds to them. If you violate the law or engage in misconduct, the state or a consumer can file a bond claim. The surety company will pay any valid claim, but you will have the obligation of reimbursing the surety company or face legal action.
2. Surety Bonds Can Provide Certain Business Benefits
While a surety bond will not protect you against liability, being bonded does demonstrate that the surety company found that you are trustworthy and credible. When you submit an application for your bond, the surety company will evaluate it through an underwriting process. Some of the underwriting factors the bonding company will consider include your business and personal credit, your experience, working capital and your character. When a surety company agrees to issue a bond to you, it demonstrates that the company found that you pose a relatively low risk of violating the regulations in your industry, committing fraud or engaging in other types of misconduct. Savvy consumers want to work with companies that they can trust. Having a surety bond demonstrate your professionalism and integrity and might help to increase your customer base so that your business can grow.
Some industries also require you to get a surety bond to obtain a license and legally operate. If you don’t get a surety bond and want to open a business in an industry for which a bond is required, you might not be able to become licensed or perform work on certain types of contracts.
3. Surety Bonds Are Required for Certain Types of Businesses
Certain types of businesses are required to purchase surety bonds to legally operate. Some of the types of businesses that are required to be bonded include the following:
• Car dealerships
• Construction contractors
• Debt collection agencies
• Health and fitness clubs
• Notaries public
• Mortgage brokers
• Auctioneers
• Travel agencies
• Medical equipment companies that contract with Medicare
Other types of businesses might also be required to be bonded in your jurisdiction. Check with your local and state government to learn about the requirements that might apply to your company.
4. There Are Many Types of Surety Bonds
There are a broad variety of different types of surety bonds. However, most surety bonds fall into one of the following four categories:
• License and permit bonds – Bonds required for businesses that operate in specific industries to obtain licenses or permits to operate
• Contract bonds – Bonds required for businesses that want to bid on public projects and perform work on them
• Court bonds – Bonds required by courts for businesses or individuals that are involved in civil proceedings
• Fidelity bonds – Optional bonds businesses can choose to purchase to protect their clients and themselves against employee theft
5. The Cost of a Bond Will Vary
When you submit a surety bond application to a surety company, you will likely be asked for a number of documents that the company can use to evaluate your risk. Since surety bonds are a form of credit, bond applications go through an underwriting process. The underwriters will consider your assets and liabilities, available working capital, experience, business and personal credit and your character, including any past incidents of misconduct.
If you have great credit and a strong reputation, you can expect to pay the lowest cost. When you apply for a surety bond, the company will give you a free quote for the bond premium. The bond premium is the amount you will have to pay to secure the surety bond and is a percentage of your total bond amount. For example, if you are required to purchase a $50,000 surety bond, that does not mean you will have to pay $50,000 for the bond. If you have excellent credit, you might be charged 1% or $500. By contrast, if you have a lower credit score and demonstrate other issues indicating a higher risk, your application might either be denied, or you might have to pay a higher percentage ranging up to 15%. Using the $50,000 bond example, a subpar bond at 15% might require you to pay $7,500 upfront for the bond.
Most small business owners need to know about surety bonds and be prepared to purchase them if they are required by the state. Even if you are not required to purchase a surety bond in your jurisdiction, it might still be a good choice to demonstrate your professionalism to prospective clients.
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