Bonds are three-party contracts between guarantors (individuals, such as contractors), obligees (the entity requiring the bond), and bonding companies. Determining whether you need to get bonded, as well as for what purposes and for how much, depends on the nature of your work and the region you’ll be working in. In order to be licensed as a contractor in most states, you must acquire a contractor license bond, and surety bonds are typically required of licensed contractors before they will be able to begin work on specific projects.
In short, bonding companies, also called sureties, can help you by facilitating the bonding process. They can provide obligees with a promise that the project will be completed and that all regulations will be followed. While this may sound simple, bonding companies perform many tasks to help contractors, and you should carefully weigh your options before choosing a bonding company.
This article will provide comprehensive guidance on this topic and arm you with the knowledge to perform your work with confidence that you’ve found a bonding company that meets your needs.
What Does a Bonding Company Do?
A bonding company protects each party involved in a construction project, including the contractor and the client. If you want to begin work on a project that requires a surety bond, you will need to reach out to a bonding company. After completing a bond application and submitting any additional requested information, you will either be approved or denied, based on other proposals they’ve received. If you’re accepted, you’ll be issued a bond to start work on the project.
However, your relationship with the bonding company doesn’t end there. If you are unable to complete the project in the terms set out in the proposal, the obligee may file a claim with the surety. The company will provide compensation to the client, then collect that money from you. While this isn’t an ideal scenario, it is far better than being liable for further legal action. In this way, bonds mitigate excess liability and protect your company.
What Do Surety Bonding Companies Require From Contractors?
Bonding companies require information from your business plan. This includes in-depth descriptions of the geographic area where the work will be completed and the type of work you intend to do. These companies may also want to learn more about the work you’ve done. If you have a history of completing similar projects, you have a greater chance of getting bonded for it. While not strictly necessary, it can help to provide references from happy clients you’ve worked with in the past.
The bonding company will also want to know your most recent financial statements (covering at least three years, if possible). They will attempt to determine if you have enough resources to complete the project in the allotted time frame. For this reason, you’ll need to provide evidence that you have enough working capital, which can include a letter from your bank showing that you have a line of credit.
If you meet these requirements, you should be able to streamline the bonding process with minimal obstacles.
Key Factors When Choosing a Bonding Company
It can be tempting to simply go with the first bonding company that will help you meet your legal obligations, but this could be a serious mistake. Going with the wrong company could lead to a failure to meet your legal obligations, excessive costs, or inadequate bond term limits.
There are several key factors to keep in mind when weighing your options for bond providers. Failing to keep even one of these factors in mind can result in a less-than-ideal bonding company choice and potentially impact your options as a contractor going forward.
Bond Company Licensure
Above any other consideration, be sure that you are purchasing a bond from a licensed company. If you are not bonded by a state-licensed bond company, the obligee may reject it. If you need a bond based on federal requirements, for example, you should ensure that the company is listed in the Federal Treasury’s list of approved bond companies. Failing to ensure this can also result in the bond being rejected. In either case, getting bonded with an unlicensed company will waste valuable time and money.
Meeting Federal, State, and Local Regulatory Requirements
Remember that you must get a bond that meets regulatory needs. Bonds that do not meet the mandatory minimum coverage for the type of work you’ll be doing will not help you become eligible to work as a contractor. Further, such bonds may not even be refundable. It’s important to ensure that you get adequate coverage through your license bond and surety bonds to be compliant with state or local requirements.
For example, general contractors in California must have a contractor bond of $15,000, in addition to a $100,000 surety bond for LLC licensees. Those in Colorado and Illinois are licensed at the municipal or county level, meaning that required bond terms will differ from area to area within these states. These examples illustrate the various bond requirements that exist in different states.
While the cost of a bond is dependent on many factors — including the bond amount, the applicant’s credit, and other variables — different bond companies will have different pricing. This can be as low as 1% of the bond’s term to as much as 20% or more, though the average amount is 3%.
For example, let’s say a contractor requires a bond of $10,000. The individual has excellent credit and shops around, ultimately finding a bonding company with a cost of 3% of the bond’s term. This means the bond will cost $300. In contrast, a contractor with fair credit settles on the first bonding company they consult, and they must pay a fee of 15%, or $1,500. These examples illustrate the importance of comparing your options. It’s wise to do some shopping around to see where you can find the best terms for you.
If your business is rapidly growing, it can be a mistake to pick a bonding company with a low single bond limit or aggregate bond limit. The first of these refers to the maximum bond term that a company can provide, while the latter refers to the cumulative amount of the bonds provided to a contractor. Each of these can restrict your ability to take on larger or more projects, respectively. Exceeding these would involve being submitted for review and approval by the bonding company, and approval is not a guaranteed outcome.
Instead, take some time to determine your company’s bonding capacity. Forming projections of your workload and growth going forward can help you pick a surety bond company that meets your needs. If you are not able to secure a surety bond that meets your desired limit, focus on improving your company’s financial situation and developing a history of successful projects; this will be useful in getting approval for bonds for higher amounts.
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