Surety Bonds Explained: License, Bid, Performance and Payment Bonds
How surety bonds differ from insurance, the main types small businesses encounter, what determines the cost, and what an indemnity agreement means for you.
Contractors and other licensed businesses are often told they need to be "bonded and insured." Insurance and bonds work together, but they are very different products. Understanding surety bonds helps you meet licensing requirements and bid on bigger jobs.
How a surety bond works
A surety bond involves three parties:
- Principal: your business, which makes a promise.
- Obligee: the party requiring the bond, such as a state licensing board or a project owner.
- Surety: the company that guarantees your promise.
If you fail to meet the obligation, the obligee can make a claim against the bond. If the claim is valid, the surety pays, and then generally seeks repayment from you.
The indemnity agreement
When you get a bond, you usually sign an indemnity agreement promising to repay the surety for claims and costs. For small businesses, owners are often asked to sign personally. This is the core difference from insurance: a bond is closer to a line of credit backed by your promise than a transfer of risk.
Common types of bonds
| Bond type | What it guarantees |
|---|---|
| License and permit bonds | That you'll follow laws and regulations tied to your license. |
| Bid bonds | That if you win a bid, you'll sign the contract and provide required bonds. |
| Performance bonds | That you'll complete the project according to the contract. |
| Payment bonds | That you'll pay subcontractors and suppliers. |
| Fidelity bonds | Protection against employee theft, such as janitorial bonds. These work somewhat differently from surety bonds. |
Public construction projects frequently require performance and payment bonds, including large federal projects under federal law and many state and local projects under similar state laws.
What affects bond approval and cost
- Personal and business credit history.
- Financial statements and working capital, for larger contract bonds.
- Experience and track record completing similar work.
- Bond type and amount.
Tips for small businesses
- Check your state licensing board's bond requirements before applying for a license.
- Keep business finances separate and well documented to qualify for larger bonds.
- Work with an agent who specializes in surety if you plan to bid on public work.
- Remember that a bond doesn't replace liability insurance; you usually need both.
Frequently asked questions
Is a surety bond the same as insurance?
No. Insurance protects you against covered losses. A surety bond guarantees your obligations to someone else, and the surety will generally seek repayment from you if it pays a claim.
Why do contractors need a license bond?
Many states and cities require contractors to post a bond as a condition of getting a license. The bond helps protect customers or the public if the contractor violates certain laws or obligations.
How much does a surety bond cost?
Bond premiums are typically a percentage of the bond amount, and the percentage depends heavily on the applicant's credit and financial strength, as well as the bond type.