If you are a small business owner, you will likely encounter surety bonds in the course of doing business at some point. Many types of businesses are required to purchase surety bonds as a condition of obtaining licenses or bidding on contracts. If your business operates in an industry that requires you to be licensed to legally operate, you are likely required to also purchase a surety bond.
While you might recognize that purchasing a surety bond is one more hoop your business needs to jump through, you may also wonder whether surety bonds offer any benefits to small business owners and what the financial and legal ramifications of failing to purchase mandated surety bonds could be for your business. This article will explain what surety bonds are, their financial benefits for small businesses and the public, and the financial and legal ramifications of failing to purchase required surety bonds.
What Is a Surety Bond for a Small Business?
Some business owners think that surety bonds are a type of insurance, but there are some key differences between bonds and insurance. Surety bonds do not protect business owners from liability and instead are designed to protect the party requiring them and the public. If a claim is filed against a business’s bond, the business will ultimately be responsible for paying it.
A surety bond is a legal contract between the following three parties:
• Principal – Business required to purchase the bond
• Obligee – Party (usually a government agency) requiring the bond
• Surety – Surety company issuing the bond and guaranteeing the principal’s legal compliance and performance
Surety bonds function as a form of credit from the surety company. Your surety bond will be issued in a maximum bond amount, which is the maximum amount that can be paid if a claim is filed against it. You will have to pay a percentage of the maximum bond amount up front to secure the bond. Your bond premium amount will depend on factors the company evaluates during the underwriting process, including your credit, working capital, assets, experience, and reputation.
At the time that you are approved for a surety bond, the issuing surety company will require you to sign an indemnity agreement through which you will agree to indemnify the surety against any valid claims that might be filed. If you fail to comply with the law or conduct your business ethically, a claim can be filed. While the surety company will step in and pay the claim, you must reimburse the surety or risk legal enforcement through the courts.
The government requires certain types of businesses to purchase bonds to protect consumers against non-performance and misconduct. Since the surety company can seek full reimbursement from you for any claims that are filed, your surety bond is a type of credit rather than insurance.
If you are required to purchase a surety bond, you can submit an application to a surety company together with other documents the company will need to evaluate your risk. Some of the types of documents you might be required to submit include the following:
• Audited financial statements
• Bank statements
• Assets and liabilities schedules
• References from past subcontractors and suppliers
• Bank letter of credit
• Details of past projects
• Business plan
• Business structure
• Resumes of important shareholders
The surety company will then send your application and supporting documents through the underwriting process, and the previously mentioned factors will be evaluated to assess your risks. Depending on these factors, the surety company will either decide to deny your application or approve it and issue a bond premium quote. If you have very poor credit or past incidents of misconduct, you might be turned down for a bond. Depending on your credit and other factors, a surety bond premium might range from 1% to 15% of the maximum bond amount.
Financial Benefits of Surety Bonds
While surety bonds primarily protect consumers and the government against legal noncompliance or nonperformance, there are a few benefits of surety bonds for small businesses. Depending on your industry, you might not be able to get a license to operate from the state without purchasing a surety bond. Because of this, a surety bond might enable you to legally operate your company.
Once you are bonded, you can include that information in your advertisements. Many individuals and businesses only want to work with companies that are bonded and licensed, so being able to advertise that your company is licensed and bonded might help to expand your business’ sales and profits. Consumers are much more aware of the need to do business with reputable companies to minimize their risks of loss. When you are bonded and licensed, it demonstrates your commitment to complying with the law.
Surety bonds also might help to free up some money for your business. Some states allow companies either to post the entire required amount up front and keep it in a trust account or to purchase a surety bond. Since you only need to pay a small percentage of the maximum bond amount to secure a surety bond, choosing that option can allow you to use your money to facilitate your business instead of leaving it in a trust account to protect the public.
Financial and Legal Ramifications of Failing to Purchase a Required Bond
If you do not purchase a bond when you are legally required to do so, you can face severe consequences. Failing to maintain a required surety bond can result in local, state, or federal fines. Your license might also be suspended or revoked, which can result in your business’s temporary closure. It can take weeks to purchase a new bond and get your license back to resume operations, so failing to maintain your bond could result in you going out of business due to substantial losses.
Types of Businesses Required to Purchase Surety Bonds
Some of the types of businesses that are required to purchase surety bonds for licensure include the following:
• Medical equipment providers that contract with Medicaid or Medicare
• Notary publics
• Travel agencies
• Real estate agents
• Health clubs
• Mortgage brokers
• Security guard companies
• Used and new car dealers
Car dealers, including wholesalers, auto auctions, and others, might need to purchase different types of auto dealer bonds, depending on the types of vehicles they sell and their specific activities. Even an individual who sells more than a minimum number of vehicles for profit per year may be required to purchase a used car dealer bond and provide a bonded title to sell any used vehicle with a lost title.
While surety bonds might be viewed as another cost involved with operating your business, being bonded can also help to show that your business is reputable and increase your customer base. Once you receive your surety bond, make sure to maintain it and build a great business reputation to help your business to be more successful.
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