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Here’s What Entrepreneurs Need to Know About Surety Bonds

By: SmallBizClub


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Opening a new business can be both exhilarating and exhausting. You must ensure that you understand and comply with all of the laws and regulations that apply to the startup you are planning to open. It can be difficult to become a successful entrepreneur, and you must be able to accurately plan and organize your business organization.

In addition to writing a business plan, securing capital funding, and choosing the right legal entity structure for your company, you will also need to secure the licenses and permits required by your state to legally operate your business.

One legal requirement for many entrepreneurs is to purchase surety bonds. For many professionals who are required to be licensed, purchasing surety bonds is something they must do. Before entrepreneurs can secure the licenses they need to operate their companies, they must obtain surety bonds, depending on the types of businesses they plan to run. Understanding surety bonds and the types of industries and businesses for which they are required is critical. Surety bonds are not something that can be ignored or avoided in many cases. Here is some information about surety bonds that you should understand as an entrepreneur.

What Is a Surety Bond?

It is common for entrepreneurs to confuse surety bonds with insurance. While it is a good idea for you to also purchase liability insurance to protect your business from potential liability, surety bonds are not the same thing. A surety bond is not something that you purchase to protect yourself. A surety bond does not protect you from liability. Surety bonds are guarantees that are meant to protect the public, and entrepreneurs that are required to purchase them are liable for claims that are filed against their surety bonds.

Parties Involved in Surety Bonds

The following three parties are involved in surety bonds:

• Principal – The entrepreneur seeking a license who is required to purchase a surety bond
• Obligee – The state or federal agency that requires the entrepreneur to purchase a surety bond before it will issue a license
• Surety company – The company that issues the surety bond and guarantees that the principal will follow the laws and regulations and will fulfill the contractual duties

If you fail to comply with the law or to perform your contractual obligations, either the government agency requiring the bond or consumers harmed by your actions can file claims against your bond. If a claim is filed, you are responsible for paying it. The surety company only steps in as a secondary party when the principal fails to pay a claim. If a surety company steps in, it will seek reimbursement from the principal.

Types of Surety Bonds

While there are many different types of surety bonds, the following three are the most common:

• Permit and license bonds – Surety bonds that are required for certain professionals to get licenses to operate their businesses
• Contractor bonds – Bonds required for companies or individuals that will perform work on public construction projects
• Court bonds – Bonds that are required by courts for different judicial purposes

Types of Businesses for Which Surety Bonds Are Required

Surety bonds are required for many different industries. For example, if you do not have a surety bond, your company will not be able to bid on public projects. If you are in the construction industry, securing a surety bond is essential.

Some examples of the types of businesses that are required to secure surety bonds include the following:

• Auctioneers
• Auto dealers
• Car dealerships
• Construction companies
• Debt collection companies
• Fitness/health clubs
• Medical equipment companies that participate in Medicare
• Mortgage brokers
• Notary publics
• Travel agencies

If you plan to open a business in one of these types of industries, you will be required to purchase a surety bond. This list is not exhaustive, so you should check with your state to learn whether you should purchase a surety bond for a different type of business.

Applying for a Surety Bond

Before you apply for a surety bond, you will first need to figure out which types you will need to get. You should also make sure that you have enough money available to purchase the bonds. Once you know the types of surety bonds you will need to purchase and have the money to pay for them, you can then apply for the bond at a surety company.

Surety companies want to know that they will face a low level of risk before they will agree to issue a bond. Depending on the size of the bond, the company might want to look at your financial statements. You will need to have sufficient working capital available to cover the potential costs of claims. The company will evaluate a number of factors during the underwriting process, including your financial strength, your credit, your reputation, and your history. If your application is approved, you will have to pay a percentage of the bond amount upfront as a premium.

If you have a low credit score or a problematic financial history, the premium you might have to pay to secure a surety bond will likely be higher. New businesses without established histories will also likely be charged higher premium amounts. Depending on the evaluation by the surety company and the type of surety bond you are applying for, you might have to pay a premium upfront of anywhere from 1% to 10% of the maximum bond amount.

As an entrepreneur, you likely have a lot on your plate. While you might need to complete a broad variety of tasks as you prepare to start your new business, you should not overlook getting a surety bond. It is a good idea to check with your state to determine your licensing requirements and purchase any surety bonds that you might need to obtain a license to operate your business. While a surety bond will not protect you, it is something that many different types of business professionals are required to purchase before they can begin their business operations.

Published: November 28, 2021

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