Why do construction companies use surety bonds?
From the Equipment that they use to their accounting policies (percentage of completion), construction companies do things their own way. One of the nuances of their business involves the usage of surety bonds. Understanding why construction companies use surety bonds and the benefits that they provide is important to learning about their business model.
What are Surety Bonds?
Surety bonds are best thought of as part Credit vehicle and part insurance contract. Surety brokers issue Surety Bonds to the owner of the property as protection from the construction company. As such they are an agreement between three parties that provide protection to the building owners and subcontractors. The contractor still bears risk as does the surety company.
Construction companies and owners benefit from surety bonds by being able to attract subcontractors who have a drastically heightened chance of being paid with a surety bond. Surety bonds will insure that they are compensated for their work which helps them to retain quality contractors. When a surety bond is used in this context, it is known as a payment bond. Surety bonds will protect the owner from the general contractors performance by ensuring that they will perform their construction in accordance with standards. When surety bonds are used in this context they are called performance bonds. Finally, there is often a significant amount of competitive bidding associated with getting an construction job. In this context, surety bonds are called bidding bonds and help to reduce the risk that these entities are facing by possibly over bidding on an job.
What are the Costs of Using Surety Bonds?
There is obviously a cost of a surety bond that is paid to the surety company as a fee for issuing the bond. This fee is typically calculated as a percentage of the amount the surety bond covers. Surety bonds are often regulated by various state insurance departments and therefore have regulations associated with them. Further, they only provide coverage up to a certain limit and getting additional coverage may be expensive. Surety bonds can be somewhat confusing to understand and therefore they may require the usage of lawyers, consultants, or financial professionals to understand and negotiate the terms of the surety bond agreements. Further, the surety company may take a significant amount of time to learn about the contractor’s financial position and their level of expertise, which may lead to a delay in the construction of the job.
Should You Use a Surety Bond on Your Construction
If you are an owner of a building looking to have a project developed it is important to have a contractor obtain a surety bond to protect your building, except for the smallest jobs. Contractors should develop relationships with surety insurers who can quickly approve the contractor and charge competitive rates due to the presence of repeat business. Further, many public jobs require surety bonds to bid or contract for work and it is therefore a necessity for them to obtain these contracts before obtaining an contract.