Bonding and Surety: Requirements for Contractors and Service Businesses

Bonds Are Not Insurance

This is the first and most important distinction. Insurance protects you. Bonds protect your client.

When you purchase an insurance policy, the insurer pays claims on your behalf and absorbs the loss. When a surety bond claim is paid, the surety company pays your client — and then comes after you to recover every dollar. A bond is a guarantee of your performance, not a safety net for your business.

Think of a bond as a three-party agreement:

Principal — You, the business owner who purchases the bond
Obligee — The party requiring the bond (usually a government agency or project owner)
Surety — The bonding company that guarantees your performance

If you fail to meet your obligations, the surety pays the obligee, then seeks full reimbursement from you.

Why Bonds Are Required

Bonds exist to protect the public and project owners from contractor failures:

Government agencies require bonds on public construction projects to ensure taxpayer-funded work gets completed
Licensing boards require bonds as a condition of obtaining professional licenses
Courts require bonds in certain legal proceedings
Private project owners may require bonds for large construction or service contracts

If you work in construction, service contracting, or any licensed trade, bonds are likely a part of doing business.

Types of Surety Bonds

Contract Bonds (Construction)

These are the bonds most contractors deal with. They come in three forms that are often required together:

Bid bond — Guarantees that if you win a project bid, you will enter into the contract and provide the required performance and payment bonds. If you refuse, the surety pays the obligee the difference between your bid and the next lowest bidder (typically capped at 5-10% of the bid amount).

Performance bond — Guarantees that you will complete the project according to the contract terms. If you abandon the project or fail to perform, the surety arranges for completion and covers the cost, usually up to the full contract amount.

Payment bond — Guarantees that you will pay your subcontractors, suppliers, and laborers. This protects the project owner from mechanic's liens and ensures the supply chain gets paid even if you default.

On federal projects over $150,000, the Miller Act requires performance and payment bonds. Most states have "little Miller Acts" with similar requirements for state and local government projects.

Commercial Bonds (License and Permit)

License bonds — Required by state or local governments to obtain a professional or contractor's license. They guarantee that you will comply with laws and regulations governing your trade. Common examples: general contractor license bonds, electrician bonds, plumber bonds, auto dealer bonds.

Permit bonds — Required to obtain permits for specific activities. Examples: building permits, street opening permits, sign installation permits.

Tax bonds — Guarantee that you will remit collected sales taxes or other taxes to the government.

Miscellaneous Bonds

Fidelity bonds — Protect against employee theft and dishonesty. These are sometimes required by clients who grant your employees access to their premises or assets.

Court bonds — Required in legal proceedings. Examples: appeal bonds, injunction bonds, probate bonds.

How to Qualify for a Surety Bond

Getting bonded is more like getting a loan than buying insurance. The surety is guaranteeing your performance, so they evaluate your ability to deliver. The three Cs of bonding:

Character

The surety examines:

Your personal and business credit history
Criminal background
Industry experience and track record
References from previous clients, subcontractors, and suppliers
Your reputation in the industry

Capacity

The surety evaluates whether you can actually do the work:

Past project size and complexity
Current work-in-progress (are you overextended?)
Equipment and workforce availability
Management team experience
Your project management systems and processes

Capital

The surety reviews your financial health:

Personal and business financial statements
Working capital (current assets minus current liabilities)
Net worth
Bank line of credit
Profitability history
Cash flow projections

For larger bonds (over $250,000-$500,000), sureties typically require CPA-prepared financial statements — and for very large bonds, audited financials. This is a significant cost and preparation requirement.

Bond Costs

Bond premiums are typically quoted as a percentage of the bond amount:

Contract bonds — 1-3% of the contract value. A $500,000 performance bond costs approximately $5,000-$15,000.
License and permit bonds — $100-$500 per year for most small business license bonds.
Bid bonds — Usually free if you have a bonding relationship, or a small fee.

Rates depend on the bond type, your financial strength, experience, and the surety's assessment of risk. Poor credit or limited experience means higher rates or denial.

What Happens When a Bond Claim Is Filed

If a client or government agency files a claim against your bond:

The surety investigates the claim to determine if it is valid
If valid, the surety pays the obligee up to the bond amount
The surety seeks reimbursement from you for every dollar paid plus investigation and legal costs
Your bonding capacity is damaged — Future bonds become harder and more expensive to obtain
Personal guarantees are enforced — Most bonding agreements include a personal indemnity agreement from the business owner

This is why bonds are not insurance. When a bond pays out, you ultimately pay the bill. The surety is lending its credit, not absorbing your loss.

Building Your Bonding Capacity

Your bonding capacity — the maximum amount of work you can have bonded at one time — grows with your business. To build it:

Maintain clean personal and business credit — Pay every bill on time
Build working capital — Retain earnings rather than distributing all profits
Complete projects successfully — Every completed bonded project builds your track record
Invest in financial reporting — Move from compiled to reviewed to audited financials as you grow
Develop a relationship with a surety agent — A good bond agent advocates for you with the surety company
Start small — Take on progressively larger bonded projects to build capacity gradually

Finding a Surety Bond Agent

Not all insurance agents handle bonds. You need an agent who specializes in surety, understands the construction or service industry, and has relationships with multiple surety companies. Ask for:

An agent with a Construction & Surety specialty
References from other contractors in your area
An agent who will help you build bonding capacity, not just process applications

The Bottom Line

Surety bonds are a fundamental requirement for contractors and many service businesses. They are not insurance — they are a guarantee of your performance backed by your own finances. Build strong credit, maintain healthy financials, complete projects on time, and develop a relationship with a surety specialist. Your bonding capacity is a direct reflection of your business's financial health and reputation.