Something to Fall Back On: Surety Bond

surety bond

There is a saying that it always pays to be safe.

When it comes to procurement, it can certainly apply. Many small businesses, upon the receipt of the contract, would probably be too excited to worry if their financial issues are alright.

If a small business is handling a federal contract (service or supply contracts) which has the value of $150,000 or up, it will be required to get a surety bond.

The surety bond’s main function is to make sure that the business/contractor can complete the contract even it (the contractor) has defaulted. To prevent contractor default, entities that award the contact (both private companies and governments) require a surety bond. In short, surety bonds acts like insurance, especially for contracts that fetch a hefty sum.

To put everything in perspective, there are three parties involved: the contactor/small business, the client (the government or another company) and the surety company. The client asks the contractor to secure a surety bond for a contract. If the contractor defaulted on the contract, it is the surety company which will find another contractor to finish the contract or compensate the client for any loss incurred.

Surety can also acts like a safety net for other situations. There are four types of surety bond that a contactor can use in any given situation. The first one is the bid bond. This bond makes sure that a bidder receives the contract and delivers the required payment (or performance bonds) to the surety company if it gets the contract. A good analogy would be a bank loan (the bank acting as the surety company).

Payment bonds are often used by clients to pay all contractors and/or subcontractors in a given project or contract. Another type is the performance bond, which guarantees that the contract will be completed according to the all contact terms and conditions. Ancillary bonds are like performance bonds. They ensure that integral requirements must be accomplished. These integral requirements need not be performance-based. Aside from these four types, there are also miscellaneous bonds that are used for transactions not covered.

Where to get one?

If a contract requires a surety bond, contactors can get the appropriate kind from a surety company. If a surety company isn’t available (especially for small businesses with no contracting experience or financial capability), the Small Business Administration (SBA) steps in and performs the tasks of securing a surety company. The SBA is not the agency that guarantees the loan for small contractors that participate in government procurement. It only uses its resources to help small businesses find a surety company. The particular office that offers this service within the SBA is the Office of Surety Guarantees. The SBA can only guarantee three types of surety bonds – bid bonds, performance bonds and payments bonds. For this service, the SBA charges a small amount of fee – usually 0.729% of the contract price when it comes to a payment or performance bond. In contrast, the agency doesn’t charge bid bonds.

The assurance that the SBA gives is a big relief for the small contractor.

Want to learn more about surety bonds? Check out the accompanying infographic too.

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