What entrepreneurs need to know about surety bonds?
The lowdown on surety bonds for entrepreneurs
Surety bonds are a legal requirement for many different types of businesses. However, as an entrepreneur, you might have no idea what a surety bond is.
Starting a business is already hard enough, but when you add in surety bonds, the process gets a lot more complicated. With the business, you need to worry about marketing, building a website, and attracting a lot of customers. However, a surety bond is on the legal compliance side. While it isn’t fun, it can destroy your business if you get it wrong.
You must understand how to protect yourself from all the different types of compliance issues you might run into as an entrepreneur.
Understanding surety bonds
A surety bond protects your customers against you potentially not delivering what you promised. If you enter into a contract that you don’t fulfill, the other person can then file against your bond. It is an intuitive process that essentially guarantees that you will meet your obligations.
The protections it provides also ensure that customers can have peace of mind when doing business with you. In the surety bond process, you have the principal, the surety, and the obligee. The principal is you, while the obligee is the entity requiring the bond. The surety is the entity providing the surety bond for your business.
It is crucial to understand whether your industry requires a surety bond or not.
Types of surety bonds
There are multiple types of surety bonds that your business can get. However, it typically depends on the type of business you are operating. These types are:
• License and Permit Bonds – These bonds are needed for certain businesses to legally operate in the area they are in. Auto dealers are an example of a business that needs this type of bond.
• Contractor Bonds – If you are working on public construction projects, it is likely that you are required to obtain a contractor bond.
• Court Bonds – These are bonds required by certain courts.
Check your state requirements first
A crucial thing to note is that surety bonds vary by state. The requirements you have will only apply to the state you do business in. Before you get started, you should check the specific requirements and follow them to the letter.
Industries that typically require surety bonds include:
• Auto lending
• Mortgage brokers
• Notary public
• Collection agencies
• Auto dealerships
• Health clubs
• Travel agencies
• Providers of medical equipment (when Medicare is involved)
Despite not being a part of this extensive list, your business should determine whether a bond is required in your industry.
Choosing a Company to Obtain Your Surety Bond
Once you have figured out if you need to get a bond or not, the next step is to find a company that will provide you with the surety bond for your business. This process is typically simplified by the fact that many insurance companies have their own surety bond divisions. However, insurance companies might not be the right choice when looking for these types of bonds.
The reality is that it is a much better choice to go with a company that is acting as a wholesaler. These companies will typically compete with insurance companies, meaning you get the best rates possible. They also don’t have to go through the bureaucracy that big insurance companies have. This model ensures that you are not just a number in a file somewhere.
Acquiring a surety bond shouldn’t be expensive
Surety bonds are not expensive to acquire. While it does depend on the type of bond and industry you are in, the truth is that the premium is usually 1% to 5% of the face value of the bond you are applying for. That amount is reasonable enough for most entrepreneurs to stomach.
The most important thing here is remembering that the underwriters will often ensure that you are financially worthy. That means examining your credit, financial strength, and even your experience in the business you are running. There are even many bonds that can be processed on the same day if all the documents are done right.
Remember that it is not insurance
The most crucial thing you need to understand about surety bonds is that it is not insurance. The bond is there to protect your client against you. Insurance is there to protect you from potential harm. When something happens with insurance, your insurance company is usually the one who pays for whatever losses the injured party suffers. However, it is the opposite with a surety bond. You are required to pay the bond as the principal. The premium you pay is the cost of obtaining the bond required to conduct your business. For insurance, the premium you pay is the price of the insurance to cover you.
Understanding the surety bond process
As mentioned above, you need a company to issue your surety bond. While the process is relatively easy and inexpensive, there is a lot of variability in the company you choose. There’s also a lot of variability in your background. This is why you need to have a clean financial background with documentation to show your experience and financial strength. It is this information that companies use to base your premium on. After signing, you can officially say you are bonded.
Remember that these bonds are not for your business
Ultimately, surety bonds can cause a lot of confusion for entrepreneurs. Once you understand the basics, it becomes an easy process to navigate. As long as you remember the fundamental reality that it is there to protect your customer, you will not have to worry about much.