Getting Your New Business Bonded

Starting a new business can be a daunting task. There are so many things to consider prior to opening for business. One of the most important items any business owner needs to research is finding out what government licenses need to be obtained and what type of bond has to be filed with it. Obtaining the proper insurance coverage is equally important prior to start-up. In this article we will review what is means to be bonded, the benefits of doing so, what type of bonds your company needs, and what you need to know prior to purchasing a bond.

What Does it mean to be “bonded”?

The phrase “licensed and bonded” is one you might see on the side of a contractor’s truck, on a mortgage broker’s business card, or on an auto dealer’s billboard. Obviously, they are all using the phrase for a marketing advantage over their competitors to show they are safe to do business with. What does it mean for these companies to be bonded? It means that a bonding company (also known as a surety) is guaranteeing the performance of their business per the terms of the filed license. If the bonded business (the principal) fails to fulfil the bond guarantee, then the obligee (whoever is requiring the bond) can file a claim to recoup losses incurred.

The process of obtaining a bond:

The government requires a bond of the business. The business then obtains the bond from a surety company.

These bonded companies are not purchasing bonds simply for advertising purposes, they obtain them because they are required to by the government to legally operate. There are literally hundreds of different occupations that are required to post a surety bond to local, state, or Federal governments. It is extremely important to find out whether you need to post a bond to run your business. Operating without a bond when one is required always results in the government halting a businesses operations. Typically, the bonds are filed to obtain a license to operate. However, there are instances where the government does not require a business to be licensed, but does require a bond to be posted. There are simply too many business types to go over them all in this article, so feel free to ask about your business getting bonded on The Surety Bond Forums.

What type of bond do you need?

There are two main types of bond products that people refer to when referring to “getting bonded”. The first is a surety bond, which is the type we were referring to above. The second type is a fidelity bond, which is a completely different product than a surety bond. As we learned above, a surety bond involves three parties: the obligee (typically the government), the principal (the business in need of the bond), and the surety (the bonding company backing the bond). A fidelity bond is actually a type of insurance product, not a type of surety. With fidelity bonds, there are only two parties involved: the principal (the business obtaining the bond) and the carrier (the bonding company backing the bond). Since fidelity coverage is a type of insurance, the principal (you) are the beneficiary in the event of a claim. An example scenario would be a fidelity bond that insures your company from employee theft. If a an employee were found guilty of theft, the bond would pay out.

Now that we know there is more than one type of bond, we can answer which one you need. The answer is usually pretty simple. If there is someone requiring the bond of you, it is a surety bond, as there are then three parties. If no one is requiring the bond and you simply want to protect your own interests, it is a fidelity bond.

Benefits of getting bonded

Surety bonds and fidelity bonds are different products and therefore have different benefits (as well as different downsides).

Surety Bonds:
As we went over in the beginning of the article, business often list that they are bonded on marketing materials. What other benefits does a surety bond provide for your company? Not many, as the bond is required by the government to protect the public, not your company. Funds from a bond claim would be distributed to those effected by your company’s lack of compliance with government regulations. One might ask, how is a bond beneficial to my company then? You have to remember, you need to post the bond to operate. The alternative is to never open business or post a irrevocable letter of credit (ILOC). An ILOC typically costs 1% and will require 100% collateral, where a bond usually costs 1-3% and requires no collateral. When you look at the alternatives, it is clear that a bond is very beneficial to your company’s operations.

Fidelity Bonds:
Fidelity bonds are rather strait forward, they are insurance product that protects your business from loss. Unfortunately, a claim will only payout in the event that the individual accused of stealing is found guilty by a court of law. On the bright side, they are relatively inexpensive and can be used for advertising in the same way that a surety bond is. Typically lock smiths and janitorial services will advertised that they are “bonded and insured”. When stating this, they are referring to fidelity coverage.

What you should know before purchasing a surety bond

You will be held responsible for any claims!
A surety bond is not insurance, it is more of a form of credit. Keep in mind the bond is guaranteeing that your business performs as required. If you fail to do so, it could result in a bond claim. Since bonds are not insurance, the bonding company will ultimately hold you and your company responsible for repayment of any losses. They are extending surety credit, not insuring your company. The bonding company will require your company and all owners to sign an indemnity agreement to ensure the bonding company is held harmless against any losses. The agreement can not be modified and they will not bond you if you do not sign.

The process of a bond claim:

The government files a claim with the surety. The surety turns to the business for repayment of losses.

Shopping for bonds can be tricky
Bonding companies are usually hesitant to review applications that they have received from multiple agents. Some carriers will decline an applicant simply because they have received the submission from too many agents. Therefore, it is best to submit to only one agency that is appointed with a large variety of different markets to properly place you bond. You can submit to more than one agency, but it is a good idea to inform all agents that you have applied with others. Any agent worth a grain of salt will then ask what bonding companies your application has been sent to. It is imperative that the carriers are not repeatedly submitted to, otherwise you may shut yourself out from the lowest rates.