What is a Construction Bond?
There are several types of construction bonds used to guarantee construction, often required by the government for public jobs. Private entities and general contractors bidding out projects to sub-contractors can also require them. You can use our contractor bond guide to learn about every bond you'll ever need for your contracting business.
Construction Bonding Types:
- Bid bonds get your foot in the door by allowing you to bid on bonded jobs! They guarantee your bid is accurate (so make sure it is!) and that the bonding company will provide a performance & payment bond if you are awarded the contract.
- Performance bonds are what guarantees your work to the owner. The required "performance" of your work is outlined in writing in the contract.
- Payment bonds guarantee that you'll pay all sub-contractors, laborers, and suppliers.
- Maintenance bonds provide a warranty on your work for a specific amount of time after the work is complete.
- Supply bonds ensure suppliers deliver materials according to their contract.
Construction Surety Bond Process: Step-By-Step
Check the job specifications to see if there are bond requirements (public projects usually have them).
Obtain a bid bond from your bond agent and submit it with an accurate bid proposal.
Provide your bond agent the bid results, whether you won or not (frees up your bond line).
If awarded the project, request a performance bond from your bond agent.
Complete the work in full (you are responsible for claims).
Once the project is done, close out the job by telling your bond agent it is complete to free up your bond line.
A maintenance bond is occasionally required after you close out the job by whoever required the bid and performance bonds; if needed, get a maintenance bond and make any needed repairs while your bond is active.
Construction Bonding Capacity Explained
Bonding capacity (also referred to as your bond line) is the pre-approved dollar amount of contract bonds that you qualify for. Your single limit is the largest bond you can get for a single job. Your aggregate limit is the total amount of bonded work on hand you can have at once for several projects. Learn how choosing the wrong construction bonding company can limit your bond lines.
Remember, active jobs count against your bond line whether you are awarded projects or not, making it important to tell your bond agent the results of every job you bid on.
A Simple Bond Line Example
Let's imagine you have a $500,000 over $1,000,000 bond line. The $500,000 single limit would allow you to work on jobs no larger than $500,000. Your $1,000,000 aggregate limit would allow you to work on two jobs of $500,000, four jobs of $250,000, eight jobs of $125,000, etc. at the same time.
Strong Financials Will Increase Your Bond Limits
When a surety company is considering writing a performance bond, your financial statements will be reviewed to help them determine how you handle your obligations and whether you are able to handle projects that come along with a larger bond limit. Your financial statements must show sufficient working capital, cash flow, equity and profit for a surety company to increase your bond limits.
When providing your financial statements to a surety company, it's highly recommended that you work with a construction CPA, as they know the industry inside and out and will be able to present your company appropriately when attempting to increase your bond limits.
Crawling with Construction Bonds Before You Run
Build Strong Foundations with Smaller Construction Bonds and Jobs
When you get construction bonds such as bid and performance bonds for a public job, you are responsible for the project's completion. If you don't complete the job according to the contract, a claim can be filed on your bond which you're ultimately responsible to pay. After all, the bonds are guarantees from a surety company that you will complete the job properly, which is why you should avoid getting in over your head by bidding on larger projects that you're not yet qualified to work on.
If you are a contractor with a new business, the surety company will likely limit you to bonds for only smaller contracts (about $350K and under). The bond limit is for your own protection since your company doesn't have a proven track record of an ability to complete larger projects. Also, you don't have to obtain CPA prepared financials for smaller jobs, which often cost thousands to have prepared and can be tough for a new business. Start with smaller jobs to gain the proper experience and allow yourself to get familiar with the entire process, from bidding on jobs to completing projects, while developing a strong relationship with the surety company.
Strengthen Your Experience and Surety Relationship, Get Bigger Bonds
Once you have the proper experience, a track record of completed projects under your belt and have built up your relationship with the surety company, you can start bidding on larger projects (about $350K+). Your relationship with the surety company is important because when they provide you bonds for public construction jobs, they are extending a form of credit to you. As mentioned above, the bonds guarantee you'll complete the project according to the contract. If you default or perform faulty work and cause claims, the surety company will pay them at first. However, they will come back for you for reimbursement. Building a strong relationship with the surety company is vital to both your company's and the surety's success.
Working on bigger jobs usually increases your company's overall profit, which makes getting the CPA prepared business financials that are required for larger bonds less of an issue as it often is for smaller or new contractors.
Bonds for Your Contractor License
Contractor license bonds are required by most states for contractors to get their license. These bonds guarantee you'll pay any claims in full that you may cause by not operating your contracting business professionally.
Developer Bonds For Subdivisions
Subdivision bonds allow developers to make improvements on public property such as roads, sewers and sidewalks. They guarantee the improvements will be done properly.
Do You Need A Subdivision Bond?
The local government will tell you if a bond is needed to perform improvements or additions after you present your site-improvement plans.
Types of Work Construction Bonds Can't Be Used For
Most surety companies in the U.S. won't provide construction surety bonds for certain lines of work; some examples include:
- Overseas projects
- Jobs on Indian reservations
- Multiyear construction jobs (three years+)
- Private home remodeling projects (unless being paid for by the government)
The majority of U.S. surety companies consider most of these project types too risky to bond. Surety bonds for public construction jobs such as performance bonds are legally binding guarantees provided by the surety company that you'll complete a job according to the contract. If you don't complete the project properly, a claim can be filed which the surety will pay initially. However, you're ultimately responsible to pay the surety company back for claims. In short, bonds for construction projects protect taxpayer's dollars.
With projects overseas and Indian reservation construction jobs, most U.S. surety companies will not consider writing surety bonds to guarantee their completion because the laws differ from state and Federal laws. Since the surety bond is legally binding and the surety company is first on the hook to pay bond claims, they don't want to take the chance of providing surety bonds in a region where they're unfamiliar with the law and risk non-payment of claims.
Also, multiyear construction contracts that last for three or more years are too risky for surety companies as they are unable to determine whether a contractor will still qualify to perform the work that far down the road. For instance, if a contractor defaults on another project while also working on a three year job, it could cause them to go bankrupt, which means the contractor wouldn't be able to finish any other jobs they were working on.
Getting construction bonds for private home remodeling projects will be impossible, not because they're too risky for surety companies, but as a result of being private jobs. As mentioned above, surety bonds for construction jobs protect the public and are used for public projects. It's possible to get surety bonds for private home remodeling jobs that are being paid for by the government, e.g. the government stepping in and paying for projects in a particular state where a hurricane caused significant damage to homes.
Performance bonds for public construction projects guarantee your performance on the project, but they are different from financial guarantees. Financial guarantee bonds ensure that payments will be made for things such as building leases or sales tax revenue. If bonds for construction projects simply guaranteed that payments would be made, more surety companies may consider writing bonds for the types of work mentioned above; however, the risk is far greater.