Being that bid bonds are required by law for construction projects using tax dollars, no matter if it’s local, state, or federal, it’s important to know how they’re calculated to ensure that you get the size bond you need. While no one can be expected to be an expert in all things related to their business, knowing the basics of bonds and how surety companies go about calculating a bond program can give you a leg up when required to get a bond for a construction bid.
Read below to learn what bid bonds are for, how they’re calculated, and ways to lower their cost.
What is a Bid Bond For?
Bid bonds are a type of surety bond that provide bid security to a project owner. They protect the project owner by providing financial relief if a contractor pulls out after winning the bid, whether by refusing to enter into the contract or failing to provide the other required bonds, like a performance and payment bond. The bid bond also helps the project owner avoid wasting time and money on unqualified contractors by providing assurance that the contractor has already been prequalified by the surety company prior to the bid. When a surety company approves a bid bond, they are saying that they are willing, in good faith, to provide the performance and payment bond if the contractor is low and awarded the job.
When applying for a bid bond, the surety company will need to determine whether the contractor has both the financial capability to complete the construction job and the experience to do so successfully. There are a few factors that surety companies consider that are important for a contractor to prepare for:
- The date of the bid
- Financial resources available to complete the job
- The contractor’s credit score
- How long the company has been in business
- The track record of profitable jobs finished, of similar scope and size
- The labor and equipment available that will help to complete the job in question
Calculating Bid Bonds
The bid bond amount is easy to calculate. As mentioned previously, the bid bond is a form of bid security. The amount of bid security required is determined by the project owner and will be outlined in the bid specifications, typically as a percentage of the total bid amount. It’s common for this requirement to be in the amount of ten percent of the total amount bid. For example, if the bid security is required in the amount of ten percent of the amount bid, and you’re submitting a bid for $1,000,000 for the construction project, then the required bid bond amount would be for $100,000 (which is 10% of $1,000,000). That being said, it’s important to understand that even though the bid bond in this example is only for $100,000, the surety company will underwrite based on the total bid amount of $1,000,000. Therefore it’s also important to make sure you’re positioned for bonding the total amount of your bid, and not just just the amount of the bid bond.
If you need to increase your bonding capacity in order to be able to bond more than just the required bid bond amount, there are several steps you can take to accomplish this, such as:
- Investing in your internal accounting to make sure you have the ability to generate a reliable financial statement and work-in-progress schedule, with job costs that are set up and expensed correctly, and having both revenue and costs posted in the same month they occur. To read more on how to invest in internal financials, we recommend reading here: How Investing in Quality Internal Financials can Increase Bonding Capacity – CSBA
- Strengthen your company’s financials by limiting your fixed asset purchases and keeping earnings within the business. This will give you greater capital to be a cushion during the project.
- Work with a surety expert so you have a specialist that can guide you through the steps it takes to expand your bonding capacity.
- Work with a CPA that is construction-oriented to ensure your financial documentation is accurate and verifiably so.
These are four steps a contractor can take to increase their bonding capacity, therein gaining bid bonds for larger projects. To read more in-depth about increasing your bonding capacity quickly, we strongly encourage you to read here:
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How is Bid Bond Premium Calculated?
Now that you know what a bid bond is and how a bid bond is calculated, you are probably wondering how much it costs. Surety companies do not charge a premium for the bid bond itself, but a premium is charged for the bonds that follow. (Remember, the bid bond is guaranteeing that a contractor will enter into the contract and provide both payment and performance bonds when required, if the contractor is low on the bid and if the contractor fails to do so, then a claim will be filed against the bid bond.) Therefore, you need to be aware of what the cost is for the performance and payments bonds, and factor that cost into your bid even though you won’t be paying for the bid bond.
The premium charge for bonds varies depending on the bond program the contractor has prequalified for, and there are several factors that help determine the cost of the bonds that are within a contractor’s control. The easiest way to lower surety bond premiums is by working with a surety agent who can guide you in taking steps to lower the price. To read more on how to lower bond premiums, we strongly encourage you to read here:
Key to Preparing for
It has been mentioned a few times in this article, but you will need to be able to qualify for more than just the calculated bid bond amount, since the surety company will base their underwriting on the total amount of your bid. This means, you might need to increase your bonding capacity in order to obtain the bid bond, and the best way to do this is with the help of a surety specialist. We at CSBA have over 225 years of combined experience doing just that. Due to our professional exclusivity with surety bonds, we have formed key relationships with surety companies and construction-oriented CPAs to help our clients have a smooth bonding process and win the bids for the jobs they want.
No matter the bid bond calculation, we at CSBA are able to guide you to meet it.
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