The surety world can be confusing for contractors as there are many kinds of bonds you’ll be faced with in order to bid on public construction projects or when required for private ones. It’s easy, especially when newer to obtaining a surety bond, to mistake one kind of bond for another type of surety bond.
As part of CSBA’s commitment to helping California contractors understand more about the bond process and surety bonds in general, this article will focus on a common area of confusion:
To begin, we’ll describe what each term means and the process to be issued one before comparing and contrasting them.
What are Surety Bonds?
A surety bond is often an essential part of construction projects funded by tax dollars, but it isn’t unusual for a surety bond to be required for private construction jobs either. A surety involvesa three-party agreement that legally ties together the principal, an obligee, and a surety company. Each role is often as follows:
Principal: This is an individual or business that has purchased the bond to guarantee to another party (the obligee) that they will complete the task, payment or service in question.
Obligee: This is the entity that requires the bond, such as a government agency or general contractor. The principal has a contractual obligation to the Obligee.
Surety: The surety company that is responsible to step in and fulfill the obligation if the principal fails to do so.
In general, the surety bond guarantees that the principal party will fulfill the obligations of the contract and if they do not, the obligee can claim on the bond to make the surety company step in and fulfill the obligation. There are several types of bonds, but the three most common ones a contractor will be required to get are:
The process a contractor must go through to be issued any of the surety bonds above are very similar but the focus may be more on one factor instead of another, depending on the type of bond you’re seeking from a surety company. If you click on any of the above types of surety bonds, you’ll see the individual process for each and have access to frequently asked questions contractors tend to have about each surety.
What are Surety Performance Bonds?
A performance bond is a specific type of surety bond that guarantees to the project owner, or obligee, that the contractor’s work will meet their contractual obligation. In other words, the work will be completed per the terms and conditions of the contract. If a general contractor is requiring a performance bond from a subcontractor, it’s the same principle, but ensuring that the sub-contractor will fulfill their contractual obligations.
Applying for a Performance Bond: As mentioned earlier, any contractor who applies for a surety bond will go through a very similar process, but the focus may be different depending on the bond need. With this specific bond, a surety company will look at various types of financial records and review the contractor’s business experience.
The specific requirements to be issued a performance bond depends on the size of the bond you need:
- Bonds less than $750,000 can be obtained with a simple 1-2 page application and are more based on the credit of the contractor who owns the construction business and their experience with similarly sized jobs.
- A performance bond that is over $750K and up to $1.5 million requires financial statements from both the contractor’s company and their personal financial statement as well.
- Bonds over $1.5 million often require a financial statement prepared by a CPA with experience in construction accounting and reports that allow the surety company to track the job performance.
A contractor’s past experience is a big factor when working to obtain a performance bond as the surety company wants to ensure they can handle the project.
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Surety Bond and Performance Bond
As you’ve likely gathered, a performance bond is a type of surety. “Surety bond” is a broad term and includes many kinds of bonds contractors may be required to get or require from their subcontractors. While a performance bond is a surety bond, not all surety bonds are performance bonds. and there are several types of surety bonds a contractor will be required to get. You can read more about those differences in the following articles:
It can be tempting to consider surety bonds as an insurance policy, but that is a common mistake contractors make when looking into bonding. To understand better why, we strongly encourage you to read this:
Surety Bond Professionals for California Contractors
The bond process seems simple enough when summarized, but if the requirements aren’t properly prepared or a contractor hasn’t done the internal work necessary to be bonded for a higher amount, there can be a lot of mishaps that extend the application time. This is one of the reasons it’s important to have an experienced surety specialist at your side, to make sure the process goes smoothly and show you how to increase your bonding capacity.
We at CSBA publish these articles for two reasons: to help California contractors develop their financial literacy and to demonstrate our expertise in surety bonds. For over 35 years, we have partnered with contractors throughout California and of different sizes to identify strategies to win bids, tackle bigger jobs, and grow their business as well as their bonding capacity.
If you’re in need of a surety bond, we encourage you to explore the CSBA difference and align with the surety experts in contractor bonding.
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