Why Surety Bonds Can Prove Crucial for Start-Ups

Surety Bonds
Start-Ups and Surety Bonds

Entrepreneurs generally have a mile-long checklist in the build up to launching their new venture.

But one item in particular routinely fails to make the cut: Surety bonds. And that can prove a painful omission depending on your industry and your overall financial profile.

In short, surety bonds are like a form of credit.   For many entrepreneurs, surety bonds will be a key part of the state licensing process. Posting a surety bond gives the state and taxpayers a degree of financial protection “” these risk-mitigation tools provide consumers an avenue of financial recourse if you fail to follow all applicable laws and regulations.

If consumers are harmed, they can file a claim against the bond and seek to be made whole. This is infinitely easier than filing lawsuits and fighting things out in court. A host of common industries require surety bonds, including:

  • Mortgage Brokers
  • Durable Medical Equipment Providers
  • Health Clubs
  • Travel Agencies

Why They’re Important

There are dozens and dozens of others. Even if your start-up doesn’t need bonds to get off the ground, they’re still a good idea that can set you apart from competitors. Consumers take notice when the phrase “licensed and bonded” appears on the business card for your home repair or grass-cutting service.

Just about anyone can patrol a neighborhood with a mower and a gas can. But obtaining a surety bond for your grassroots start-up says a lot about your professionalism and financial health. Given the economic events of the last 18 months, consumers are looking for all the protections and guarantees they can get.

Companies can also protect themselves by purchasing surety bonds. Accounting and research-and-development outfits often purchase Employee Theft Bonds, which provide financial protection in case one of their employees steals physical or intellectual property or otherwise violates laws or regulations.

How Surety Bonds Work

These are basically three-way agreements among a surety (either an insurance company or independent surety agency) a principal (the employer, individual or company performing work) and the obligee (the project owner, often a state agency).

Here’s a basic example: In most states, you have to post a surety bond if you want to start a business as a notary public. The state agency that handles your license (typically the Secretary of State office) acts as the obligee. You file your bond with that office along with paperwork seeking a license. If you somehow harm a consumer or fail to fulfill your legal duties as a notary public, affected parties can file a claim against the bond. The surety company ensures that valid bond claims receive necessary compensation, either by compelling the notary or covering the compensation itself (and then seeking to recoup funds from the notary later).

Purchasing Surety Bonds

Surety companies and insurers utilize an underwriting process when evaluating bond applications. They will scrutinize an applicant’s finances, credit and other key issues before making a decision. Some bonds are more easily obtained than others.

Costs can vary based on a host of factors, including the type of the bond and your financial state. Expect to pay a premium anywhere from 1 to 3 percent, although the rates can climb significantly higher depending on the bond and on your financial profile.

Start-ups can sometimes face higher costs for certain types of bonds because they lack a substantial track record and financial history. Remember that rates change, and that shopping around for the best deal is always a good idea, especially for entrepreneurs.

Chris Birk

Chris Birk is a former newspaper and magazine writer who now works for a pair of Inc. 500 companies, including military home-buying hub VA Mortgage Center.com. He also teaches at a private Midwestern university. Follow him on Twitter.