License bonds and surety bonds for contractors

How a bond differs from insurance

Every surety bond has three parties. You, the contractor, are the principal. The obligee is the party protected, such as a state licensing agency, a city permit office or a client who hired you. The surety is the bonding company that guarantees you will meet the obligation. If you fail and the obligee makes a valid claim, the surety pays and then turns to you for reimbursement under the indemnity agreement you signed when the bond was issued.

That repayment promise is the key difference from insurance. Insurance spreads losses across many policyholders and expects some claims. A surety expects no losses and underwrites you the way a lender would, looking at credit, finances and track record. Owners who treat a license bond as a kind of insurance are often surprised when a claim payment shows up as a debt they owe, sometimes with personal liability if they signed the indemnity personally.

The bonds service contractors run into

Most residential service work only ever touches the first two rows. Bid, performance and payment bonds become relevant when a company starts bidding schools, municipal buildings, housing authorities or large commercial maintenance contracts. SBA groups these as contract bonds: bid, payment, performance and ancillary bonds. It guarantees contract bonds but not commercial bonds such as license bonds^[2]. With 521,315 specialty trade contractor establishments competing for work in 2023^[4], a bond requirement also narrows the field, which is one reason bonded public and commercial work can be worth the paperwork.

When a license bond is required

Requirements vary widely. Some states require a bond for every registered contractor, some only for specific trades, and some leave it to cities or counties, which may require bonds before issuing electrical, plumbing, mechanical or right-of-way permits. Washington is a clear example: registration requires a $30,000 bond for general contractors and $15,000 for specialty contractors, along with liability insurance, and the state says these rules exist to protect the public^[1].

Washington also notes that a registration can be suspended for an unsatisfied judgment^[1]. That is the practical risk of a bond claim: it is not only the money but the license status that keeps your trucks working. Before you apply, ask the licensing office four questions: the bond amount, the exact obligee name, the required bond form and whether the bond must run continuously or renew each year.

• Check state, county and city rules separately; a state bond rarely satisfies a city permit bond requirement.
• Use the agency's own bond form if it has one. Sureties know most of them.
• Keep the bond in force for as long as the license is active; a lapse can suspend the license automatically.
• Record the bond number, amount and renewal date in the same calendar as your license and insurance renewals.

How bond pricing works

The bond amount and the bond premium are different numbers. The amount is the maximum the surety may pay, set by the obligee. The premium is what you pay the surety each term, normally a percentage of the bond amount that depends on your credit, financial strength and experience. Small license bonds are often written quickly with a credit check. Contract bonds involve full underwriting: financial statements, a schedule of work in progress, bank references and resumes of key people.

For firms that cannot get contract bonds on standard terms, SBA's Surety Bond Guarantee program backs participating sureties on contracts up to $9 million for non-federal work and $14 million for federal work. The guarantee fee is 0.6% of the contract price for performance and payment bonds, there is no SBA fee for bid bond guarantees, and SBA returns the fee if a bond is cancelled or never issued^[2].

What underwriters look for

Sureties often talk about character, capacity and capital: whether you pay your obligations, whether you can do the work, and whether you have the money to finish if something goes wrong. Time in business is a big part of that judgement, because many firms do not last. BLS tracking of private establishments that opened in March 2015 shows 79.6% still operating after one year, 50.2% after five years and 34.6% after ten^[3].

• Clean books: accrual-basis statements, ideally reviewed or audited by a CPA once you seek larger contract bonds.
• Working capital and a bank line that can carry a job if a client pays late.
• A record of similar jobs completed on time, with references.
• Personal credit for owners, since smaller firms are underwritten partly on the owner.
• No unresolved liens, judgments or license complaints.

How to get bonded

1. 01

   Confirm the requirement

   Get the bond amount, obligee name and form from the licensing office or the bid documents.

2. 02

   Use a surety agent or broker

   Agents who specialize in contractor bonds work with several sureties and know which ones write your trade and size.

3. 03

   Prepare your file

   For a license bond, expect an application and credit check. For contract bonds, prepare financial statements, a work-in-progress schedule, bank and supplier references and a list of completed projects.

4. 04

   Read and sign the indemnity

   Understand who is personally liable and what collateral the surety may demand if a claim is made.

5. 05

   File and calendar

   File the bond with the obligee, keep a copy with your license records and set a renewal reminder well ahead of expiry.

Questions to ask a surety agent

1. Which sureties do you place contractor bonds with, and which write my trade and size?
2. What will the premium be for this bond amount, and how is it calculated?
3. Does the indemnity agreement require personal indemnity from owners and spouses?
4. What financial statements will you need for contract bonds, and at what level of CPA work?
5. What single-job and aggregate bonding limits could I expect after the first year?
6. Do you work with the SBA Surety Bond Guarantee program if I need it?

If someone files a claim on your bond

Respond quickly and in writing. The surety will ask for your side, documents and a plan. Often the cheapest outcome is to resolve the underlying dispute directly, finishing the work, paying a supplier or settling with the homeowner, before the surety pays and comes to you for repayment plus costs. Ignoring the surety rarely makes a claim go away and can lead it to pay a claim you could have defended.

• Send the surety your contract, change orders, photos, invoices and correspondence within the deadline in its letter.
• Explain any defense clearly: work was completed, the client changed scope, or the supplier was paid.
• If the claim is valid, ask whether you can fix the work or pay directly, which usually costs less than repaying the surety later.
• Tell your license bond agent before renewal; an open claim affects your next bond and its price.

Example: a first performance bond

Example (fictional): a 14-person electrical contractor that mostly does residential service wants to bid on lighting upgrades at three public schools. The bid requires a bid bond and, if it wins, performance and payment bonds. Its license bond agent cannot place contract bonds, so the owner moves to a contract surety specialist, has the CPA prepare reviewed year-end statements and lists five comparable commercial jobs with references. The surety offers a modest single-job limit and suggests the SBA guarantee program because the company is new to bonded work. The company wins one of the three schools, finishes on time, and the surety raises its limit the following year.