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What Every Contractor Needs to Know About Construction Bonds

Brad Ballew
Published May 29, 2024

Success is never a sure thing in the construction industry. As a contractor, you buy insurance to protect your business from all the risks that can come your way. Naturally, project owners want to protect themselves too, which is why they might ask you to provide a construction bond before you can come on-site.

As a surety professional, I work with a lot of folks who know they need bonds but aren’t sure how they work, or how to get the best rates. To help answer some of the most common questions I get, I’ve put together this guide. 

If you’re unsure about what construction bonds are, or why you need them, keep reading.

Key Takeaways


  • Construction bonds protect project owners from things like bad work, nonpayment, company default, and warranty issues.
  • Larger projects will almost always require bonds, especially for public works projects.
  • The surety company you work with wants to see a clear history of performance and accountability from your business. Basically, they want to see how trustworthy you are.

What Are Construction Bonds & How Do They Work?

Construction bonds (also known as construction surety bonds or contract bonds) protect project owners from losing money on a build. Basically, they’re a form of risk management for whoever’s funding a job, whether it’s an individual owner or a public entity like a local government. They act as a ‘guarantee’ that a construction company will fulfill the terms of the contract. Like a mechanics lien, bonds are a protective tool.

Bonds cover everything from bad workmanship on construction projects to warranty issues. In the extreme case that your construction company defaults, the bond will also protect against this.

There are three parties to every bond:

  • The principal is the general contractor or subcontractor purchasing the bond.
  • The surety company offers the bond for the job. If the project isn’t able to be completed, they’re responsible for covering that financial loss. The company may hire new contractors to finish the project, or they may just pay the owner for any damages incurred.
  • The obligee is the person or business protected by the bond. If something goes wrong on the job, they can file a claim to the bonding company to make sure the project is completed.

Now, here’s the thing: There’s a big misconception that bonds protect contractors. Unfortunately, that’s not the case. So if you’re wondering, what’s in it for me?, the answer is, frankly, nothing - at least, on the surface. But if you want to take on larger, more profitable projects, you’ll have to have bonds. And if you haven’t encountered them in your business yet, you will sooner rather than later. 

What’s the Difference Between a Construction Bond & Insurance?

construction bonds vs. insurance

While traditional insurance and construction bonds both offer financial protection, they function in very different ways. Insurance covers everything. On the other hand, construction bonds are job-specific. One contract = one bond. 

Unlike construction insurance, which you’re pretty much required to have for any job, not all construction projects will require bonds. Another big difference is how losses are treated. Your insurance company expects to take some losses throughout your policy term - that’s why you pay them monthly. Surety companies give out bonds with the expectation that there will be no losses. If a contractor defaults or doesn’t fulfill the construction contract, that means we haven’t done a good enough job vetting that company - and we have to pick up the pieces. It’s a worst-case scenario.

When Do You Need a Bond?

Not every project will require a bond. Smaller projects that don’t carry as much risk might not require them. Larger projects will almost always require you to purchase a bond. Large projects mean more complexity and more parties working together on the ground - which inherently means more risk. It comes down to the risk appetite of the owner, but you can generally expect this to be the case.

Usually, the general contractor is responsible for getting a bond, but if you’re a subcontractor in a more risky trade or working on a scope that’s high-risk to the overall project, you also might be required to purchase a one. In some cases, the GC could provide that bond to you, or you might have to go through the process of getting one yourself. 

If you’re a GC working on a project funded by public money, like a local government project, The Miller Act requires you to have a payment and performance bond (more on the different types of surety bonds later). These bonds must have a value equivalent to the contract price. 

How To Get a Construction Bond

When it comes time to get a bond, you’ll work with a surety company to purchase one. Here’s the kicker though: you can’t just walk into a bonding company’s office and walk out with a bond. You have to submit a bond application and qualify, which means there’s some underwriting that we have to do to assess your risk. It’s kind of like applying for a mortgage at the bank. 

There aren’t specific financial requirements you have to meet - bonds operate on a case-by-case basis. Underwriters will take a look at documents like your financial statements and WIP reports to get a sense of your financial position, along with your organizational strengths and weaknesses. We’ll also sit down with you and get a feel of your personality. While the financial side is important, a lot of what we’re looking for boils down to:

  • Are you trustworthy?
  • Do you seem like you have good character?
  • Are you experienced enough to know what you’re doing?

Our job is to look at the evidence and decide whether or not we think your company can complete the project the bond is provided for. We want to work with good people we can trust, so if you come in with a great attitude and sense of responsibility, that’s one box already checked. 

How Much Does a Bond Cost?

Unlike the insurance premium you pay monthly, bonds are a one-time purchase, and the rate you pay is based on the total contract amount. Different states have different methods, but in my state, those rates are set by the department of insurance. Where you work will determine both your base rate, and if those rates fluctuate based on job performance, etc.  

The bond you buy will cover a project’s full contract amount. For instance, if a contract is worth $1 million, the bond amount will also be $1 million.

10 Types of Construction Bonds You Might Encounter

There are a lot of different types of construction bonds, but the main three you need to be familiar with are payment, performance, and bid bonds. 

1. Payment bond - A payment bond guarantees that the GC will pay all subcontractors and vendors for their labor and materials. These bonds are designed to protect project owners, but also extend protection against nonpayment to subs and suppliers.

2. Performance bond - As the name sounds, performance bonds guarantee that the contractor will perform the work as laid out in the contract. If the contractor doesn’t deliver quality work, disregards the contract terms, or defaults, the owner can make a claim to the surety company.

3. Bid bonds - Once you’ve entered the bidding process for a job, owners want to know that you’ll follow through. Bid bonds guarantee that the principal contractor has the capacity to finish the contract as bid.

It also doesn’t hurt to be familiar with these other types of bonds: 

4. License & Permit Bonds - Certain cities and jurisdictions require you to obtain specific licenses or permit bonds. While they’re called ‘bonds’, they’re closer to insurance, and they’re not hard to get. For example, in my city, you have to get a $50k general contractor’s bond to be able to work.

5. Maintenance & Warranty Bonds - These bonds are common if you’re working on public/federal infrastructure. They guarantee that there will be no issues or defects with your work for a specified length of time.

6. Mechanics Lien Bonds - If a contractor or supplier has filed a mechanics lien on a property, a mechanics lien bond removes that claim on the property and attaches it to the bond.

7. Subdivision Bonds - If you’re working in a subdivision, you might be required to buy a subdivision bond. These guarantee that you’ll make improvements (things like electrical upgrades, etc) to the subdivision as reflected in your contract with the local jurisdiction.

8. Supply Bonds - On large projects that require a lot of materials, a supplier may provide a supply bond to the GC or owner. If the supplier defaults, this protects them.

9. Completion Bonds - Similar to performance bonds, completion bonds reassure owners that a project will be finished on budget, on time, and without liens. The difference here is that completion bonds cover the entire project, not just a specific contract.

10. Retention Bonds - These bonds replace retainage on a project. By offering this bond, you would be able to get your full progress payment each pay period, without anything being held back for retainage. If you’re looking to maximize cash flow, this could help you save a lot (depending on the price of the bond).

What Happens If There’s a Claim Against a Bond?

A bond is an agreement. If that agreement is broken, then things escalate. For example, a lower-level subcontractor could make a claim against a GC’s payment bond saying they were not paid for their work. The general contractor would receive a notice informing them that someone has made a claim. They’d need to either provide evidence of previous payment or pay the subcontractor what they’re owed to avoid further investigation/escalation by the surety company. 

Tips From a Surety Professional 

If you called up my office today asking about bonds, here’s the advice I’d give you. 

Have a clear business model - We want to see that you have strong internal operations and controls from the job site to the back office. If you can tell us where your business is today, where you want it to be in the next 5 years, and outline the steps you’re going to take to get there, that’s perfect. Essentially, we want to know if you have a plan.

Show performance and accountability - Does your plan have any weight behind it? If you’re coming in for your first construction bond, we want to see you follow through on the steps you’ve outlined to us. We’re going to check in on your balance sheet, P&L statements, and WIPs to see how the project is progressing throughout the year. For longer projects, you’ll also need a CPA to prepare a financial statements once a year. 

Be easy to work with - We’re human. If you come in with a friendly attitude and a willingness to learn, we’ll get along just fine. 

At the end of the day, we want you to succeed, because when you’re successful, we’re successful. But to get that first bond and establish a good working relationship, we want to make sure you’re trustworthy.

Wrapping Up

I get it - no one wants to spend more money than they have to to run their business. That’s a sentiment I encounter every day from contractors who’ve just put in their first bond application. If you want to grow your construction company in the long term though, you need to get comfortable with bonds. Larger projects bring more profit, but they also carry more risk to everyone involved. If you’re going to take on these kinds of projects, you have to help shoulder some of that risk. 

 

For surety bond services, get in touch with Brad and his team at Ballew Surety Agency. 


Author
Brad Ballew

Born and raised in Austin, TX, Brad Ballew is President of Ballew Surety Agency, Inc.

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