Working in construction is no walk in the park, and plenty of things can go wrong. Whether you’re a contractor, investor, or owner, one small mistake can be disastrous in the world of construction. One way to counteract the unpredictable and fickle nature of construction is through insurance and surety bonds. Surety bonds have become a widespread practice in construction and for good reason.
Whether you’re looking to start your own construction company, or you’re curious to learn about the industry and bonds, you’ve come to the right place! Here’s everything you need to know about surety bonds and why they’re so important in the construction industry and projects. Read on to learn more about these interesting bonds and the crucial part they play in the topsy-turvy world of construction!
What is a surety bond?
Before getting into the details of why they’re so important in construction, it’s important to understand what surety bonds are first. First, a surety bond is a contract where a company promises to pay the owner of a project if the contractor taking out the bond fails to meet demands. Any surety bonds, whether in construction or not, involve three parties: the principal, the obligee, and the surety.
The principal is the contractor, person, or company that needs to uphold a standard or agreement. The obligee is the project owner who needs the guarantee and the surety is the issuer of the bond. Ultimately, the bond payment responsibility falls on the obligee, who will also reap the rewards. It’s important to mention that a surety bond, while it may provide financial security and assurance, is not a financial bond.
Surety bonds help to transfer the risk of a typical, tricky construction job. This happens when one party guarantees to another that a third will uphold the contract. Depending on what you’re looking for, there are many surety bonds available to construction companies and clients alike. Performance bonds are a specific type of surety bond that is an example of a more detailed agreement.
Why construction contractors need surety bonds
Now that you’re all caught up on the details of the agreement, it’s time to see why they're so popular in construction! Construction work is a risky business, and there are many reasons why surety bonds are a good move. Here are the main reasons why surety bonds make up such an important part of construction work.
One of the main reasons why construction companies and contractors use surety bonds is because of financial security. There’s no shortage of financial risks in construction especially when it involves other parties. Surety bonds help to bridge the gap and protect companies, investors, and contractors. They keep them safe from financial ruin should a party not obey or uphold the contract.
These bonds help establish small businesses and help them carve a name for themselves. Surety bonds ensure that workers and employees still get paid should a contractor back out or not fulfill their end of the deal. Surety bonds also have many traits of bank credit and can help keep these construction companies afloat during the project.
Lower costs of construction
Aside from offering more financial security, surety bonds also help to reduce the cost of construction. Whether you’re constructing a shed or a duplex, construction projects can get pricey. With every delay or mistake, the project gets more and more expensive. If not planned for well, these setbacks could use up all the funds for your project and stop it in its tracks. Surety bonds help to keep the peace and keep the project going while lowering costs.
The specific agreed-upon terms of the surety helps to keep all parties focused on the project at hand. Through competitive bids, surety contracts are also able to keep costs low in some cases, as an added bonus. Keeping costs low in construction is all about careful planning and fund allocation, which is exactly what surety bonds are all about.
Protection and reputation
In today’s modern and uncertain world, the best way for a company to protect itself is through a surety bond. Before getting approved, the contractor or company will need to be examined. They will need to go through a rigorous pre-qualification process. During this, the company’s financial statements, loan agreements, and credit history will be evaluated and looked at.
After passing the evaluation, the company's credibility to perform the contract is solidified. This then becomes a sign to other contractors and competitors that this company means business. Your construction project and business as well as reputation can skyrocket with the help of a properly executed surety bond. This will help you continue to grow and amass more clients in the future based on your success.
Another reason why surety bonds are so important in construction is because of the nature of the industry. In an industry as big as construction with many big companies at play, foul play can be quite common. Many large companies, with ulterior motives, can take advantage of a construction project to the detriment of others. From fraud to money laundering to simple fund diversion, there’s no end to foul play in construction.
Surety bonds help to keep these practices out of the equation and help keep things more honest and transparent. With the right contract, the possibility of contractors diverting money from the project at hand disappears. With the addition of a surety contract, the owner can also air complaints and grievances to the surety with ease.