By Melanie Baravik

Business ownership is both rewarding and challenging, and starting from scratch is full of uncertainty. The licensing process often presents countless questions and a laundry list of costs for new entrepreneurs. Surety bonds are a common component of business licensing, but many first-time entrepreneurs don’t know about them and are surprised by the sudden extra cost for something they’ve never heard of. Knowing what surety bonds are and the purpose they serve before you embark on your small business journey can alleviate stress on your startup capital and more importantly, yourself.

What is a surety bond?

In proper terminology, a surety bond is a contract between three parties. For a business license and permit bond, the three parties are as follows:

  1. Principal – you, the business owner purchasing the surety bond
  2. Obligee – the entity requiring you to purchase the bond, usually the government
  3. Surety – the company backing the bond, providing its line of credit

In simpler terms, these types of surety bonds act as a promise that the business is following their city, state, and federal government’s legal requirements for their particular type of business. In the event that the business does do something wrong, the bond is in place to protect the customer from financial loss or damages. If a business violates the rules and regulations they’ve agreed to and it results in a loss for the customer, the customer can file a claim against the business’ surety bond. If the claim is validated, the surety will pay out the customer’s claim up to the full amount of the surety bond. The business owner must then reimburse the surety for the full claim amount.

Who needs a surety bond?

Surety bonds are required for many types of businesses, including these common industries:

  • auto dealers – new and used
  • cleaning businesses
  • businesses selling alcohol or lottery tickets
  • health clubs
  • contractors
  • telemarketers

If your business license requires you to be bonded, the bond type will usually be specified in the form provided by your licensing department. If you’re unsure about what bond you may need, this interactive map can help you find what your state requires. Then, contact a surety bond provider to answer your questions and walk you through the bond application and purchase process.

How much do surety bonds cost?

Surety bonds will cost a varying percentage of the full amount of the bond coverage. The premium (or cost you pay) ranges anywhere from 2 percent to 10 percent of the bond’s amount required. Premiums are determined by the surety provider based on factors like your credit score and the risk factor of your business.

What do surety bonds do for me?

Surety bonds often help lend credibility to your small business as well as build trust in your customers. Because you’ve posted the bond and are being held accountable for your business practices, customers will see you as the credible, dependable option. Businesses can also benefit from bonds that aren’t required: for example, cleaning companies often purchase business service bonds to deter employee theft from clients. Being able to label your business as “properly bonded” can help potential customers determine that you’re the right choice. They’ll feel both confident in your abilities and satisfied that they won’t suffer any financial loss at your hands.

Surety bonds are a common piece of the business startup puzzle. As an industry professional, doing your homework and staying on top of your legal obligations will keep business running smoothly, all the way to success.

Melanie Baravik is part of Outreach Team.