This post is meant for the emerging contractor who is starting to bid on larger projects to build a portfolio of successful projects.
Let's go over the construction surety bond process at a high level while still covering important bond details you should know about.
When you're starting to bid on larger projects that require bid and performance bonds, these construction surety bonds can seem like an inconvenience or hassle.
However, you'll quickly realize these bonds are a major key in growing your construction business the smart way.
Why Are Construction Surety Bonds Important?
Construction surety bonds along with other forms of insurance allow every party to manage risk.
From a surety bond perspective, most construction projects, both public (government owned) and private, will use surety bonds to manage the risk of getting a project to completion.
For you as the contractor your ability to obtain surety bonds will:
- Let you bid with confidence on the projects that match your company's growth
- Allow you take on multiple projects at the same time
- Open up a path for you to secure lower bonding rates saving you substantial money
When you're able to secure lower rates this lets you be more competitive with your bids or straight up increase per project revenue.
Of course there is a lot that goes into construction projects.
And in a big way, these surety bonds are your company's growth lever.
What Are The Main Construction Surety Bonds?
I am just going to mention these and give you the links so you can dig into the details yourself.
Bid Bonds
A bid bond protects a project owner from a construction company that wins a project and either:
- Refuses to take on the project
- Or can't secure the performance and payments bonds
Click here to learn more about bid bonds.
Performance Bonds
A performance bond is used to protect the project owner from the worst case scenario of the contractor being unable to complete the project.
Click here to learn more performance bonds.
Payment Bonds
A payment bond is used to protect both the project owner, but primarily subcontractors and material providers from not being paid by the general contractor.
Click here to learn more about payment bonds.
Retainage Bonds
Payment retainage is a large part of any construction project. A retainage bond is optional but it can unlock cash and give you the cash flows you need to complete a project or bid on a new project.
Click here to learn more about retainage bonds.
Bidding On A New Construction Project
This process is going to be high level. There are many circumstances that affect a construction project. And every project has its own challenges.
Once you construct your bid package for a project, you likely will have to purchase a bid bond.
During this process you'll also get approved for the performance and payment surety bonds.
Remember, the bid bond not only ensures you as the contractor will complete the project if you win it.
But it also ensures that you'll be able to secure your payment and performance bonds.
This is why getting approved for your performance and payment bonds is so important. You will know, if you win the project you can have these bonds immediately issued and begin work.
That is exactly what project owners are looking for.
The cost of a bid bond is effectively zero. For some contractors, we will charge a small $100 fee that is applied to your performance bond if you win the project.
Construction Bonds During The Construction Phase
As far as the primary performance and payment bonds during the construction project, you really should not have to worry about these.
It goes without saying that you don't want to put the project in a position where you can't complete it or you can't pay for the materials to get the project done.
But there are project circumstances that will affect your performance bond.
Project Change Orders
Every construction project will likely have some change orders that change the scope of the project.
This matters because at the end of the project the performance and payment bonds need to be reconciled with the final project totals.
For example, if the original project amount of $500,000 and you completed an additional $80,000 of work for the project, the surety company that underwrote your performance and payment bond will require you to pay the premium on that additional $80,000.
But this also works in the other direction.
If you complete the project and it comes in $80,000 less than the initial $500,000 project, the surety will refund the premium you paid on that $80,000.
Retainage Surety Bonds
Throughout a construction project a portion of your payments (5% to 10%) will be subject to retainage. This means the project owner (or even a general contractor) will hold onto this cash.
The reason is to ensure that project punch-list items get completed on time, plus any required administrative paperwork to complete the project is properly handled.
Cash flow is one of the most important factors for a successful project outcome. And the project owner (or a general contractor) using cash retainage limits your available cash flows.
You have the option to purchase a retainage surety bond. This bond unlocks the cash being held and ensures that if you don't complete the project or provide paperwork the project owner (or general contractor) can make a claim against the bond for the financial resources to finish things off.
Again, this is not required, but it might be a strategic option for your business as you begin to take on more construction projects.
Subcontractor And Supply Bonds
While we've focused on these bonds being required by the general contractor (GC) of a project, it's very possible the GC may require subcontractors to provide performance bonds of their own.
This is common on smaller projects (less than $5 to $10 million). On large projects (well over $10 million) it's common for subcontractor default insurance to be used. But this is outside the scope of this article.
There is one surety bond a general contractor may use depending on the project requirements, a supply bond.
The project requires a custom fabrication from a supplier or maybe a more rare material to purchase a surety bond ensuring they will complete their delivery.
This is often required when the specific supply is vital to the project timeline and completion. For example, if a custom fabrication was delivered to incorrect specifications and that would delay the project, the contractor would make a claim for financial compensation to ensure they are not penalized for circumstances outside their control.
Plus general contractors can and often do hold 5% to 10% of subcontractor payments in retainage. This means the option for a retainage surety bond is also available for subcontractors.
Construction Bond Reconciliation
When the project is officially deemed complete, the final project total needs to be reconciled with the current performance and payment bond amounts.
We've already mentioned this when talking about change orders above.
Just to recap, once all change orders have been accounted for, if the project value increases the underwriting surety will require you to pay the premium on the increased amount.
The opposite is true as well, if after the change order has been accounted for, the project value is lower than the original bonded amount, the underwriting surety will issue you a refund for the premium you paid on that overage.
As an emerging contractor, it's important to know that your bond amounts will be reconciled to the final project amount when the project is complete.
It's also important to account for the premium on each change order and work that into the cost. This way, you're effectively working any additional premium into the reconciled cost of the project.
Maintenance or Warranty Period
Most performance surety bonds include a 12 month maintenance or warranty period on the completed project.
This period ensures that in the event of one or more project defects, you will fix the defect within the 12 month period.
Project defects do not include accidents that damage the final project or any natural wear and tear. This is why this period is capped at 12 months.
Project defect can include things like:
- Concrete mixing issues that cause cracks in flooring or sidewalks
- Improperly installed pipe joints that lead to leaks
- A section of roof that was not installed properly
Keep in mind for public (or government owned) projects, they typically require a separate surety bond called a maintenance bond for this purpose.
The primary reason would be a warranty period that lasts longer than one year.
It's important to understand that even though your performance bond remains "active", once the project is complete the project amount will be restored to your available bond capacity. This will allow you to improve your rate structure or bid on another project.
How To Start Growing Your Construction Portfolio
This was a high level overview of the surety bonds and their roles in a construction project.
Every project is slightly different, but when it comes to each surety bond's purpose, that does not change.
For an emerging contractor the key is to have an aggregate limit of bonding capacity that fits where your business currently is.
This is what we can help you do. We are Surety Bonds Direct and we want to be your construction bond producer by first getting you approved for up to $3 million in aggregate bonding capacity.
Think of this as a pre-approval for the construction bonds you need to bid on, win, and complete to grow your business.
Once approved for a monetary limit that suits your business's experience and goals, all you have to do is submit the project contract to have the required bonds issued.
- This gives you more confidence to bind the right jobs
- It lets you manage manage multiple jobs at the same time
- And it shows project owners your company has the backing needed to be successful
When you're ready to get approved for your first construction bond capacity limit, complete a quote request and tell us about your business or call a bond specialist today at 1-800-608-9950.
We will help you get approved for a limit that matches your business goals.
