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An Introduction to Surety Bonds

Small business owners are faced with many of the same challenges, obstacles, and business process requirements as large corporations. They must create a business plan, forecast sales and profit, obtain proper legal advice, secure adequate business insurance, manage accounting and taxes, oversee a workforce, and more. But one requirement that is unique to some businesses is a surety bond.

What is a Surety Bond?

Surety Bond Definition: The definition of a surety bond is as follows: A surety bond is a binding agreement between three parties. This agreement sets forth a financial guarantee by one party ( "surety" ) to another party ( "obligee" ) that a third party ( "principal" ) will fulfill required obligations to the obligee, and that state, federal, and local laws and applicable regulations will be adhered to. Let's examine each of the three parties.

- Principal: This is the business owner that is required to present the bond. This might involve a specific project (as is the case in contract surety bonds) or it might be a stipulation for doing business in a particular state (as is the case with commercial surety bonds).

- Obligee: This party is the one requiring the surety bond to begin with. In the case of a construction project, this would be the project owner. For commercial bonds, this is typically a municipality such as state, county, city, with states being the most common type of obilgee in commercial surety bonds.

- Surety: The surety is typically an insurance company that will issue the surety bond to the in exchange for a premium payment, which is much like a standard insurance premium. They are most concerned with determining the risk associated with the agreement. Credit worthiness of the principal is one of the main factors they use when determining the risk, and thus the premium.

Who Needs Surety Bonds?

While the most common form of surety bond is used for construction, there are many types of surety bonds available for a large variety of business and industries such as medical suppliers, mortgage and insurance brokers, auto dealers, health club owners, Notaries Public and more. Surety bonds can be a critical part of the success of any business owner as they help protect public and private investments by providing a secure foundation.

A surety bond is not a form of insurance but rather a financial guarantee or form of credit. This is an important distinction in the definition of a surety bond. The specific type of surety bond is defined by what it guarantees, but essentially all bonds guarantee the fulfillment of a legal obligation between three parties and are designed to protect these parties from financial loss. Additionally, businesses and industries purchase surety bonds to guarantee their customers are protected in the event of contractual problems or default. If a valid claim is made, the surety company will either reimburse the customer or make good on the contract.