Surety Bond Basics for Young Entrepreneurs

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As a young entrepreneur, you might feel overwhelmed when you think about the various laws and other industry regulations your new start-up will have to follow. Keeping track of legal requirements is hard enough, not to mention understanding the purposes they actually serve. Surety bond requirements are one such legal stipulation that young entrepreneurs often know little about. To help you on your way, this article will give you a brief and relatable explanation of surety bonds.

To put it simply, surety bond insurance guarantees that a job will be performed as expected. Unlike traditional insurance policies, surety companies do not anticipate financial losses when issuing bonds. As such, surety companies are selective when issuing bonds, whereas insurance companies accept most anyone.

Surety bonds work as three-party agreements that involve a business professional, an entity requiring a bond and a surety bond company.

1. The business professional, which is recognized as the bond’s “principal,” promises a job or service will be performed according to expectations.
2. Before issuing a business license, a state agency might require the business owner to get a surety bond. This entity is known as the “obligee.” The bond protects the obligee from taking on costs at the expense of the principal.
3. Finally, the surety bond company, simply called the “surety,” issues a bond to the principal. By financially backing the principal’s promise, the surety works as a kind of reference for the principal. If the principal fails to fulfill the expectations laid out in the contract, the surety takes on the financial losses.

The bonding process is a complicated business in itself. It becomes even more confusing when you consider individual state requirements, surety company expectations and individual applications. As a college student, the simplest way I can explain the bonding process is by comparing it to leasing an apartment.

When applying to lease their first apartments, most college students haven’t established credit and other credentials to convince landlords that they’ll pay rent on time each month. So, landlords require young lessees to provide co-signer agreements signed by the tenant (in this case, the student) and a reliable co-signer who has relatively good credit (likely a parent or guardian). A typical co-signer form states that the co-signer will assume responsibility for the tenant’s shortcomings if he or she fails to pay rent or otherwise breaks the lease — which typically means covering the incurred costs.

This is similar to how surety bonds work. Imagine the principal promising to fulfill a task is the student signing a contract. The surety would be the parent who backs the promise with a contract, but a surety bond is used rather than a co-signer form. By requiring the bond, the obligee is like the landlord. The contract keeps the obligee from taking on financial losses caused by the principal because the surety agreed to take on those unexpected costs.

However, a surety company does not simply issue bonds and run the risk of financial loss without collateral. When applying for a surety bond, the principal must pay a premium. The premium is essentially a service charge for issuing bond. If the surety has to pay for the principal’s shortcomings, the principal will be expected to repay the surety — just as a parent might expect a child to repay them for bailing them out of financial trouble.

Although the business of surety bonding can be a tad overwhelming, it’s easier to comprehend when put in terms of more familiar territory. Comparing surety bonds to leasing an apartment helps simplify surety bond basics.

Jessica LeMay is principal at SuretyBonds.com, a nationwide surety producer that helps new business owners fulfill licensing requirements every day. Jessica is currently pursuing a degree in journalism, so shewrites about topics that help entrepreneurs make the most of their ventures.

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