Tech companies have proliferated over the past few decades. While they used to carry a fair degree of risk for surety companies, many tech companies have become established players, making it easier for them to secure surety bonds. A surety bond may be a good way for tech companies to guarantee that they will perform their commercial obligations under a contract instead of relying on letters of credit or other methods. If you are a tech entrepreneur with a startup company, here are some things about surety bonds to consider.
What Are Surety Bonds for the Tech Industry?
What is a surety bond? Many tech entrepreneurs wrongly believe that surety bonds are a type of insurance. They are not. Getting a surety bond means purchasing one from a surety that guarantees you will perform as promised under your contract. Instead of protecting you from liability, surety bonds protect the businesses or entities with which your company signs contracts. If you fail to perform as promised, contractors can file claims against your surety. However, the surety company that issued the bond is only a secondary party, which means you will be required to pay any valid claim filed or risk losing your surety bond. Surety companies can also pursue legal action against your company for unpaid claims and seek to recover the reimbursements they are owed.
What Are the Parties Involved in Surety Bonds?
Surety bonds are legally enforceable contracts. When you get a surety bond, you will be required to sign an indemnification agreement. A surety bond involves three parties, namely:
- Principal: The company seeking a surety bond.
- Surety: The surety company issuing a surety bond to guarantee the principal’s performance.
- Obligee: The party requiring the principal to secure a surety bond.
In the surety bonds of tech companies, the obligee can either be a governmental agency or company with which the tech company pursues a contract. For example, tech companies that want to bid on government contracts may be required to secure bid bonds to guarantee they can handle the contract if it gets awarded to them. Tech companies that contract third parties to perform services or goods may also be required to secure surety bonds to guarantee they will perform as promised in their contracts.
Does the Tech Industry Require Surety Bonds?
In some industries, entrepreneurs and startups are required to secure surety bonds as part of getting licensed. While tech companies are generally not required to get surety bonds, certain types of bonds can still be relevant for them. For example, any tech company that wants to secure a government contract will have to secure a contractor bond to bid on the project and start work. That may be relevant for companies that want to secure contracts to replace or upgrade a government agency’s computers. Other situations may also require guarantees of performance through private contracts to perform services or provide technological equipment.
Surety bonds are required in many industries. Some examples of industries that require surety bonds are:
- Medical equipment providers with Medicare contracts
- Construction companies with public project contracts
- Car dealers and dealerships
- Notary publics
- Travel agencies
- Mortgage brokers
- Debt collection agencies
What Is Involved in Getting a Surety Bond?
If you are required to get a surety bond to secure a contract for or bid on a government project, the process is similar to applying for business credit. The surety company will want to understand your business and its financial state before it agrees to issue a surety bond. You will need to gather some documents to apply for a surety bond, including:
- Business plan
- Financial statements
- Organizational chart of your company
- Resumes of key players
- Most recent business and personal income tax returns
- Bank letters or statements
- Personal financial statements of major shareholders
- Certificate of insurance
Surety companies need these and other documents to evaluate the risks that issuing surety bonds to guarantee the work the principals will provide pose. You can contact a surety company, complete the application, and submit your supporting documents. The surety company will then complete the underwriting process before agreeing to approve your surety bond application. If you get approved, you will have to sign an indemnification agreement and pay an upfront premium.
What Factors Are Considered in Surety Underwriting?
Surety companies want to ensure that the companies they issue surety bonds for will not pose undue risks. As a result, a surety company will want to evaluate your credit record, available working capital, experience in performing similar projects, and reputation and moral character before agreeing to approve your request for a surety bond.
Before you get approval, the company will want to see that you have sufficient working capital to perform the work stated in your contract and pay any claim that may be filed against your surety. Surety companies also want the principals they issue bonds to to have good credit and experience in performing similar projects. Finally, your history and character are important. If you have a history of unpaid claims and a bad reputation within your industry and among your former clients, it will be difficult for you to secure a surety bond.
How Much Does It Cost to Get a Surety Bond?
The cost of a surety bond will depend on the maximum bond amount, size of the project, and factors considered during the underwriting process. You will be expected to pay a percentage of the total bond amount upfront. If your company has a great reputation, substantial experience, strong working capital, and excellent credit standing, your premium may be as little as 1%. In contrast, if the surety determines that you pose a higher risk but still agrees to issue a bond, you may expect to pay as much as 15% of the bond amount upfront.
While most tech companies are not required to get surety bonds, more companies are turning to them. If you do decide to get a surety bond to secure contracts that guarantee your performance, you will need to make sure that you gather the correct documents. Finally, if you get a surety bond, you need to make sure to avoid claims by performing your contractual obligations.