Bonding for Small Businesses

Bonded and insured. You’ve probably seen this phrase printed on business cards and in online and newspaper advertisements for all kinds of businesses, ranging from tree trimmers and locksmiths to commercial painters and janitorial services. But what exactly is bonding? And is getting bonded something that’s critical for your business?

A bond is a type of guarantee that usually provides a way to recoup losses. There are a number of different types of bonds that serve various purposes. The following are the main types a small business might use.

Commercial Bond

In many industries, commercial bonds are legally required before a company can operate a business. These industries typically include travel agencies, car dealerships, collection agencies, gyms and health clubs, and telemarketing firms, to name a few.

Also referred to as license or permit bonds, these bonds help prevent consumer fraud by keeping unscrupulous and unqualified businesses out of the marketplace. They are obtained by businesses from their state or local government, which verifies that the business is operating in compliance with its industry’s specific regulations.

Surety Bond

The purpose of a surety bond is to ensure that contracted work is performed according to agreed-upon specifications. There are three participants to the agreement: the principle, or the company that is contracted to perform the work; the obligee, or the entity for whom the work is being performed; and the surety, which is providing the bond.

A surety bond is purchased by the principle on behalf of the obligee. If the principle fails to complete the work per the terms of the contract, or causes any kind of damage or loss while performing the job, the surety will pay the amount of the bond to the obligee. Construction, maintenance, information technology, security and alarm, and janitorial companies often must purchase surety bonds in order to be considered for jobs, especially government contracts.

While the surety is usually an insurance company, a surety bond is not insurance; rather, it is a form of credit in which the principal is responsible for reimbursing if any claims arise as a result of not abiding by the terms of the bond. The alternative to a bond would be to post cash or secure a letter of credit. Bonding is generally preferable though because it typically requires no collateral, thus freeing up capital for other more productive uses.

Fidelity Bond

Fidelity bonds are more similar to insurance policies because the principal, rather than the obligee, is the beneficiary of the bond’s proceeds.

There are two types of fidelity bonds. One protects employers from employee fraud and embezzlement, while the other protects employers from theft committed by employees while they are performing work on a customer’s premises. The former will reimburse a business if an employee is convicted of fraud or embezzlement, while the latter will enable the business’s customer to recover claims if the business’s employee is convicted of theft or other wrongdoing.

One common example is a janitorial services bond, which provides protection for customers of cleaning businesses whose employees have easy access to their customers' assets and personal belongings. Similar types of bonds are available for other businesses whose employees perform work on their customers’ premises, such as computer repair consultants and commercial painters.

Tax Bond

This type of bond is used to obtain release of an Internal Revenue Service tax lien placed on a business’s property. The lien will be lifted within 30 days of the IRS accepting the bond. It is typically used by companies that do not have sufficient liquid funds to pay off the tax debt themselves.

Don Sadler is a freelance writer and editor specializing in business and finance.