The term bond - brings to mind an investment that returns interest income to the investor. But there are other types of bonds that have nothing to do with investing; they relate to business operations and function much like insurance. Understand what a bond is, when it's required in your business, and how to get it.
What are business bonds?
Bonds, in the business context, are like insurance. They back up a promise to do something; if the promise is breached, the bond pays off to complete the promise.
Common bond-types are:
- Fidelity bonds that provide insurance against loss from employee misconduct, such as theft or embezzlement, which is not otherwise covered by a compan's regular insurance coverage. A bond can provide blanket coverage for the actions of all employees or can be tailored to cover one or more specific employees (as is the case with a pension fidelity bond discussed below).
- Surety bonds, which are contracts involving three parties: the party required to perform (called the'principa'), the party for whom the work is being done (called an'oblige'), and the party who insures the action of the principal (called the'suret'). If the principal fails to perform a job covered by the surety bond or otherwise causes damage or loss to the obligee, then the surety pays the bond amount to the obligee, who can then use the money to complete the job with another company.
When do you need bonds?
Depending on the type of work your business conducts or for certain other business-related activities, you may want or need to obtain a bond.
Contract surety bonds. If you are a contractor, manufacturer, or supplier, you may be contractually obligated to maintain a surety bond to guarantee your performance. For example, if you are a paving contractor and bid for the paving at your local town hall, typically you are required as part of the bid and contract process to obtain a surety bond that will pay the municipality if you fail to complete the contract. The municipality can then use the proceeds to pay another contractor to finish the job.
Business services (fidelity) bonds. If you have employees working on customer' premises, this type of bond will provide coverage for employees' fraudulent or dishonest acts. For example, if you have a cleaning service, this bond will reimburse you if your employee steals from a customer. You can then use the proceeds to reimburse your customer.
Fidelity bonds for pension plans. If your business has a defined benefit (pension) plan, you are required by tax law to have a fidelity bond equal to at least 10% of the assets. The maximum bond required is $500,000 ($1 million if the plan holds employer securities). No deductible is allowed in the bond and it must be in the name of the plan or trust (not the employer), or the bond must specifically state that the plan or plans (by name) are covered and that the general bond deductible doesn't apply per ERISA requirements. The bond protects against dishonesty by those handling the company's pension plan.
Tax bonds. If the IRS has placed a tax lien on your property, you can get the lien released by posting a bond; the release is made within 30 days of IRS acceptance of the bond. This type of bond is not commonly used, however, because most businesses subject to a tax lien use funds to pay down (or off) the tax debt that triggered the lien rather than to obtain a bond.
How do you get bonds?
Bonds are obtained through surety companies or bonding agents that function much like insurance companies.
Special surety bond programs. The U.S. Small Business Administration's Office of Surety has special programs--Prior Approval or SBG Program, and the Preferred or PSB Program”that provide government guarantees of privately issued bonds for qualified small and emerging businesses. A bond is obtained from a surety company, but is guaranteed by the SBA, inducing the company to give a bond to a business that might have a poor track record or is new with no track record. The Office of Surety has a list of approved companies that businesses can use for the programs. An application for a bond under these programs can be made electronically.
What do bonds cost?
There is no fixed rate for bonds. There are many factors that impact cost, such as the extent of coverage, whether there is a deductible (if allowed), and the surety company that issues the bond. As a rule of thumb, a fidelity bond can cost about ½% to 1% of the coverage obtained, so a $1 million bond would cost $10,000. The range for a performance bond generally is ½% to 2% of the contract amount, so a bond for a construction job of $1 million could be up to $20,000.
Because surety and fidelity bonds are a risk management tool, it is helpful to discuss your business needs with your insurance agent. He or she can then refer you to a surety company when traditional insurance won't provide the protection you want or need.
Barbara Weltman is an attorney, author of several business books including J.K. Lasser's Small Business Taxes, and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and her monthly e-newsletter Big Ideas for Small Business®; both are available at www.barbaraweltman.com, and host of Build Your Business Radio. Follow her on Twitter at twitter.com/BarbaraWeltman.