License bonds
Many states and municipalities require contractors to post a license bond. Underwriting is usually simpler and often focuses on the owner's personal credit.
Bid, performance and payment bonds
A bid bond guarantees the contractor will sign the contract if it wins. A performance bond guarantees the work will be completed under the contract. A payment bond guarantees subcontractors and suppliers will be paid. Public projects commonly require performance and payment bonds above certain contract sizes.
For contract bonds, sureties look at the contractor's financial statements, work in progress, experience with similar projects and bank relationships. Larger programs use a bonding line with single-job and aggregate limits.
Federal and public work
On federal construction contracts, the Miller Act requires performance and payment bonds on contracts above the threshold set in the Federal Acquisition Regulation. Most states have similar laws, often called Little Miller Acts, for state and local public projects, each with its own threshold. Because public owners cannot be subject to mechanic's liens, the payment bond gives subcontractors and suppliers a way to be paid.
Building bonding capacity
Sureties extend credit based on what they call the three Cs: character, capacity and capital. In practice that means a clean payment history, experience on jobs of a similar size and type, and working capital and net worth that can carry a job through slow payment. Contractors who want larger bonds usually move from compiled to reviewed or audited financial statements prepared by a CPA familiar with construction accounting.
A work-in-progress schedule shows each open job's contract value, costs to date, estimated cost to complete and billing. Sureties use it to see whether jobs are profitable and whether the contractor is overbilled or underbilled.
Documents a surety may ask for
- Year-end and interim financial statements
- Current work-in-progress schedule
- List of completed projects with owners and contract sizes
- Bank line of credit details
- Resumes of key staff
Frequently asked questions
Is a performance bond the same as insurance?
No. It guarantees the contractor's performance to the owner. If the surety pays, it expects the contractor to repay.
How does a subcontractor claim on a payment bond?
Each bond and statute sets notice deadlines. Subcontractors and suppliers should read the bond and the governing law early, because missing a notice date can bar a claim.