The Industrial CapitalistA surety bond is a guarantee from a third party, the surety, that a contractor will do what the contract requires. If the contractor fails, the surety steps in to finish the job or pay the loss, then pursues the contractor for it. Bonds are required on almost all public work and much private work, and a contractor’s bonding capacity is one of the hardest limits on how big it can grow.
The three main bonds
- Bid bond. Guarantees that if the contractor wins, it will sign the contract and provide the other bonds. It keeps bidders honest.
- Performance bond. Guarantees the work will be completed according to the contract. If the contractor defaults, the surety arranges completion.
- Payment bond. Guarantees that subcontractors and suppliers are paid, so they cannot lien a public project.
How capacity is set
A surety underwrites a contractor much as a bank does: financial statements, working capital, experience, backlog, and the owner’s personal finances, because owners generally indemnify the surety personally. The result is a single-job limit and an aggregate limit. Capacity grows with retained earnings, clean job records, and a good accountant. It shrinks fast with a bad year.
Why it matters
A contractor with strong crews but thin capital will hit its bonding ceiling before it hits its ability ceiling. Building capacity is a deliberate, multi-year effort that decides what work a company can even bid on.
Related terms: prevailing wage, personal guarantee.