The phrase ‘licensed, bonded, and insured’ is used by business owners across many professions—including construction contractors, auto dealers and others—to attract customers and build a sense of trustworthiness.
While licensing and insured are more commonly known terms, you might be wondering, “What does bonded mean?”
Bonded means that a business has obtained a surety bond, which guarantees that a business will meet all their legal obligations. Think of a surety bond as a security mechanism that protects buyers and clients.
Let’s dig into the way bonding works, and why a business might pursue it.
What Does It Mean to Be Bonded?
A surety bond functions as a contract between three parties. The first is the business that is getting bonded, called the principal. The second is the licensing authority that requires the bond, such as the state board of contractors, or the party that can benefit from it, which is the customer or construction project owner. They are referred to as the obligee of the bond. The third party is the surety, which provides the bond and backs the company
If your business has a surety bond, it means that the surety—or bonding company— has secured funds to pay customers who make a claim against your company. However, your business will have to repay the surety soon after. You can think of a surety bond as an extra line of credit—it helps ensure a fast resolution or payment to the customer, but you are still responsible for repaying the surety, as well as any other incurred fees.
Another way to think of it? A surety bond provides extra protection for customers. In essence, it’s a mechanism for risk mitigation. That’s why it’s considered safer to use the services of bonded businesses.
You may need to obtain a bond as a requirement for your professional licensing or for conducting other professional activities. You can also choose to get bonded as a sign of trustworthiness for your business.
The Difference Between Insurance and Surety Bonds
While both insurance and surety bonds are risk-mitigating mechanisms, they function in different ways.
Business insurance protects your company against financial losses. It’s provided by an insurance company that pays the claims.
For example, when you get general liability insurance, you’re protected from financial liability in case of bodily injury or property damage to a third party. Another common type of insurance is workers’ compensation insurance, which is often a legal requirement you have to meet when hiring employees. Motor vehicle insurance and property insurance are also used regularly to provide compensation in the event of damages.
A surety bond, on the other hand, protects your customers from any actions on your side that may cause damages for them. It guarantees that you will follow the law in your work and ensures compensation through claims.
Let’s say that you’re a licensed and bonded contractor. If you behave unethically or fraudulently, a customer can make a claim against your bond. The case is then investigated by the surety. If proven, you owe reimbursement to the claimant. The compensation can be as large as the bond amount you have obtained.
Whether you opt for a surety bond or an insurance policy, you’ll have to pay a non-refundable premium. It’s a small percentage of the bond amount or the insurance coverage.
Premiums are calculated differently for insurance and for bonding. With insurance, factors such as the type of policy, the level of risk that you transfer to the insurance company, and the specifics of your business help determine your premium amount. For surety bonds, your premium is usually based on the strength of your personal and business finances, including your credit score.
When you pay insurance premiums, they work as an investment in a future claim that you may make. In contrast, when you pay a bond premium, it's more like making installments on a credit provided by the surety bond company.
When Is Bonding Required?
Posting a surety bond is a typical requirement for getting a business license in different trades.
For example, construction specialists, plumbers, electricians, auto dealers, and freight brokers typically have to get a license to operate. If this is you, you’ll need to satisfy a list of criteria issued by your licensing authority. Obtaining a bond is among the most common criteria.
Another typical use for surety bonds is for bidding on construction projects. Contractors often have to obtain contract bonds to participate in public and even in private bids and to sign project contracts.
Many businesses choose to get bonded without being legally required to do so. For example, fidelity bonds are rarely required, but companies may choose to obtain them anyway. These bonds protect companies from employee theft and fraud.
Types of Surety Bonds
Commercial bonds and contract bonds are two of the primary bonds you can get for your business. The other common type is a fidelity bond, which works in a slightly different way.
Commercial bonds are commonly known as license bonds. You may need to post them to get a license from city, municipality, state, or federal authorities.
The professionals that often need to get license bonds are auto dealers, contractors, mortgage brokers, freight brokers, collection agencies, and telemarketers, among many others.
Contract bonds are necessary only for construction contractors. If you want to participate in public projects, you’ll need a contract bond. You may also need one for private projects (homeowners might require one, for example).
The goal of a contract bond is to protect the project owner by guaranteeing that you will execute the work as laid out in the signed contract. A contract bond ensures that a project will be completed on time and meet quality standards.
There are a few different types of contract bonds. The main ones are bid bonds, performance bonds, and payment bonds.
- Bid bonds guarantee that a contractor will take on the project if they win the bid.
- Performance bonds ensure the successful execution of a project, protecting owners from incomplete work and issues with quality.
- Payment bonds are a security mechanism for subcontractors and suppliers who work with the general contractors, safeguarding them from non-payment of services and materials.
For small-scale contractors, obtaining the required contract bonds can be challenging. That’s why the Small Business Administration (SBA) provides assistance to through its Surety Bond Program. The SBA helps contractors get bonded, so they can bid on larger projects and expand their portfolios.
Fidelity bonds are slightly different. Business owners choose to obtain them to protect themselves from theft and fraud committed by their employees who work at customers’ locations or handle customers’ property or monies. They can also help protect against employee time theft.
There are a few different types of fidelity bonds. They include:
- Business Service Bonds
- Janitorial Bonds
- Employee Dishonesty Bonds
- Financial Institution Bonds
- Employee Retirement Income Security Act (ERISA) Bonds
Janitorial services, pest control companies, personnel agencies, and financial institutions are some of the typical businesses that get fidelity bonds.
Licensed, Bonded, and Insured: A Winning Step for Your Small Business
Getting your business licensed, bonded, and insured is not only good advertising, but it ensures all-around protection for your business, customers, employees, and third parties.
Licensing is obligatory for many types of professionals. Local, state, and federal authorities use it to ensure that business owners are qualified to conduct their activities. If you have not obtained the proper licensing for your trade, it’s illegal to operate.
Bonding is one of the most common requirements that you have to satisfy to get licensed. As explained in the previous sections, surety bonds usually protect your customers from incomplete or subpar services, non-compliance with applicable laws, fraud, and employee theft. Getting bonded helps prove your trustworthiness to potential customers.
Insurance may or may not be required for your professional license. Auto dealers and contractors, for example, often have to get general liability insurance. Other specialists may not need it officially, but may still want it. Insurance safeguards your business in case of accidents beyond your control. If you end up with a serious liability lawsuit, having the right insurance can save you from bankruptcy.
Need Workers’ Comp?
Managing all the different aspects of a small business can be tough.
Hourly is here to take some of that stress off your shoulders. With Hourly, you can link your payroll to your workers’ comp policy to pay your bill automatically. At the end of the day, you’re going to save money because your workers’ comp will be tied directly to your actual payroll.