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A performance bond is a type of contract surety bond guaranteeing that a business will successfully and ethically complete a service.
As the name implies, it guarantees that projects using contractors, such as construction, are fulfilled according to the client’s satisfaction.
Typically, an insurance company or bank issues performance bonds. They are often included in a construction contract to protect property.
Read on for everything you need to know about performance bonds, including how to get bonded, how much they cost, and their other uses.
What is a performance bond?
In real estate, construction, and other contracted jobs, performance bonds are used to protect the property investor or owner (the obligee) from unforeseen damages or a loss of value. If you’re a contractor or developer of any kind, your clients will most likely require you to procure a performance bond. That would make you the principal in this agreement.
In short, performance bonds guarantee that you finish what you start, and that the client is satisfied with your work. For example, if you’re a contractor on a construction project, your performance bond would legally “bond” you to stipulations in your contract with the property owner. Those stipulations may outline a certain level of quality or a time frame for project completion. No matter what they are, you would be required to provide your clients with a 100% reimbursement if you don’t meet your obligations.
At this point, the surety provider (an insurance company or bank) would pay these costs. In turn, you would be expected to pay back that amount to the provider in full. Performance bonds also cost an annual premium to the provider, which differs in value based on several factors that we’ll discuss later.
How do you get bonded?
To bond with your coworkers, you need team-building activities. To get bonded, you need a surety provider.
You can receive a surety bond from a bank, insurance company, or other financial institution. Normally, they will ask you to provide these items before approving you for a performance bond:1
- Details on the project requirements, like size, risk, and contractor qualifications
- A business plan outlining the project scope
- A copy of your contract with the client
- CPA-prepared financial statements from the past three years
- A completed surety application
Next, we’ll explore what else you can expect when applying for a performance bond.
How much do performance bonds cost?
Most contracted projects involve job bidding, which is the process of pitching your capacity and plans for the job. One contractor team is chosen as the winning bidder to complete that project.2
Due to this process, every project is unique in its requirements and price. Naturally, that also makes the cost of every performance bond unique.
There are a few different ways that you can determine the cost of a performance bond:
- In general, you can expect a performance bond cost valued at 1% of your contract’s value.
- For contracts valued over $1 million, your performance bond premium may depend on your creditworthiness. This can range from 1.5% to 2% of the contract value.
- For specific values outside the norm, contractors will have to provide a thorough record that supports their desired bond amount.
Even though performance bonds seem to cost a lot of money just to protect another party, they present several benefits to the principal (that’s you).
Other uses for performance bonds
On top of construction projects, you can also use performance bonds in commodity contracts.
A commodity contract is drafted between a seller and a buyer. The seller is expected to procure a performance bond to promise that they will deliver an item or items being sold. If these commodities are not delivered, the principal is obligated to compensate the buyer for any monetary losses related to the failed delivery.
Performance bonds don’t just protect second parties from low-quality work. They also cover them in the case of a contractor’s insolvency or bankruptcy. If a project is left incomplete due to any of these situations, the client is entitled to monetary compensation.
While this may seem like an imbalance of protection in favor of second parties, this type of assurance encourages property owners to hire contractors. Performance bonds offer them peace of mind.
As the winning bidder, when you set up a new construction contract, you can include contract surety bonds for your clients and discuss your contractual obligation. Keeping your clients zen is a massive sales win and can contribute to additional contracts.
Insurance is a performance bond’s costar
When it comes to protecting your business, performance bonds don’t act alone. They share the stage with insurance. Performance bonds, while vital to your credibility with clients, should not be the only form of coverage you pursue.
Performance bonds protect your clients (the obligee) from damages or unfulfilled contractual obligations by the contractor (you, the principal). They don’t protect you from the costs associated with these damages. While there are many benefits to procuring a bond for your contracts, you shouldn’t start a project without insurance coverage.
But as a small business owner, it may seem like insurance is too pricey and inflexible to purchase on top of a costly performance bond.
That’s why you need Thimble. Thimble arranges small business insurance coverage that works when you do. We offer coverage that’s affordable, flexible, and convenient. Simply click “Get A Quote” or download the Thimble mobile app, breeze through a few details about your business, and we’ll generate a quote in minutes.
From there, you can purchase with one last click and receive your Certificate of Insurance (COI) immediately in your email inbox. We can send you as many COIs as you need at no additional cost.
Performance bonds let you perform at your best
Performance bonds put your clients or buyers at ease, boost your credibility, and allow you to navigate the tough world of contracting a bit easier.
Don’t neglect these contractual stars when going into projects. While they benefit your clients, they can also help keep you accountable as you pursue your best work.
As a business owner with a passion for quality, commitment, and hard work, performance bonds can only help you. Just remember: to stay fully protected, you’ll want to invite insurance to the stage.