Editorial Note: We earn a commission from affiliate links on Forbes Advisor. Commissions do not influence the opinions or ratings of our editors.
If your small business involves contracts with customers, you may need to have a warranty that protects your customer if you do shoddy work. A surety bond can also cover fraud and theft charges committed by your employees. There are several different types of bonds that apply to different types of small businesses, such as maintenance bonds, bid bonds, performance bonds, and payment bonds.
Although not technically insurance, the bond also covers your customer if they claim that your business has not fulfilled its contractual obligations. For example, if your customer says your work was incomplete and inadequate, they can file a claim with the warranty company for the cost of hiring another company to properly complete the work.
How does bond insurance work?
A surety bond is a contract between three parties:
- Director: The business that buys the bond.
- Liable person: The customer who wants the warranty.
- Warranty: The company that guarantees the bond.
If your customer files a claim (such as for poor performance), the warranty company will reimburse your customer and your business must pay the warranty company back.
For example, if your painting business buys a warranty bond at the request of your customer and the customer claims your work was inadequate and shoddy, the customer can file a claim with the warranty company for the cost of hiring another painting company to redo and finish the job. Your painting business will have to pay the warranty company back.
What is the difference between insurance and bond?
Although a bond is not an insurance policy, you may hear the term “bonded and insured.” This refers to two separate things:
- Insured means you have purchased business liability insurance. This is a form of small business insurance that covers your business for accidental property damage and injury to others. General liability insurance claims cover expenses such as medical expenses, repairs to damaged property, and your legal costs if you are sued for a problem that is covered by your insurance.
- Connected means you’ve purchased a warranty to cover your business against claims such as fraud, theft, and incomplete or poor workmanship. Bond claims are paid to your client.
Many large clients require their business partners to be bonded and insured.
What does bond insurance not cover?
Bonds are designed to cover your customer for issues such as incomplete or poor workmanship. Here are examples of claims not covered by bonds:
Advantages of bond insurance
A bond can help increase legitimacy if you have a small business that works for others. It assures clients that the work will be completed and if your work is substandard, your clients will not be left with a large bill for poor work.
Some customers require a guarantee before doing business with you. Without one, you could lose your job.
Categories of bonds for licenses and permits
A license and permit bond is a type of bond that ensures a business adheres to federal, state, and local regulations and industry standards. There are four categories of license and permit bonds:
- Compliance Bonds ensure that your business will operate in accordance with the law. For example, a municipality that requires an electrician to comply with local building codes.
- Financial surety bonds guarantees payment of fees or taxes. For example, a liquor tax bond ensures that state taxes on the sale of alcoholic beverages will be paid.
- Public Protection Bonds protecting the public from financial loss due to fraud and unfair dealing. For example, a mortgage broker’s bond will pay off a customer if their mortgage company fails to provide accurate loan information.
- Public Safety Bonds cover the public against financial loss due to physical damage, such as after-the-road insurance in the event that an oversized or heavy load causes damage on the road. These types of bonds are also called indemnity bonds.
When do small businesses need bond insurance?
Small businesses may need bond insurance for reasons such as:
- Customer requires a guarantee.
- Your industry demands it.
- You must comply with federal, state or local laws.
For example, if you own a cleaning company, a client may require you to have a janitorial bond in addition to your cleaning insurance. Another example would be a license and permit bond in addition to contractors insurance.
Where to get an insurance guarantee
You can purchase small business insurance coverage from:
- Business insurance companies. For example, travelers insurance sells several types of bonds, including bid, performance and payment bonds, as well as license and permit bonds.
- Warranty companies. The Small Business Administration provided this list of guarantor companies. You can also check this list of certified companies from the US Bureau of the Fiscal Service.