Bid bonds and performance bonds explained

Bid bond

Guarantees that if you are awarded the contract, you will sign it and provide the required performance and payment bonds. If you win and walk away, the owner can claim the difference between your bid and the next bidder's, up to the bond's penal sum.

Amounts differ sharply between federal and state practice, and this trips people up. At state and local level, bid security is typically 5 or 10 percent of the bid amount, and is often accepted as a certified or cashier's check instead of a bond. Federally, FAR 28.101-2 sets the bid guarantee at "at least 20 percent of the bid price" with a $3 million cap, a materially different instrument that exists to cover the cost of re-procurement.

Bid bonds usually carry no premium. Sureties issue them as part of the relationship, on the expectation of writing the final bonds if you win.

Performance bond

Guarantees you will complete the contract per its terms. If you default, the surety's options usually include financing you to finish, tendering a replacement contractor, or paying the owner its loss up to the penal sum. Almost always written at 100 percent of the contract value on public work.

Payment bond

Guarantees your subcontractors and material suppliers get paid. It exists because you cannot lien public property. Nobody is foreclosing on a school. The payment bond is the substitute remedy. Federally, FAR 28.102-2 requires the payment bond to equal 100 percent of the original contract price, plus 100 percent of any increase.

On public work these are usually issued together as a single performance and payment bond with two penal sums.

The others you may meet

• Maintenance or warranty bond: guarantees workmanship for a defined period after completion, commonly one to two years, typically 10 to 25 percent of contract value.
• Supply bond: guarantees delivery of materials under a supply contract.
• License and permit bonds: required by a state or municipality to hold a contractor's license, unrelated to any specific project.

The federal Miller Act gets all the attention. It is not the law that applies to your city paving job. Every state has its own "Little Miller Act" setting when public bonds are required, and the numbers vary widely.

California. Civil Code § 9550 requires a direct contractor awarded a public works contract "involving an expenditure in excess of twenty-five thousand dollars ($25,000)" to give a payment bond before commencing work. That is a low bar, and it means bonding is in play on very small California public jobs.

Florida. Section 255.05 of the Florida Statutes requires a payment and performance bond on public construction, but with meaningful exemptions: for state work, no bond is required where the contract is for $100,000 or less, and local officials or boards may exempt contracts of $200,000 or less at their discretion. Florida also sets tight claim deadlines. A claimant's notice of nonpayment may not be served earlier than 45 days after first furnishing labor or materials, nor later than 90 days after final furnishing, and suit on the payment bond must be brought within one year.

Federal. For comparison, FAR 28.102-1 implements the Miller Act requirement for performance and payment bonds on any federal construction contract exceeding $150,000. Between $35,000 and $150,000 there is no automatic bond. Instead the contracting officer selects two or more alternative payment protections from a list that includes a payment bond, an irrevocable letter of credit, a tripartite escrow agreement, certificates of deposit, or a security deposit, and the contractor supplies one of them.

Two practical points. First, the threshold in your state may be far lower than the federal one, so "I am too small for bonding" is often wrong. Second, non-construction service contracts (janitorial, landscaping, security, food service) are frequently bonded too, by contract term rather than by statute, so read the solicitation rather than assuming. See how to get school district janitorial contracts, how to get government landscaping contracts and how to get government security guard contracts.

Bid bonds: usually no premium.

Performance and payment bonds: quoted as a rate per thousand dollars of contract value, and typically land in the range of roughly 1 to 3 percent of the contract amount for standard-market contractors, on a sliding scale that drops as contract size increases. A strong contractor with audited financials and a long clean record may be quoted below 1 percent on larger work; a new or thin-balance-sheet contractor in a specialty program may be quoted 3 percent or more.

The important budgeting point: the premium is a direct cost of the job and belongs in your bid. On a $1.2 million contract at 2 percent, that is $24,000 you either priced or absorbed. Public owners expect bond cost to be in the price; some solicitations ask you to list it as a separate line item.

The SBA Surety Bond Guarantee Program

If the standard market will not write you, the SBA guarantees bid, performance, payment and ancillary bonds issued by participating sureties. The program covers contracts up to $9 million for non-federal contracts and $14 million for federal contracts. The small business pays SBA a fee of 0.6 percent of the contract price on performance and payment bond guarantees; SBA charges no fee for bid bond guarantees, and the guarantee fee is returned if the bond is canceled or never issued. That fee is on top of the surety's own premium, so budget both.

For a contractor with two or three years of history and no bonding relationship, this is the most common route in. Work through an agent who writes SBA-backed bonds regularly. Not every agent does.

Sureties underwrite on what the industry calls the three Cs: capital, capacity and character. In practice you will be asked for a package that looks like a commercial loan file.

• Financial statements. Two to three years. Internally prepared may be enough for small single jobs; a review or audit by a CPA who understands percentage-of-completion accounting is generally required as you scale. This single item is the biggest constraint on capacity growth for small contractors, and it is worth the cost of a proper CPA long before you think you need one.
• Work-in-progress schedule. Every open job: contract value, billed to date, cost to date, estimated cost to complete, gross profit. Sureties read this more carefully than the balance sheet, because it reveals whether you estimate accurately and whether you are over- or under-billed.
• Working capital and net worth. A common rule of thumb is that a surety will support a single job roughly ten times working capital and an aggregate program roughly twenty times. That is a guideline, not a rule, and every surety applies it differently.
• Bank line of credit. An unused, committed line materially improves your position.
• Personal credit and personal indemnity. Owners' personal credit is checked. Owners (and usually their spouses) sign a general indemnity agreement making them personally liable to reimburse the surety.
• Experience. Completed project history of comparable size and type. A surety will rarely bond a job several times larger than anything you have completed.
• Continuity plan. Who finishes the work if the owner is hit by a bus. Sureties genuinely ask.

Set the relationship up before you need it. A first-time bond approval takes two to four weeks. Once you are approved with a program in place, a bid bond for a specific job can often be issued in a day or two. Chasing a surety the week a bid is due is how firms end up no-bidding work they could have won.

Capacity is granted in steps, and the steps are predictable.

1. Get your books right. Move to a construction-literate CPA and to percentage-of-completion accounting. Stop taking distributions that strip working capital at year end. Retained equity is exactly what the surety is measuring.
2. Open a bank line and leave it unused. The availability is the point.
3. Start with an SBA-backed small program. A single-job limit of $250,000 to $500,000 is a realistic first approval for a contractor with a clean two-year record.
4. Bid work inside your limit and finish it clean. Completed, on time, subs paid, no claims. Two or three of these change the conversation.
5. Ask for an increase with evidence. Updated financials, a clean work-in-progress schedule, and owner letters. Capacity typically increases in increments rather than jumps.
6. Graduate to the standard market. Once you are outside SBA's program you drop the 0.6 percent guarantee fee and get better rates.

Two shortcuts while you build. Subcontract to a bonded prime. You gain public project experience and references without carrying the bond, though the prime may require a subcontractor bond from you. And target unbonded work: quotes below the state competitive threshold, service contracts that require insurance but not bonding, and cooperative contract purchases. See RFP vs RFQ vs IFB vs ITB for where those live and how much does it cost to bid on a government contract? for how the economics compare.

• Submitting a bid bond without the power of attorney. The bond must be accompanied by the surety's power of attorney showing the attorney-in-fact had authority to sign. Missing it is a classic responsiveness defect that gets bids rejected at opening. See how to respond to an RFP.
• Wrong penal sum. If the solicitation says 10 percent and the bond says 5 percent, the bid is non-responsive.
• Wrong obligee name. The bond must name the awarding public body exactly as the solicitation states it, not the department, not the abbreviation.
• Expired validity. Bid security must remain valid through the bid validity period, often 60, 90 or 120 days. Check the dates on the bond against the solicitation.
• Not confirming the surety is acceptable. Many public bodies require the surety to be listed on the U.S. Treasury Department's Circular 570 list of approved sureties, to be licensed in the state, and to hold a minimum A.M. Best rating. Check before, not after.
• Forgetting the premium in the price. On a low-margin bid, an unpriced 2 percent bond premium can be the whole profit.
• Assuming service contracts are unbonded. Multi-year janitorial, landscaping and security contracts frequently carry a performance bond requirement by contract term.

If bonding capacity is the thing keeping you out of the work you want, it is worth mapping which opportunities in your market fall below the bonding thresholds while you build. Book a call and we will go through it.