Obtaining a Surety Bond to Land a Federal Contract
A record number of federal contracts for small businesses are expected to be issued throughout 2023 due to the Infrastructure Investment and Jobs Act. Businesses, however, shouldn’t celebrate just yet –many of them could be excluded from competing for lucrative federal projects due to constrictive bonding requirements.
This was evidenced in 2022 – according to the US Small Business Administration, a record 27.2% of federal contracts, or $154.23 billion, were awarded to small businesses, an $8 billion increase from 2021. While this may seem like good news for Main Street businesses, the number of small businesses winning those contracts dwindled down to just over 71,000 companies from roughly 125,000 just a decade ago, as more well-established companies with greater access to surety bonds were awarded contracts.
The federal government also failed to reach its goal of awarding a certain percentage of those contracts to women- and minority-owned small businesses, as well as small businesses operating in underserved communities. One of the main reasons is that those businesses have a more difficult time in getting approved for and putting up the required capital to purchase surety bonds.
What are Surety Bonds?
When public works projects were created during the New Deal to combat unemployment, the federal government passed the Miller Act in 1935. This is a federal statute that requires companies contracted by the federal government to provide payment and performance bonds to ensure that the government could recoup any losses if the contracted company defaults on its work or goes well over its budget.
Are Surety Bonds Cost Prohibitive?
These bonds are typically equivalent to the value of the contract, and most state governments also require surety bonds for local construction projects. The problem for small businesses is that they are typically required to pay a premium for the bond. While the premium is typically a small percentage of the total amount of the bond, this amount can be exorbitant for small businesses that don’t have a lot of available cash.
For example, if the total value of the bond is $1 million and the upfront cost is 5%, that would be $50,000 that the small business would have to put up. That amount could be prohibitive for small construction companies that already operate on a thin profit margin, especially at a time when inflation and labor costs are rising.
If your company doesn’t have a lot of cash on hand to put up for a surety bond, one possible solution is to establish a line of credit so that your business has money at its disposal to pay for the bond.
You Must Qualify
Most large insurance companies offer surety bonds, and there are hundreds of small companies that specialize in offering them. Additionally, the SBA has a surety bond program for emerging small businesses that may find it difficult to qualify for a bond. Similar to many of its small business loan programs, the SBA doesn’t actually offer surety bonds, rather, it will serve as a guarantor for the bond, thus making it easier for qualifying small businesses to obtain a bond and win a government contract.
Qualifying for a surety bond is somewhat similar to qualifying for a small business loan and can be difficult for small businesses that are newly established or don’t have a long credit history. Bonding companies typically require that:
- The applicant has the capacity to complete the project. This means that the small construction firm has the experience and the know-how to complete the given construction project. If your company is fairly new, you may want to hire workers who have worked on similar projects.
- The applicant has good credit. Doing what you can to improve your FICO score will go a long way towards qualifying for a surety bond. Additionally, being in good standing with a lending institution will help, as bonding companies often require a letter of credit from a bank guaranteeing your financial obligation to the bond.
- The applicant offers a promissory note. If your small business cannot get a letter of credit or has poor financials, the bonding company will often require you to write a personal promissory note guaranteeing the value of the bond.
- The applicant puts up cash collateral. If you have a less-than-stellar FICO score, some bonding companies may require you to put up cash collateral in addition to the premium to help guarantee the bond.
- The applicant can handle the upfront costs associated with the project. Often, the bonding company will require that the applicant have an established line of credit to handle those costs.
Different Types of Surety Bonds
There are several types of surety bonds that companies will have to purchase before engaging in a government construction project, depending on the terms of the contract:
Performance Bonds – Performance bonds ensure that the project owner (the federal or state government) will be compensated in the event that the contracted company fails to meet its expectations. This is the most popular, and most expensive, type of surety bond.
Payment Bonds – Bonds that ensure that workers and subcontractors on a project be compensated.
Bid Bonds – Bonds that ensure that a government agency will be compensated if the winning bidder unexpectedly backs out of the project.
Supply Bonds – These bonds ensure that the contracted company uses the money paid to it to purchase the appropriate supplies and materials to complete the given project. It’s relatively rare, however, that these types of bonds will be required.
If your small business is seeking to compete for a government contract, it’s important to do what you can to ensure that your company can meet the basic requirements of obtaining surety bonds. One of the most important things you can do is to establish a history of completing projects on time and on budget. It’s also important to follow tips on winning government contracts, such as getting your inventory in order and researching contacts at government agencies that may be offering bids on contracts.