What You Should Know About Performance Bonds

In the construction industry, performance bonds serve as a guarantee that the contractor will finish the project correctly and satisfactorily. As a contractor, you must knozw the details about performance bonds as you protect your business.

What is a Performance Bond?

A performance bond is issued by your insurance company or a bank and guarantees to the project owner or manager that you will meet your contractual obligations. You’ll need to put up real estate or another investment as collateral.

After you purchase a performance bond, you’re ready to complete the construction project. If you don’t follow through on your commitment, the bond company pays out the bond, and you must repay the bond company.

Who Needs a Performance Bond?

Contractors who perform private sector or government work need a performance bond for each project. It ensures that contractors do the job right and don’t waste taxpayer money.

Documents Required to Request a Performance Bond

Insurance and bond companies require different types of paperwork depending on the cost of the project and its difficulty. In general, you will need to assemble the following documents before you request a performance bond.

  • A copy of the contract

  • Completed surety application

  • Detailed CPA-prepared financial statements from the past two years

How Much Does a Performance Bond Cost?

Performance bonds cost a percentage of the contract value. For large projects, the percentage is usually one percent. Smaller contracts may require a bond of as much as three percent.

Your creditworthiness, type of job and state in which you live also affect the bond’s cost. You’ll add its total cost to your project bid.

What Happens After the Performance Bond is Cashed?  

When you don’t complete your contractual obligations, the project manager can file a claim against the performance bond. The bonding company will evaluate the claim. If it’s legitimate, the company will pay the bond amount to the project manager. Remember that the contract for each project must be specific. A vague contract with terms that are open to interpretation could void the performance bond.

The only person who can receive the performance bond payment is the property or project owner.  With that bond money, the project manager can pay to complete the project or hire a replacement contractor who will finish the job properly.

If the bond company pays out a claim, you are responsible to repay the debt. You can cover the cost with your collateral or another form of payment.

Performance bonds protect project owners and ensure they receive quality work as outlined in the contract. Before your next bid, be prepared with a performance bond.
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