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Free-up your capital
Surety bonds are an effective alternative to bank guarantees and retention monies, with many benefits for building contractors.
Building contractors are increasingly turning to surety bonds as a financing option alternative to bank guarantees and retention monies. The purchase of surety bonds from a bond provider (usually an insurance company) can deliver many benefits for business operations, such as cash flow advantages and freeing up working capital.
Surety bond facilities are available for a broad range of project types and are an accepted form of security by most contract principals including local, state and federal government departments.
What you need to know
What are surety bonds?
Surety bonds provide protection to the contract principal against default by the contractor. A bond is an undertaking by the bond provider to the principal that the contractor will perform in accordance with the terms and conditions of the contract.
The bond is issued in favour of the principal and the contractor pays the premium applicable to the bond provider. Once a surety bond is issued it is irrevocable by the bond provider, who is then committed to pay should the contractor default. In the event of a claim being paid under a surety bond, the bond provider will seek recovery from the contractor through a deed of indemnity.
In essence, bond providers undertake the credit risk of being unable to recover funds paid out by them under the bond from the contractor.
Why use them?
Surety bonds can be a valuable alternative to bank guarantees or cash retentions and an effective way of increasing a contractor’s capital base. Unlike bank guarantees that are supported by collateral and tie up valuable working capital or other assets, surety bond providers evaluate the performance risk of the contractor and the contractor’s ability to complete the works.
A premium is paid by the contractor to the bond provider on the amount of the bond issued, instead of the contractor incurring alternative costs, such as those associated with bank overdraft facilities.
Bond and contract types
There are a number of different types of bonds available, depending on the particular requirements of the contract conditions.
The type of bond could be in the form of:
- Advance payment.
Advantages of using bonds
Some of the advantages of using surety bonds, compared to traditional bank guarantees and cash retentions or deposits, include:
- No tangible security or collateral required, thereby freeing up assets for other purposes (such as business growth or procurement of additional working capital)
- Improved liquidity
- Bonds enhance working capital by not having to use established credit lines for contingent liability purposes
- A bond facility will allow the contractor freedom to submit tenders, without the restrictions or limits imposed by banks
- Contractors only pay for the bond limits used, not the whole facility
- Bids may be viewed more favourably, as the contractor’s financial status has been independently assessed by a third party (the bond provider) who is willing to issue to the principal a written unconditional guarantee of the contractor’s ability to perform the contract.
General minimum underwriting criteria
- The Company must turn over at least $50m per annum
- The Company must have a minimum net tangible worth of $5m
- The Company must have Positive cash flow/Positive working capital
- The Company must have at least 3 years of continuous trading profitability.
In addition to the operational benefits of surety bonds, the premium payable in most cases is more competitive than bank guarantees when the total cost is taken into account.