Tricia Tetreault

Banks and lenders use the 5 C’s of credit analysis to determine a borrower’s risk and creditworthiness. Some create point systems for each category, while others consider the 5 C's using their subjective judgment during the approval process. Although these characteristics are weighted differently from lender to lender, most use the same aspects to evaluate each category: Character: This measures your reliability and trustworthiness as a borrower. Generally, lenders will evaluate your credit score, credit history, and how you’ve handled your previous and current debt obligations. Capacity: This considers your level of cash flow and measures your ability to repay your debt. Banks and lenders are looking to see if potential borrowers have enough cash to pay back what they borrow. Capital: Lenders evaluate your net worth and equity in comparison to your current debts to gauge your access to capital. The more equity and less overall debt you have, the better. Conditions: Lenders factor in the current economic condition of the industry in which a business operates, as well as how the borrower intends to use the money. They also want to know how a borrower plans on using loan proceeds. Collateral: This is the business and personal assets you can pledge to back the loan. For loans that don’t require collateral, such as an unsecured loan, the other four characteristics will have a higher level of importance. Understanding the 5 C’s of credit and how they apply to a lender’s decision-making process will be helpful as you apply for a small business loan. The stronger your business looks as a borrower, the more likely it is to be approved for a loan. Both your personal and business credit scores often play an important role in a lender's evaluation of your overall creditworthiness. Staying on top of your personal credit scores is easy with a free service like that provided by . If you use for your business checking account, you can access your Dun & Bradstreet business credit score for free. Character: Your Credit History & Background When considering character, lenders analyze both your personal and business credit scores, as they’re a reflection of your borrowing history. These scores are also a part of both your personal and business credit reports, which show factors such as payment history, liens, and credit utilization. Repayment history accounts for 35% of your personal credit score. Beyond your credit, lenders may also look at your reputation, business or personal references, and how you’ve interacted with those references. For example, when applying for a Small Business Administration (SBA) loan, SBA Form 912 is required and helps the lender determine your eligibility based on reputation. Capacity: Your Ability to Repay Debt Capacity to repay debt is important since lenders want to ensure that your business has adequate cash flow to repay the new loan. Lenders generally will evaluate your capacity through these three measurements: Debt-to-income ratio (DTI): This is a measurement used for individuals that evaluates the percentage of your monthly debt obligations and your monthly gross income. The lower your DTI ratio, the more willing a lender will be to lend you money. Debt service coverage ratio (DSCR): This measures your business’ ability to repay debt by dividing your net operating income by your total debt and interest payments. Lenders generally use this to evaluate your capacity because it shows if your business is generating enough income to pay its debt. Level of excess cash flow: Lenders use your financial statements, such as business cash flow statements, to analyze the level of excess funds available to repay any debt obligations. Capital: What You Owe vs What You Own Debt to net worth (or debt to equity) is one ratio used to measure capital for both individuals and businesses. Net worth is defined as the value of all non-financial and financial assets. To calculate your net worth, subtract your total liabilities (what you owe) from your total assets (what you own), including your investments. Your debt to net worth shows how financially stable you are as an individual or business. A lower ratio suggests you have minimal debts, so you’ll appear as a less risky borrower. Additional ways that lenders evaluate capital include: Loan-to-value (LTV): This is a comparison of your loan amount to the appraised value of the asset you’re purchasing, such as a piece of equipment. Down payment percentage: The amount of money you’re bringing as a down payment can be calculated as a percentage if you divide it by the total loan amount—typically, you can expect a lender to require a down payment equal to 20% of the purchase price. Conditions: Market, Economic, Industry & Other Factors When evaluating your application, lenders want to understand the conditions that surround your business. Not every industry or business faces the same set of external conditions, so understanding the current market, the overall economic environment, and how the borrower looks to use the loan proceeds aids the lender in making a loan determination. The conditions lenders consider for businesses include the: Current market Industry your business is in Current economic environment Interest rate of the loan Size of the loan By evaluating these conditions, lenders ensure that risks are identified and mitigated. While it can be challenging to identify each lender’s process, they often compare how you’re doing relative to your competition. Collateral: Available Assets for the Lender Lenders will always take collateral into consideration for secured loans when collateral is required. However, if a lender doesn’t need collateral to support the transaction, it’ll likely value other characteristics more, such as a higher credit score, better cash flow, lower leverage, a lower loan amount, or a higher interest rate to offset a lack of collateral. Loans that are secured by collateral are considered less risky to the lender than unsecured loans. As a result, you'll often receive better terms with secured loans—and it’ll be easier to qualify. Your business collateral can be inventory, equipment, accounts receivable, or any assets the lender can liquidate if you default on the loan. In some cases, a borrower’s home can serve as collateral and back the loan. How To Improve Each C The 5 C’s of credit are important for those applying for a loan and those who might consider applying for business financing in the future. Here are some ways that you can improve your standing within each of the 5 C’s of credit. Character Build your credit score and reputation: A good credit score for both the borrower and the business is incredibly helpful to show good character with managing money. To improve or maintain your credit scores and character you should Make your payments on time Avoid defaulting on your financial obligations Avoid bankruptcy Pay your taxes Prevent lawsuits Capacity Pay down your existing loans: By focusing on reducing your debts, you can lower your DTI ratio and increase your DSCR. This will improve your capacity to repay any future lending obligations. Increase revenues: Another means of increasing your DSCR is by increasing your revenues. If you can show the lender that your projected revenues are increasing, this can help improve your capacity for borrowing. Capital Use some of your own cash: Individuals should monitor their levels of personal debt. Business owners can invest some of their personal equity into their business to help improve the business’ equity position. Individuals and business owners can use their capital as an indicator of the amount of financial leverage they have. Conditions Plan carefully: While you can’t control the economy or your industry, you can keep tabs on your competitors and adapt to changing business conditions as appropriate. It doesn’t hurt to utilize outside resources, such as SCORE or the Small Business Development Center (SBDC), both of whom counsel businesses and provide additional analysis and support. Collateral Consider what collateral you can pledge: If you can’t provide enough collateral, consider an unsecured business loan. Before getting an unsecured loan, make sure you can pay it off in a reasonable amount of time. If not, create a financial plan and wait until you have enough collateral to support the loan. Bottom Line The five C’s of credit are character, capacity, capital, conditions, and collateral. An analysis of these factors helps lenders determine if you're a reliable borrower. Although most lenders consider all these factors, how they’re weighted varies by lender and loan type. Ensuring that you pay your bills on time, have sufficient cash on hand to support repayment of debt, and have sufficient collateral to back your loan will help improve your chances of receiving the business loan you’re applying for.

Public liability insurance covers businesses for claims made by third parties, such as customers, for injury or property damage caused by the insured business. Public liability typically only covers injury and property damage claims that happen at the physical location of the business. How Public Liability Insurance Works Public liability insurance is designed to protect businesses from claims made by members of the public. Since it’s liability coverage, it’ll cover the insured business’ costs for legal defense, settlements, court fees, and damages if someone claims that they were injured on the business’ premise or that the business is responsible for damaging their property. What Public Liability Insurance Covers A public liability policy covers the liability costs to a business for third-party claims of bodily injury and property damage and requires the event that caused the claim to take place at the business’s physical location. What Public Liability Insurance Doesn’t Cover Public liability insurance strictly covers physical and bodily injury and damage to property. That’s important to note as a general liability policy would cover personal and advertising injuries, such as slander, libel, or false arrest in addition to bodily injury and property damage claims. Public liability insurance is also limited to a business’s physical location, so it’ll only cover the insured business if the claim is made that the person was injured on the business’s premise. For instance, if an electrician accidentally injures a customer while at their home and a claim is filed, it won’t be covered by the policy because it was off-premise. The other restriction of public liability insurance is that it’s strictly for claims made by third parties, such as customers or members of the public. This means that claims of injury or property damage made by a business’ employees wouldn’t be covered, nor would claims made by the owner of the business. Below are the main claims not covered by public liability insurance: Reputational harm: Covered by the personal and advertising injury component of general liability insurance. Employee injuries: Covered by workers’ compensation insurance. Injuries due to products or completed operations: Covered by the product-completed operations component of general liability insurance or standalone product liability insurance. Claims of professional negligence: Covered by professional liability insurance. Injuries due to alcohol consumption: Covered by liquor liability insurance. General Liability vs Public Liability Insurance General and public liability insurance policies are similar in that they’re both business liability coverages that would pay the cost of legal defense, court fees, settlement, and damages in the event a bodily injury or property damage claim is made by a third party. The main differences are in the details. General liability insurance is more expensive to purchase for a business but offers broader coverage. For instance, general liability insurance covers reputational harm and product liability claims while public liability insurance doesn’t. General liability insurance also doesn’t limit itself as to where a third party is injured or their property is damaged. If someone is accidentally injured at their home by an employee of a business, general liability insurance would cover that claim while public liability wouldn’t because the injury didn’t take place at the business’s physical location. If you’re thinking that general liability coverage might be a better fit for your business, check out —you can get a quote in minutes. CoverWallet will also do a coverage comparison against others in the same industry to see where you line up. Common Business Liability Claims Public liability insurance can be a low-cost insurance option, especially for customer slip-and-fall injuries, which are common business liability claims. Below are some common types of business liability claims, their severity, and whether public liability or general liability covers them: *From The Hartford Claims data Public Liability Pros & Cons Whether your business prefers public liability insurance, a more comprehensive general liability insurance, or individual policies to cover personal and advertising injury or product liability claims, it should have some form of business liability insurance. Below are some of the pros and cons of public liability coverage: Public Liability Costs Public liability insurance is very inexpensive, with minimum premiums starting at around $500 per year, with the range of costs being around $500 to $1,600. Across various industries, due to the coverage limitations, public liability insurance will usually be around 10% less than general liability insurance. Some of the biggest factors of public liability premium costs are the size of the physical location, company revenues, and operational risks in terms of how many people are coming through the premises. Other factors specific to the insured will also impact the price, such as claims history, coverage limits, and the selected deductible amount. Public Liability Cost Average by Industry *According to data from BizCover Although general liability coverage may be more expensive, can ensure that you get top-of-the-line coverage for a great price by placing add-ons to the policy for other protection like professional liability, internet-related advertising liability, and coverage for data breaches. Who Public Liability Insurance Is Right For Ultimately, public liability insurance should only be purchased by businesses who need to save money, assuming that the same business mostly has on-premises risks and no exposure to potential personal and advertising claims. Overall, this coverage will be better suited for businesses with physical locations. Below are some of the best business types that public liability insurance would be good for: Restaurants Coffee shops Retail stores Grocery stores Hotels, motels, and bed and breakfasts Dry cleaners Bottom Line Public liability insurance can be a low-cost alternative to business insurance such as general liability coverage. Though its protection isn’t as robust, public liability will still protect your business from claims made by third parties for bodily injury or damage to property that they own. This ensures that in the event of a claim, the costs of legal defense, court, settlements, and legal damages don’t have to come out of your pocket.

General liability insurance, also known as business liability insurance, covers businesses for financial losses due to third-party claims of bodily injury, reputational injury, or property damage to others. It’s an essential liability coverage for all businesses, given that all businesses are exposed to these types of risks. If you’re looking for general liability insurance for your business, working with an insurer like is a good idea. The Hartford’s team of insurance specialists can evaluate your small business’ risk and point you toward the appropriate coverage. Coverage in a Standard General Liability Policy “Covering financial losses” means that an insurance company will pay for items like court fees, defense attorney costs, damages, and/or settlement costs if a third party claims that the insured business is responsible for their bodily injury, reputational injury, or property damage. General liability coverage can also include components like products and completed operations insurance, which covers bodily injury or property damage claims resulting from the use of a product made by the insured business or as a result of completed work. Additionally, it can include premise liability coverage, which is coverage for claims involving accidents that take place on a business’s property or premise. Insuring Agreement The insuring agreement section of a commercial general liability (CGL) policy summarizes which scenarios or perils are covered under the policy for each coverage type. It also details other rights and responsibilities of the insurer, such as their right to settle a claim and their obligations to defend the insured in covered suits. The insuring agreement section is where it’s stated that an insurer is legally responsible for paying losses described in three primary coverage sections: Coverage A: Bodily injury and property damage liability Coverage B: Personal and advertising injury liability Coverage C: Medical payments liability Coverage A: Bodily Injury and Property Damage Coverage A is the section of the policy that covers claims of liability associated with bodily injury and property damage to others. It's important to note that mental injury or emotional distress can also be included in bodily injury. Here’s an example of a bodily injury liability claim: A customer visits your store, and a large box of merchandise falls from the top shelf and hits them in the head, causing a concussion. Your business has a $1 million per occurrence and $2 million aggregate general liability policy and files a claim. The insurance company feels it’s best to settle and offers the customer $200,000, which they accept. Your aggregate general liability limit is now reduced to $1.8 million. A good property damage claim example involves a plumbing business that does some basic pipe replacement at a house. Two weeks later, one of the pipes bursts and floods the kitchen, causing $80,000 worth of damages. The plumbing company has a $1 million per occurrence and $2 million aggregate general liability policy, which includes $1 million for products and $2 million for completed operations. The $80,000 loss is paid by the insurer, leaving $1.92 million for the remaining policy term. Coverage B: Personal and Advertising Injury Coverage B is the part of a general liability policy that covers the insured for claims of reputational harm, infringement on intellectual rights, or infringement on personal rights of a third party. Some common examples of personal and advertising injury are libel, slander, false arrest, copyright infringement, and wrongful eviction claims. The following is an example of a personal and advertising injury claim: The CEO of ABC Retail does an interview and makes false statements about a competitor, who then files a slander lawsuit. ABC Retail has a general liability policy for $2 million per occurrence and $4 million aggregate, with a $1 million personal and advertising limit. ABC elects to take it to court, which ends up costing $600,000 in defense fees, court fees, and court-issued damages. The insurer pays the $600,000, leaving $400,000 remaining in the personal and advertising limit of the policy. Coverage C: Medical Payments Coverage C is the section of a general liability policy designed to prevent potential lawsuits by paying for third-party medical expenses. It’s considered “no-fault coverage,” so no lawsuit needs to be filed for an insurer to pay these costs, which can include expenses for medical care, surgeries, ambulances, and even funerals. The limit for these sections of coverage is much lower than Coverage A and B because no legal expenses are included. Let’s say, for example, that while walking to the bathroom, a restaurant customer slips and sprains their ankle. After X-rays and medical care, their total bill ends up being $6,000. The restaurant has a general liability policy that includes $10,000 for medical payments per person, from which they pay the expenses for the injured customer. Because the policy is written as $10,000 per person, the limit for medical payments isn’t reduced. Who Is Covered by a Standard General Liability Policy? A standard general liability policy covers your business for claims laid out in coverages A, B, and C. It generally won’t cover independent contractors, subcontractors, or freelancers that your business hires. Additionally, only injuries or damages to the property of third parties will be covered, so employee injury claims or property damage to your company isn’t covered. What Is Not Covered in a Standard General Liability Policy? Following the insuring agreements of each coverage are the exclusions sections. These describe specific situations that aren’t covered by the general liability insurance policy. These situations are excluded because they don’t involve a third party or because the loss isn’t due to physical injury, reputational injury, or property damage. Below are common exclusions of general liability insurance: Damage to property owned by the insured: This would be first-party property damage covered by commercial property insurance. Claims of negligence or errors made by a business when providing a professional service that caused financial loss to a client or customer: This wouldn’t involve physical or reputational injury. Professional liability would cover this type of loss. Injuries to employees of the insured: Employees aren’t considered third parties, so their injuries would be excluded under general liability but covered by workers’ compensation. Claims of company mismanagement by shareholders: This doesn’t entail physical injury, reputational injury, or property damage to others. Directors and officers (D&O) insurance would cover this kind of claim. Employment-related claims such as discrimination or sexual harassment: This is excluded since employees aren’t considered third parties and are covered under employment practices liability insurance. Data privacy, negligent security, or data breach claims: Cyber-related claims are excluded from general liability insurance but are covered by cyber liability insurance. Liability claims of incidents involving company vehicles or employees using personal vehicles for company use: Excluded by general liability insurance but covered by commercial auto coverage Injury or damage claims associated with serving, selling, or manufacturing liquor: Excluded by general liability but covered by liquor liability insurance. For more information on what general liability doesn’t cover, check out our article on the 16 common general liability insurance exclusions. Types of General Liability Policies Regarding claim coverage based on when the incident took place and when the claim was filed, there are two types of general liability policies: occurrence and claims-made. While a majority of general liability policies are written as occurrence-based, some carriers will write them as claims-made. Occurrence Occurrence general liability policies will cover losses that take place during the coverage or policy period, regardless of when the claim is made. For example, Hank’s Electrical Company had an occurrence general liability policy from January 1, 2019, to December 31, 2019. They did electrical work for one of their customers in October 2019. On February 2, 2020, after the policy period, a claim was filed by the customer which stated that miswiring done by Hank’s Electrical Company caused them to shock themselves, leading to burn injuries. Because the electrical work occurred during the policy period, the insurer will cover the loss associated with it. Claims-made A claims-made general liability policy will only cover claims that were reported during the policy period, as long as the incident took place on or after the policy’s retroactive date. The retroactive date is the date on which coverage starts, typically before the actual policy period. For example, instead of an occurrence policy, Hank’s Electrical Company had a claims-made policy from January 1, 2019, to December 31, 2019, with a retroactive date of January 1, 2015. Hank’s Electrical Company did work for a customer in October 2018, and in February 2019, miswiring caused the customer to shock themselves, which led to burn injuries. The customer claimed that the work from 2018 by Hank’s Electrical Company caused these injuries. In this case, since the work took place after the retroactive date―January 1, 2015―and was reported during the policy period, the insurer will cover the loss. Bottom Line General liability coverage pays for defense costs, court fees, settlements, and damages owed due to third-party claims of bodily injury, advertising injury, and property damage. It also holds the same exclusions across the board for first-party losses and claims not related to injuries or property damage. Although the coverage and exclusions are universal across policies, businesses may find differences in coverage A, B, and C in terms of the limits provided by the insurer. There may also be differences regarding claims-made vs occurrence policies.

A certificate of insurance (COI), sometimes called a certificate of liability insurance, is a one-page document that summarizes your coverage and can be used as proof of insurance. The form includes policy details, such as coverage limits and effective dates, so business owners can find and share them easily without revealing other, more private information. Companies often require businesses they partner with to carry liability insurance because they don’t want to risk being held solely responsible for any damages stemming from the collaboration. For example, say a company hires a contractor who doesn’t have general liability. That company could end up paying for damages or injuries caused by the contractor’s work. However, if the contractor can show they have coverage, the company knows the contractor can stand behind their work. Business owners who need liability coverage and certificates of insurance immediately should apply with . As a small business specialist, Hiscox understands how important it is to get your proof of insurance as soon as coverage is in place, so it emails certificates within an hour of binding and never charges for the service. When Do You Need a Certificate of Insurance? Business owners should ask for their certificate of insurance from their insurance carriers when they bind policies so that they have it whenever someone requests proof of liability insurance. These requests are common when bidding on jobs or signing contracts. Similarly, you may want to request any business you work with to show proof of liability insurance. Small business owners are wise to keep a certificate of liability insurance as a proactive measure. Being able to present proof of insurance immediately demonstrates a degree of professionalism and trustworthiness that can help you secure larger contracts and grow your business. How to Request a Certificate of Insurance Insurers often include certificates when they issue policies, but you may need additional copies as your business grows. You can request certificates through the provider who originally sold the policy—typically the carrier, agent, or a commercial broker. Some insurers charge up to $50 per certificate while others provide them for free. The steps you may need to take to obtain a certificate of liability insurance include: Find out what coverages and limits you need: If the company requires higher limits than what you already have, getting your certificate of liability insurance may take a bit longer as you wait for your coverages to be adjusted. Confirm coverage limits with your provider: If you need to increase your limits, you can adjust the policy, or you may be able to purchase a rider to cover the duration of the contract. Your insurance agent can help with this process. Request the certificate after making any changes: This requires filing the paperwork required to adjust your coverage adjustment, submitting payment, and requesting the certificate listing the appropriate limits. Give the certificate to your client: Some companies require a paper copy they can keep on file while others are satisfied with an emailed PDF. Certificate requests can take anywhere from minutes to days to complete. Yours may take longer if the company you’re working with requires unique wording on your certificate, if your insurer creates certificates manually, or if you make an error in the certificate holder’s information. Some providers, like Next and Thimble, are making it easier for policyholders to create, share and obtain instant COIs. Both of them have this as an option on their mobile app. Certificate of Liability Insurance Example Liability certificates have nine sections that summarize what insurance policies a business owner has, the limits of each policy, the name of the insurer, and several other key details. Disclaimer: A statement explaining the COI and intended use of information. Producer: The insurance company, broker, or agent representing the insured. Insured: The person or entity that purchased the insurance policies listed in the COI. Insurers Affording Coverage: The insurance companies that provide the coverage listed in the COI. Coverages: Descriptions of the specific policies purchased by the insured. Description of Operations, Locations & Vehicles: Detailed information about the business. Certificate Holder: The person or business to which the certificate is issued. Cancellation: An explanation of cancellation notification requirements for the insurance company. Authorized Representative: The insurance company, agent, or broker authorized to sign the certificate. Having a certificate of liability insurance can help protect you in a variety of circumstances. But understanding the information contained within it is almost as important as the certificate itself. When to Add Certificate Holders Business owners often need certificates when they sign a new contract, but they might also need one when they apply for professional licenses or sign commercial leases. In these situations, your agent creates a certificate with the other party’s name listed as a certificate holder, and each certificate holder gets their own copy for their records. When the other party has a financial interest in your business, they may want to be more than a certificate holder. They may ask to be an additional insured, a status that grants them some of the protections found in your liability insurance. For example, commercial landlords usually want to be additional insureds in case your injured customer sues them for damages. General contractors may also ask for additional insured status to protect against lawsuits stemming from a subcontractor’s work. Liability Certificate Holder Examples Business owners typically need to create certificates for certificate holders when they’re about to enter contracts that require liability insurance coverage. Essentially, the party you’re contracting with wants to know if you’re financially stable, and your certificate of insurance shows that you’re able to pay if mistakes happen. Some examples of when a business owner needs a certificate of liability insurance include: A food truck owner wants to work the county fair, and the county requires proof that they carry at least $1 million in general liability insurance if they want a spot. A yoga instructor wants to teach at a new studio, but the owner wants to see a certificate of liability insurance first. A cleaning business owner has an opportunity to get a big commercial contract, and the company requires a certificate of liability showing general liability and workers’ compensation coverage. A semi-truck driver wants to be an owner-operator working under their own authority and needs a certificate proving liability coverage and the respective limits. A plumber has an opportunity to work on a construction project, but the general contractor only works with subcontractors who have their own workers’ compensation coverage. There may also be times when you may want proof of insurance from a partner. Perhaps you’re considering a new subcontractor, manufacturer, or third-party logistics company and want to make sure they have the financial means to meet their obligations. The information on their ACORD certificate is evidence that you may be able to recoup your losses if things take a turn for the worse. Bottom Line A COI provides proof of insurance and lists all the essential information about the policies your small business carries. Almost any business owner who works with the public should have a certificate of insurance on hand. Even if it’s not requested, presenting the COI demonstrates a high degree of professionalism and can help you win contracts and bids on projects.

A surety bond is a type of financial coverage that is designed to guarantee the performance of contractual obligations by the contractor who purchases it. A bond is generally required by the owners of the project for the primary contractors to purchase but can also be required by general contractors for subcontractors to purchase. Surety bonds can serve many purposes, but the ones available are dependent on the project and specific industry. How Surety Bonds Work What makes bonds a bit different from standard liability insurance policies is that there are three parties involved in a bond as opposed to just two. The way it works is that a project owner or general (prime) contractor (GC), known as the obligee, can require a business or individual that they hire to purchase a bond in the event that some type of obligation is failed to be met. That business or individual, which can act as a general contractor to the project owner or a subcontractor to the GC, is known as the principal. The principal would purchase this bond from a bond issuing company known as the surety. The bond surety company would pay the bond amount―on behalf of the principal―to the obligee in the event that a claim is filed against the principal for not fulfilling particular contractual requirements that were covered by the bond. After damages are paid, the principal usually has to pay back the surety for the covered damages. Parties Involved in a Surety Bond Below are the role and descriptions of the three main parties involved in a surety bond: the obligee, principal, and surety. Obligee The obligee is the organization or individual that is asking the business or individual to purchase a bond. Depending on the contractual hierarchy and project scope, the obligee can be a government entity, project owner, or general contractor, if work is being subcontracted. The obligee is the one that would determine the bond type, set the amount, determine the term, and be the one who files the claim if obligations are not met. Let’s say a private school is doing a renovation, and they hire a general contractor to do the work. The school requires that the contractor purchase a performance bond. The school is considered the obligee as they are the project owners. Principal The principal is the entity or individual that has been hired to do work and is required by the obligee to purchase the bond. The principal can be a general contractor or subcontractor, depending on the order of the hierarchy. Often, after a claim is filed by the obligee and paid by the surety, the principal will have to pay back the damages amount to the surety. In the same example about the private school hiring the general contractor to do renovations, the general contractor is the one that is hired and asked to purchase the bond. Therefore, the general contractor is considered the principal. Surety The surety is the bond issuing company that underwrites, finances, and pays the bond in the event of a claim. A surety can be a bank but is most commonly a specific department or division of an insurance company that handles surety bonds. The surety will review the credit history and financial statements of the principal as well as be the one responsible for collecting collateral before issuing the bond. The surety will seek out damages from the principal after a bond is paid. If the general contractor doing work for the private school went to a bond provider called Surety Now to purchase the bond, Surety Now would be the surety as it is the one underwriting and financing the bond. Surety Now would also be the one to pay the private school if performance obligations are not met by the general contractor. Sureties can sell bonds in-house but, generally, will use authorized independent insurance agencies to sell bonds. Types of Surety Bonds Surety bonds can take the form of literally thousands of different subdivided types, all of which fall into four main bond categories: contract surety bond, commercial surety bond, fidelity bond, and court surety bond. Contract Surety Bond A contract surety bond is a financial guarantee that the contractor (principal) will follow certain contract obligations laid out by the obligee. This type of bond might ensure that the bid a contractor submitted is done so in good faith (bid bond). It can also be used to ensure that the principal will complete the performance scope and project deliverables correctly within the other contractual terms (performance bond). A contract surety bond is also used to ensure that the principal will pay subcontractors and suppliers (payment bond). Commercial Surety Bond A commercial surety bond is mandated usually by government agencies and designed to protect the general public from fraud or poor business practices. Many commercial surety bonds are in the form of license bonds, which would require a licensee to purchase a bond to hold a license or certification. Below are some common industries that would require a commercial surety bond: Alcohol beverage sales Banking Mortgage broker services Financial services Tax preparation Notary services Insurance Construction Fidelity Bond A fidelity bond is a type of surety bond that serves more as a traditional insurance policy. It protects businesses against theft, forgery, or other fraudulent acts committed by the firm’s employees. This type of bond is commonly used in cash businesses like cash checking offices, grocery stores, restaurants, or convenience stores. When a fidelity bond is purchased to protect a bank or financial institution however, it's known as a financial institution bond. Court Surety Bond A court surety bond can be pretty broad in terms of all the subtypes of bonds included. Essentially it is designed to decrease the risk of financial loss for people going through our court or legal system. There are two main types of court bonds, the first being a judicial bond which is designed to guarantee payment of legal fees to an attorney or costs of appealing a court decision. The second is known as a fiduciary or probate bond, which is used to ensure that individuals appointed by a court will manage an estate's assets in a proper manner. Surety Bond Procurement Process Procuring a surety bond is very similar to procuring other commercial insurance in that it utilizes applications and an underwriting process. The main difference comes down to how the risks are underwritten and how coverage is bound. Underwriting a surety bond takes into account more financial risk factors as opposed to physical risk factors like fire hazards. A surety bond provider will evaluate credit history and the business financials as well as the type of work being done to determine whether or not to issue a bond and for how much. The premium is usually going to be a percentage of the total bond amount being requested. If the principal―either individual or owner of the business―has a poor credit rating, the surety may ask them to put up collateral, which can be for up to 100% of the bond amount. After the underwriting process is completed and quotes are presented to the principal, the surety company may require the principal to sign some type of indemnity agreement prior to the bond being issued, which would lay out repayment terms from the principal to the surety in the event that a claim is filed by the obligee and paid for by the surety. “Indemnity is an agreed compensation for loss. As part of the surety bond, a principal and surety will enter into an indemnity agreement that outlines the terms of repayment should a claim be filed. Some agreements require collateral while others don’t.” —Dr. Tenpao Lee, Professor of Economics, Niagara University Surety Bonds vs. Insurance Below illustrates the main differences between surety bonds and commercial insurance policies: Surety Bonds: Cost, Terms & Qualifications Surety bonds range on a wide spectrum of different types, varying terms, and a range of bond limits. These elements, along with underwriting factors, ultimately dictate the overall premium cost for the bond. Sample Surety Bond Cost Estimates Based on Industry & Term While some sureties can offer set prices and terms for businesses and individuals looking to purchase a bond, most of them are going to use a set percentage of the bond amount. For example, if an electrical company is required by the general contractor of a project to have a $100,000 performance bond, and the surety offers the bond at 10% of the limit, then the bond premium cost to the electrical company will be $10,000. Bond premium percentages are going to range from 1% to 15%, depending on the industry, principal experience, credit history, and past financial performance. Most of the time, the surety will want the bond paid in full upfront. Below illustrates some sample surety bond cost estimates based on industry and credit history: *Bond requirements vary by state and industry. The estimates above are based on online price estimates by bond type, limit, and credit history. Surety Bond Amount & Terms There is no actual declared maximum limit on a bond amount that can be purchased. A general rule of thumb, however, is that the principal business has at least 10% of the bonded amount in working capital―current assets minus current liabilities. Another cap on a bond amount that a surety could use is limiting the total maximum amount to 10 to 15 times the value of the total equity of the company. While bonds generally have a term of one to four years, they may also use a continuous surety bond general term that keeps it active until cancellation by the principal. After the expiration of bonds with set terms, the bond can be renewed if needed by the principal. Surety Bond Qualifications The credit history of the principal is going to hold a huge weight on whether the surety will issue a bond. The other important qualification factors include company financial performance―past and current―and industry experience. If underwriters can see that the business can do well from a financial standpoint, and that the business owner has relevant experience that can reduce the chances of an issue occurring, then the underwriter will take that into account in their risk evaluation. Keep in mind that even after a bond is issued, the surety may require the principal to send updated information periodically. This might include items specific to the project like change orders and overall completion progress as well as financial information like revised cost estimates and estimated gross income. Who Needs a Surety Bond? For most businesses, the reason a surety bond is attained is for compliance or due to contract requirements. For example, if a business is selected to work on a construction project, the project owner will likely require them to hold a few types of contract surety bonds in addition to their other insurance requirements. Additionally, businesses trying to attain licenses, permits, or are part of a particular high-risk industry, such as alcohol or tobacco, will be required by the specific governing body to hold certain types of commercial surety bonds. Another reason to hold a surety bond is for marketing or branding purposes. You may see contractor trucks saying “we are bonded” in an attempt to show that they practice solid risk hygiene that, ultimately, would protect their customers. Surety Bond Example ABC Plumbing Company has just won a contract for $20,000 of plumbing work for John’s General Contractor, Inc. John’s General Contractor, Inc. is requiring ABC Plumbing Company to maintain a performance surety bond of $20,000 for that specific plumbing work. ABC Plumbing Company has a great financial history, and the owner has a near-perfect credit score. Surety Bond Corp. sees ABC Plumbing Company as a solid risk and offers a surety bond for 2% of the bond amount for one year, which is the equivalent of a $400 premium. ABC Plumbing Company pays the $400 premium in full to Surety Bond Corp. After completion of the work, it is discovered that ABC Plumbing Company installed everything incorrectly in terms of what was laid out in the contract. John’s General Contractor, Inc. files the claim with Surety Bond Corp and receives the full $20,000 bond amount. After the claim is paid, Surety Bond Corp requires that ABC Plumbing Company repay the $20,000 of damages, referencing the signed indemnity agreement in favor of the surety made prior to issuing the bond. When To Get a Surety Bond There are two main scenarios for when businesses acquire surety bonds. The first and more common one is for when a bond is required for government or contractual compliance. The second is when a business owner willingly purchases a bond for financial risk-management reasons. This type of reasoning, which encompasses protecting their customers, can be used as a branding tool. Where to Get Surety Bonds The surety bond market is loaded with many providers. So, when looking at where to obtain a surety bond, you’ll want to consider the fact that bond providers generally have specific targets or “sweet spots” that they want to focus their book of business on. Below are just a few bond providers that can be considered: What to Look for in a Surety Bond Provider Surety bonds are issued by either banks or insurance companies, which will distribute them by using brokers or insurance agents on a commission basis. When looking for a surety bond provider, you’ll want to check that the surety bond provider: Has obtained a bonding license for your location Offers the specific bond type that you need and can provide specialized offerings relevant for your business Is getting you the most competitive rates available on the market Can ensure a smooth process from underwriting all the way to potential payment of a claim Here are five surety bond providers that can help get you the coverage you need. Nationwide offers businesses peace of mind in terms of meeting state and local licensing requirements when seeking a surety bond. It works especially well with some of the specialty artisan contractors as well as landscaping businesses. Philadelphia Insurance Companies has a pretty easy online system for quotes and allows certain industries to generate bond quotes with errors & omissions (E&O) insurance. One of these industries is for notary services that also can provide automatic renewals on loss-free businesses. JW Surety Bonds Thanks to partnerships with large surety companies like The Hartford and CNA, can offer competitive rates for a wide range of industries. Its width of capabilities can even assist higher-risk businesses that have had trouble with underwriting. Travelers tends to be known for its range of capabilities in terms of what it will write for surety bonds. It can take more risk with less-experienced businesses and has a sizable book of business with smaller contractors. This makes it a solid fit for startup construction businesses that might struggle procuring bonds. Liberty Mutual Any individual starting a business that has poor credit ratings will want to try first for their bonding needs. It tends to have a less gruesome underwriting process that asks minimal questions relative to other providers. It also can handle a plethora of different bonding types. Bottom Line A surety bond is a financial risk-management product designed to allow a principal to protect an obligee. This is a similar coverage to traditional insurance but involves three parties and uses different underwriting factors for evaluation. Potential customers and clients will want to know that they are doing business with firms that can guarantee their contract terms.