Many different types of businesses are required under state regulations to obtain licenses. One common state licensing is to post a commercial bond. If you are required to secure a commercial bond for your license to operate your business, you must maintain it. There are many different types of commercial bonds that you might need, depending on your business and industry. For example, most states require motor vehicle dealers to purchase auto dealer bonds while mortgage brokers must purchase mortgage broker bonds. Here is what you should know about commercial bonds and how they might affect your business.
What Is a Commercial Bond?
Commercial surety bonds are legal agreements between the following three parties:
- Principal - Business required to post the bond
- Obligee - Party requiring the bond, which is a government agency
- Surety - Surety company that issues the bond to the principal as a guarantee that the principal will comply with the law
Commercial or business bonds function as guarantees that the businesses will comply with all relevant laws and conduct their operations ethically. If a business holding a surety bond violates the laws or regulations, the government can file a bond claim. While the surety company will then step in and pay the bond, the business will have to reimburse the surety company.
Most states include bonding requirements as a condition of obtaining different types of licenses. A business that is required to purchase a surety bond to obtain a license must keep the surety bond in place to continue operating. The surety company guarantees that the principal will operate within the laws and regulations governing the business's industry, and these laws and regulations can include those established under the local, state, or federal government.
How Does a Commercial Bond Work?
Surety companies evaluate individuals and businesses for the levels of risk they pose for claims based on multiple underwriting factors. At the time you apply for a commercial bond, you will need to submit some of the following types of documents:
- Personal and business financial statements
- Business's organizational structure and key personnel
- Resumes of the business's key stakeholders
- Bank statements
- Bank letter of reference
- Tax returns
- Letters of reference from companies with which you have done business
The surety company will then complete the underwriting process and determine whether to issue the bond to you. Some of the key factors the company will consider include your business's working capital and experience, your personal and business credit profiles, and your personal and business reputation. If your credit is poor, your bond application might be denied. Alternatively, the surety company might provide a quote for a higher bond premium you would need to pay upfront to secure the bond. If you have a lot of experience, excellent credit, and a strong reputation in the community, you can expect to receive a lower bond premium quote.
Bond premiums are generally calculated as a percentage of the total bond amount and can range from as little as 1% up to as high as 15%, based on the underwriting factors. The bond premium is the amount you must pay to secure the bond at the time the bond is issued. If you accept the quote, the surety company will also require you to sign an indemnity agreement in which your company will agree to indemnify the surety company for any valid claims it pays on your behalf. Commercial bonds are not permanent. Instead, you will need to pay annual premiums to maintain your bond or purchase a new one. If your bond is terminated or lapses, the surety company will report it to the state, which could then suspend or revoke your commercial license.
Types of Commercial Bonds
Many industries require different types of commercial bonds for businesses operating within them. Commercial bonds protect consumers against businesses that might violate the law or engage in unethical practices. While there are hundreds of different types of commercial bonds, some of the most common types include the following:
Auto Dealer Bonds - States require car dealerships selling new or used cars in wholesale or retail to purchase auto dealer bonds. An auto dealer bond guarantees that the auto dealer will follow all federal and state laws to protect the customer against false advertising, fraud, and unethical acts. Used car dealer bonds are required in many states for anyone selling more than a minimum number of vehicles per year.
Freight Broker Bond – Also known as BMC-84 bond, this $75,000 surety bond is required by the FMCSA for all freight forwarders and freight brokers. It is one of the prerequisites for obtaining a Freight Broker license.
Contractor License Bonds - These are licenses states require for contractors that want to do business valued above a statutory threshold as a condition of obtaining contractors' licenses.
DMEPOS Bond – This bond, also known as Medicare Surety Bond, is required for all DMEPOS manufacturers and suppliers. It exists to protect patients who are sold superfluous therapeutic equipment. It also safeguards the government from clinical invoicing fraud.
Telemarketing Bond – Telemarketing companies operating in some states may be required to obtain this surety bond. Its purpose is to ensure compensation to claimants should a company violate telemarketing regulations.
Some other examples of commercial bonds you might encounter include sales tax bonds and utility bonds.
Who Needs a Commercial Bond?
Many businesses need to purchase commercial bonds to protect their customers. Various government agencies enforce bonding requirements as a condition of licensure to ensure businesses will operate ethically and legally. If your business needs a license to operate in your state, you should check your state's license requirements to determine the type of bond you might need to purchase. Most bonds have one-year terms and must be renewed to remain active.
How Much Does a Commercial Bond Cost?
The bond amount varies depending on the industry and the type of license you need. For instance, an auto dealer in Washington State must purchase a bond with a $30,000 total bond amount. The surety company calculates yearly premiums based on factors such as your experience in the industry, your business financial health, and your credit score.
The cost of the commercial license bond is a percentage of the total bond amount. You can pay as little as 0.5% per year or as high as 15% per year based on the underwriting factors as previously discussed. If you have less-than-perfect credit, you will pay higher premiums.
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What Does a Business Bond Cover?
Business bonds are not insurance and do not protect the companies that are required to hold them. Instead, they are designed to protect the government and the public if your business violates the law or engages in unethical conduct. If a valid claim is filed against your bond, the surety company will pay it. However, you will be required to reimburse the surety company for any amount it pays. If you fail to do so, the surety company can initiate legal action against you to recover its losses.
Commercial bonds are a necessary part of doing business for many different types of companies. If you are required to purchase a commercial bond, you should make sure you comply with the law and conduct your business honestly and fairly. Doing so can help your business to maintain a good relationship with your surety company and continue your business's operations.
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