If you are a contractor, you will often be required to provide a Surety Bond or Guarantee to your client/principal as security against your default or non-performance.
So, what exactly are Bonds and Guarantees and how can they be arranged?
Surety Bonds are a form of security issued by a Surety (an insurer or specialist bond provider) in favour of your client (Beneficiary/Principal) to guarantee that you (the Contractor) will meet the requirements of the contract. They are commonly known as Performance Bonds.
A Surety Bond is much like a Bank Guarantee, both being unconditional and on demand. The difference being that Surety Bonds are issued by insurance companies or specialist bond issuers and Bank Guarantees are issued by banks.
What are the advantages and drawbacks of both?
Whilst they both perform the same function, in order to provide a guarantee facility, your bank will require cash or security over your business and/or personal assets to cover their risk. This increases the risk to your business and will reduce the working capital or security available to your company for use in the business.
On the other hand, surety providers underwrite based on the performance of the business. They will only offer a facility to companies who meet their criteria and do not require security over the company’s assets, relying instead on an indemnity from the Contractor. This allows the Contractor to utilise their cash and assets to support normal business operations.
On top of this key advantage, Surety Bonds also represent a cheaper alternative to bank guarantees with no non-utilisation fees (so you only pay for the bonds which are issued).
What are the key considerations for a suitable facility?
- Facility size and rate
- Issue fees
- Renewal fees
- Access to bank fronting
What are the key considerations from an insurer’s perspective?
- Balance sheet size (i.e. generally looking for a minimum net equity position of $2M +)
- Minimum turnover of $20M + and rising
- Past history of guarantees issued (e.g. have there been any claims in the past)
- Frequency and value of guarantees
Who needs Bonds or Guarantees?
Typical users include civil contractors, construction companies, waste management firms, earth movers etc but the real answer is anyone who needs to guarantee that they will perform a contract.
If you don’t want to tie up assets or cash which could be used in the business, talk to us to see if you qualify for a surety bond. It is a great product to help growing businesses.
Get in touch to speak to one of our Finance Executives about how your business may benefit from Surety Bonds.
What are Bank Fronted Guarantees?
In rare instances, a Principal/Beneficiary may require a Bank Guarantee in lieu of a Surety Bond and in these situations, the Surety can arrange for the issue of a Bank Guarantee under an arrangement they have with a major bank.
Whilst there is some additional cost in arranging a guarantee through the Surety, the main benefit to the client is that they provide no security to support the guarantee as this is provided by the Surety.
Surety Bonds Case Study of an Engineering Client
- Ledge was recently engaged to review a company’s existing banking arrangements.
- The client ran an engineering business and hence were involved in many construction projects where cash retentions and bank guarantees were required.
- Ledge had a meeting with the client to gather all information and completed initial assessment based on their requirements – delving deep into their business, history, structure, financial position etc.
- As part of this process, Ledge commenced the review by focusing on their Bank Guarantee side of things.
- The client had a $12M Bank Guarantee facility secured dollar for dollar by their bank.
- Ledge was able to undertake a comprehensive finance submission that resulted in us securing a Surety Bond limit of $18M (without property or cash security) and retained a small $2M Bank Guarantee limit.
- Thereby giving the client a $20M combined facility and released $12M cash back to the client.
- While pricing was slightly higher in the surety bonds, security / cash was released back to the client. This facility also has the ability to increase in limit, in line with the clients growing requirements, as the business expands over time.