Home Business Beginners Guide to Bid Bonds for Contractors 2020

Beginners Guide to Bid Bonds for Contractors 2020

by Jovica Radulovich

The Covid-19 pandemic dealt a terrible blow to the otherwise vibrant U.S. construction sector. By disrupting precise supply chain and project completion schedules, the virus outbreak is breaking the industry’s seamless operations.

Contractors have to contend with massive delays, disrupted supply chains, and spiraling costs. Unprecedented executive orders to combat the rising Coronavirus further compound these problems. For example, in March, 85% of the construction projects in New York ground to a halt after the government restricted construction work.

The directive affected roughly 30,000 construction sites deemed nonessential by new orders from the city officials. One month later, only 16% of the closed sites had resumed operations due to strict health regulations.

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What can you do?

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Such unprecedented occurrences underlie the need to secure all the necessary surety bonds when embarking on a construction project. A Bid Bond is one of the most crucial sureties as it limits your financial exposure if you’re forced to abandon a construction project.

Luckily, you can get this bond alongside your insurance coverage, as many insurance companies double up as certified bond agencies.

What is a Bid Bond?

It is a guarantee that assures a client that you’re submitting an accurate bid when bidding for a construction job.

Project owners use them to ensure contracts don’t submit low quotes that increase their chances of winning a competitive deal, but might not be able to complete the project to the standard and at the price stipulated in the contract. It assures the client that your contractor company will deliver the project at the quoted price.

If you’re unable to start the project after winning a contract, it compensates the client without exposing you to further financial liability. They are mandatory for construction projects that require performance bids and payment bonds.

You can obtain a bid bond from a surety agency such as a bank or an insurance company.

Why are Bid Bonds so important?

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A competitive bidding process favors the client by triggering a bidding war among contractors. However, setting up a proper bidding process has a cost implication. For starters, a client must advertise the actual tender date through various media outlets to reach qualified contractors

The client also needs to hire architects and engineers to evaluate the various bids. Then they meet each contractor bidding for the job to pore over project specifics.

Since it has a cost implication, it filters out frivolous bids that would otherwise amount to a waste of time. It also lets the client evaluate offers from qualified contractors, making for a seamless selection process.

Also, the client gets compensated if you win the contract but fail to honor the terms of engagement.

Submitting a quote without one amounts to an exercise in futility as the proposal is automatically disqualified.

How does a Bid Bond work?

In competitive bidding, a client will often hire you if you submitted the lowest offer while demonstrating that you can get the job done.

Sometimes, unforeseen events such as the current pandemic might hinder your ability to complete the project without raising the cost. At that point, you may revise the price upwards before initiating the project, which amounts to a breach of contract.

In response, the client might cancel the contract and pick the next lowest offer on the list. The client may decide to start afresh and call for fresh quotes, which leads to further delays. The bid bond covers the price difference between your bid and the next lowest bid.

How much does a Bid Bond Cost?

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The cost depends on the size of the construction project.

Small construction projects carry a flat fee of $100 or $200, while the penal sum determines the bid bond cost for large projects. The penal sum is usually 5-10% of the contract cost. If the client sets the bid bond at 10%, a project worth $500,000 will have a penal sum of $50,000.

However, projects funded by the federal government carry a 20% bid bond, which raises the penal sum on a $500,000 project to $100,000. It costs 1-5% of the penal sum, depending on your choice of surety agency. Since a regular project worth $500,000 carries a penal sum of $50,000, the bid bond will cost between $500 to $2,500.

Several factors influence the cost for large projects:

  • Total project cost
  • The project’s location
  • The client
  • Your financial history

What makes a good Bid Bond company?

It’s in your best interest to get a bond from a registered bond company as it increases your chances of success. Luckily, the U.S. Treasury Department Circular 570, which is available online, lists all certified bond companies in the country.

The best bond companies are certified by the government and are rated A- or better by rating companies such as AM Best.

Getting a Bid Bond

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Getting one entails sending the bid invitation letter, job specifications, and bid request form to your preferred bond agency. The client provides all the necessary documents to request a bid bond. Some clients use custom specific forms while others use the industry-standard forms.

Before issuing one, a bond agency will conduct extensive background and financial checks on your company. They need to be sure you have the financial muscle and capacity to complete the job. As part of their due diligence, a bond agency digs into your credit history, financial statement, years of experience, and area of specialization.

Are insurance companies good Bid Bond agencies?

Insurance companies make excellent bond agencies because:

  • They have a national presence
  • They offer other surety bonds
  • They are competitively priced
  • They have loads of experience
  • They provide surety credit

Alternative to Bid Bonds

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While these are an absolute requirement when bidding for a federal project, some contracts allow for alternatives. Irrevocable letters of credits or cash deposits are some of the popular substitutes. Unfortunately, these options are inferior and don’t afford you the protection you need.

A cash deposit lowers the project kitty as well as your borrowing capacity. It also complicates the process of getting a performance and payment bond when you win the contract.

An irrevocable letter of credit won’t cover you if there’s a problem or a claim on the contract.

Securing a sufficient bid bond from a reputable bond agency protects you against financial liability and fraudulent claims. Before the bond agency pays off the project owner, they must investigate to ensure that a claim is valid.

Conclusion

Bid Bonds protect the financial investment of the project owner and reduce the risks of the contractor. It is a win-win arrangement.

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