How Does a Construction Bond Work? A Simple Guide for New Contractors

Let’s say you just landed your first big contract. Everything looks great on paper, but the project owner throws in a new requirement and you need to provide a construction bond. If your first thought is, “What is that?” you’re not alone.

Construction bonds are one of those topics that sound more complicated than they are. But understanding how they work is critical for building trust, getting contracts and protecting your company’s reputation as you grow. Whether you’re working on public projects or venturing into larger private jobs, bonding will likely become part of your everyday reality.

Let’s break it down in simple terms and show you how a construction bond works, why owners require them and how you can use them to grow your business.

What is a construction bond and why does it matter?

A construction bond is a type of surety bond that protects project owners from financial loss if a contractor fails to meet their obligations. Think of it like a safety net for the project owner

There are three parties involved:

• The principal: That’s you, the contractor
• The obligee: Usually the project owner or developer requiring the bond
• The surety: A bonding company that issues the bond and backs your obligations

When you provide a bond, you’re telling the project owner that a third-party surety has reviewed your financials, track record and capacity and is confident you can deliver. If you don’t, the surety steps in to compensate the owner or fix the problem (and then comes back to you for reimbursement).

In construction, margins are tight, delays are costly and one mistake can ripple through the entire supply chain. For growing contractors, qualifying for bonds signals to owners and GCs that you run a financially sound operation. In many cases, it can be the deciding factor between winning and losing a job.

 

 

The Main Types of Construction Bonds

Not all bonds are created equal. As a contractor, you’ll likely come across several different types depending on the job, the project owner’s requirements and whether it’s public or private work. Each serves a distinct purpose and knowing the difference can help you plan ahead and protect your business.

Bid Bond

This bond guarantees that you, as a contractor, will honor the bid you submitted. If you’re awarded the project and then back out or fail to secure the necessary performance and payment bonds, the owner can call on the bid bond to cover the cost difference of hiring someone else. It shows that you’re serious and capable of following through.

Performance Bond

Once you land the job, the performance bond protects the project owner if you fail to complete the work as specified in the contract. If you default, the surety will either pay to complete the work or hire another contractor to finish the job. This bond is especially common in large-scale projects where delays or poor performance could have major consequences.

Payment Bond

This bond ensures your subcontractors, suppliers and laborers get paid. If you run into financial trouble and fail to make payments, the surety steps in. This protects everyone involved and reduces the risk of liens or legal action against the project owner.

Maintenance or Warranty Bond

Also known as a retention bond, this covers defects in workmanship or materials that show up after the project is completed. It typically covers a period of one to two years and provides peace of mind to the owner that issues will be addressed at no extra cost.

Supply or Subdivision Bond

These are more niche. A supply bond ensures that suppliers deliver materials as agreed. A subdivision bond may be required by municipalities to guarantee improvements like roads or sidewalks are built properly in new developments.

Each of these bonds involves a slightly different underwriting process, but all are based on your financial strength, experience and past performance. That’s why it’s essential to have strong financial controls and systems in place.

How the Bonding Process Works From a Contractor’s Perspective

So how do you actually get bonded? If you’re new to this, it might feel like you’re applying for a loan or trying to impress a very cautious investor. And in a way, you are.

Here’s what to expect:

Step 1. Prequalification

Before a surety agrees to back you, they’ll evaluate your financial health, experience, project history and creditworthiness. They want to know that you can complete this job on time and on budget. This involves reviewing your balance sheet, backlog, references and more.

Step 2. Underwriting

Once prequalified, the bonding company will assess each project you want to bond. Underwriters consider your capacity (how much work you’re taking on), character (your reputation and reliability) and capital (your financial resources). They’ll review your financial statements and may ask for a CPA-prepared work in progress (WIP) schedule.

Step 3. Issuance and Cost

If approved, the bond is issued. Costs vary depending on the bond type and the size of the job but generally range from 0.5% to 3% of the contract value. Stronger financials and experience usually translate to lower rates.

Step 4. Claims and Resolution

If something goes wrong and the project owner files a claim, the surety investigates. If they determine you failed to meet the terms of the contract, they will resolve the issue on the owner’s behalf. That could mean hiring another contractor or covering financial losses. But remember, this isn’t free money. The surety will expect full reimbursement from you.

 

 

When Bonding is Required (or Optional)

Understanding when you must provide a construction bond versus when it is optional can save time and protect your reputation. Bonding requirements depend heavily on the type of project and who is funding it.

Public Projects

If you’re bidding on a federal construction project valued over $150,000, the Miller Act requires you to provide both a performance and a payment bond. Most states also have their own versions of the Miller Act (commonly known as “Little Miller Acts”). These laws apply to state-funded projects and often extend to municipalities, counties and school boards. In Florida, for example, public projects over $200,000 typically require both types of bonds.

Private Projects

Bonding is not always required in the private sector, but more owners and general contractors are requesting them as a form of risk protection. A private developer may require a performance bond to ensure a project is completed to spec, or a payment bond to prevent liens from unpaid subcontractors.

For emerging contractors, bonding can also help you stand out in a crowded field. Offering to bond a job voluntarily tells an owner you are financially stable and confident in your team’s ability to deliver. It can mean the difference between being seen as a risky bid and a reliable partner.

Even when not required, being “bond ready” improves your credibility and increases your odds of landing higher-value projects. It shows you operate with the kind of professionalism that owners and developers value. If you’re unsure whether a project requires bonding, consult your contract or talk to your advisor early in the process.

What happens if things go wrong?

Construction is full of variables. Even the best contractors can run into problems. But when a project backed by a bond runs off course, the surety is there to step in.

If a contractor fails to perform according to the contract, the project owner can make a claim against the performance bond. Similarly, if subcontractors or suppliers are not paid, they can make a claim on the payment bond.

When a claim is filed, the surety will conduct an investigation. If they determine the claim is valid, they will pay the project owner or complete the project. Then the surety will then seek reimbursement from you. This is called indemnity; you are still financially responsible for the failure.

Even if the surety resolves the issue quickly, the claim itself can hurt your business. It may reduce your bonding capacity in the future or increase the cost of future bonds. Some bonding companies may even decline to work with you again, which could limit your access to public or bonded work altogether.

That is why it is critical to:

• Keep detailed records and WIP schedules
• Monitor project costs and timelines
• Communicate early with your bonding company and advisors if a problem arises

Staying ahead of potential issues and being transparent can sometimes help you avoid a claim entirely. And if a claim does occur, having the right financial systems and documentation can reduce the impact.

At James Moore, we work with contractors to build the financial clarity that keeps bonding relationships strong. From construction-specific reporting to long-term planning, we help you put the tools in place to reduce risk and protect your reputation. It is just one way we help better our clients’ business.

How Your Construction Firm Can Use Bonds Strategically

Construction bonds are often seen as a requirement or hurdle to overcome, but the most successful contractors use them as a strategic advantage. If you’re planning to grow your business and take on larger projects, bonding should be part of your long-term strategy.

Here are a few ways to think strategically about bonding:

• Use bonding to increase project size and scope. When you can show strong financials and a successful track record, bonding companies are more likely to support higher limits. That means you can pursue bigger contracts and joint ventures with less hesitation.
• Build your financial credibility. Sureties look closely at your financial statements. Having CPA-reviewed or audited financials, along with accurate job costing and work in progress reporting, improves your standing. It also makes you more attractive to lenders and partners.
• Stay proactive, not reactive. Don’t wait until a bid deadline to figure out your bonding capacity. Work with your CPA and surety agent throughout the year to prepare and plan ahead.

If your construction firm is ready to grow and wants to make bonding part of that growth, we are here to help. From financial forecasting to internal controls, our Construction Services team has the experience to guide you through the process and beyond.

 

 

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.