Surety bonds are regularly utilized to support the acquisition goals for independent sponsors and private equity (PE) groups alike. In recent years, PE firms have invested in construction industries and have used surety bonds to assure contractor payments. The article will present an overview of surety bonds including the characteristics of the bond as well as bond termination, penalty, options to terminate certain types of bonds and four types of surety bonds. The article will also include a discussion of the criteria required by surety companies as well as the advantages and disadvantages of utilizing surety bonds to raise capital.
A surety bond is essentially an agreement between three parties and includes the principal, the surety and the obligee. Surety bonds are typically used to safeguard against contracts from future insecurity and risk. The surety is the party responsible for the contract, obligation or debt. Typically, the surety is a surety bond broker or insurance company. The purpose of the surety is to answer for the default on the principal’s behalf in accordance to the provisions set forth in the bond agreement. In PE transactions, the principal is the PE firm, whereas, the obligee, is the contracting firm.
The tender option – The obligee and surety can consent on a replacement contractor to complete the bonded work. The surety tenders a new contractor to the obligee. Subsequently, the obligee has the advantage to deal directly with the new contractor.
Takeover option – The surety itself assumes the responsibilities of the work to complete it. Furthermore, the surety appoints professionals to oversee the work.
Advise the obligee – The obligee is informed that the surety opts to not be involved in the work. This option prevents unduly delays from completing the work.1
Contract surety bond – Guarantees the performance of a bonded contractor. This type of bond is the most common type of bond, and the bond ensures that a contractor adheres to the designs of a construction contract. The project owner is the obligee and the surety bond guarantees that the principal contractor will accomplish the contract.
Commercial surety bond – Pledges performance in circumstances that occur from other contracts. The obligee to this type of surety bond is public. Typically, government agencies mandate that new businesses obtain a commercial surety bond.
Fidelity surety bond – This type of bond protects the firm against the negligence of an employee who manages cash to warrant against financial losses as well as the customer’s money, personal materials and equipment.
Court surety bond – The bond is demanded by an attorney prior to a court proceeding as a security against potential losses. In addition, this type of bond typically pledges the costs of payments associated with the lawyer’s fees.1
Surety Executive Survey
Source: FMI Corporation
Surety bonds support to the increase in contracting opportunities and are frequently used in the construction industry. Private equity companies represent the principal, whereas the obligee is typically a contracting company from another industry. The surety company utilizes the surety bond as a guarantee against unforeseen financial challenges that may arise with the principal. During a default case, the surety company has the option to takeover, tender a new contract or advise the obligee. Surety companies ensure that PE firms meet certain criteria prior to structuring surety bonds to support their business plan. Although, the surety company and obligee benefit from surety bonds, additional risks can be incurred when PE firms are unwilling to provide indemnity.
 The Associated General Contractors of America, An Overview of the Contract Surety Bond Claims Process, (2004), https://www.suretec.com/uploads/files/AGC%20surety%20claims%20guide.pdf.
 Evan Tarver, Surety Bonds & How They Work, (Aug 17, 2017), https://fitsmallbusiness.com/what-is-a-surety-bond/.
 Timothy R. Sznewajs & Curt M. Young, Surety Firms Weigh in on Construction Markets and Contractors:
FMI Surety Providers Survey, (2010), https://www.asaonline.com/eweb/upload/SuretySurvey_2010April.pdf.
 R. James Reynold, Jr, Handling Surety Performance Bond and Payment Bond Claims, MARGOLIS EDELSTEIN, http://www.margolisedelstein.com/files/reynolds_-_surety_performance_bond_claims_1.pdf.
 Jeff Ciecko, Don’t Let Surety Be an Afterthought When Acquiring a New Construction Company, (Oct 19, 2016), http://enewsletters.constructionexec.com/riskmanagement/2016/10/dont-let-surety-be-an-afterthought-when-acquiring-a-new-construction-company/.
Jenn Abban contributed to this report.