A bond is a promise by a bond company, sometimes called a surety, to pay a customer if a service provider fails to meet a contractual obligation and the failure causes losses to the customer. Sometimes bonding is required by local or state law, but, since sole proprietors are personally liable for their businesses, bonding may be advantageous even if it isn't required.
Bonding protects your customers. As the sole proprietor, you pay a premium to a bonding company, either annually or for a given term, to provide that protection. From this perspective, bonding may help induce your customers to contract with you, because they are protected against losses if you fail to fulfill the contract. Further, this protection costs them nothing, because you pay for it. Bonding is beneficial to sole proprietors as well, because sole proprietors are personally liable for their businesses. If you can resolve an issue with a bond payout, that's better than subjecting your personal assets to a lawsuit and, thereby, in some cases, public record.
The maximum amount a bond company pays out is called the "penal sum." Its extent is usually determined by how much you pay in premiums – anywhere from 0.5 percent to 3 percent of the contract amount, in most cases. The penal sum isn't a guaranteed payout; it's the maximum coverage on the bond. Any payout is determined by the extent of the damage or loss caused by your failure to fulfill the contract. A bond is not an insurance policy, either. After making a payout, the bond company seeks reimbursement from the sole proprietor.
Bonding may involve several parties. Even though sole proprietorship entails one person handling all business affairs, a bond recognizes the importance of other parties. For example, bond companies usually require that the spouse of a sole proprietor – or anyone else who may have claims to the proprietor's personal assets – indemnify or agree to reimburse the bond company after a payout, too. This is because personal assets back bonds issued to sole proprietors.
Licenses and Permits
Some municipal or occupational licenses and permits require that a sole proprietor be bonded. This requirement comes from a local or state government as a prerequisite to licensure or permitting; that is, the license or permit is not issued until the proprietor shows bonding. Some examples of required bonding may include that construction contractors bond to guarantee their compliance with local laws or that import/export traders bond to guarantee tax remittance. Spas, health care facilities, babysitters, pet sitters, cleaning companies, environmental companies and others may have to bond, too.
Construction contractors almost always bond multiple times throughout the course of a job: during bidding to guarantee they will perform the work if awarded a bid, for performance of the actual construction once it commences, for supply provision during construction or for maintenance afterwards. Construction contractors that want to work with the government must additionally provide their bonding to state certifying agencies that handle government bids. Most construction companies are not sole proprietorships, though, simply because the liability risks are too great.
Some sole proprietors may have to bond because of a court order. This is an extreme instance where a proprietorship has failed to fulfill contracts in the past or when the court orders a proprietor to fulfill a contract it has tried to avoid. There may be miscellaneous reasons for bonding if a sole proprietor chooses to undertake a personal contract or enter a specific contract that requires bonding, like environmental reclamation or other work.