If you're bidding on construction contracts—especially larger ones or government projects—you've probably encountered the term "performance bond." At first glance, it sounds like just another hoop to jump through. But here's the thing: performance bonds actually protect both you and your client, and understanding how they work can give you a competitive edge in the bidding process.
Think of a performance bond as a financial safety net. It's a guarantee from a surety company that says, "If this contractor doesn't finish the job according to the contract terms, we'll step in to make sure it gets done." For project owners, it's peace of mind. For contractors, it's proof that you're credible, financially stable, and serious about delivering quality work.
What Is a Performance Bond?
A performance bond is a type of surety bond that guarantees a contractor will complete a construction project according to the terms specified in the contract. It's a three-party agreement involving the principal (that's you, the contractor), the obligee (the project owner or developer), and the surety (the insurance or bonding company that issues the bond).
Here's how it works in practice: Let's say you win a contract to build a municipal parking garage. The city requires a performance bond equal to 100% of the contract price—that's standard for most projects. If you fail to complete the work, abandon the project, or don't meet the specifications, the surety company steps in. They'll either hire another contractor to finish the job or compensate the project owner for their financial losses, up to the full bond amount.
The performance bond usually equals 100% of the original contract price and remains in effect until the project is completed and accepted by the owner. But don't worry—you're not putting up that full amount in cash. You pay a premium, typically 1-3% of the contract value, and the surety provides the guarantee.
When Are Performance Bonds Required?
Performance bonds are mandatory for certain projects and optional for others. Under the Miller Act, all federal construction contracts over $150,000 require both performance and payment bonds. Many state and local governments have similar requirements—often called "Little Miller Acts"—for their public projects.
But it's not just government work. Private developers frequently require performance bonds for commercial construction projects, especially larger ones. If you're building an office complex, a shopping center, or a residential development, there's a good chance the developer will ask for a bond. Why? Because it protects their investment and signals that you have the financial backing and track record to get the job done.
Even when bonds aren't required, some contractors voluntarily obtain them to make their bids more competitive. Being bondable tells project owners you're a low-risk choice, which can be the difference between winning and losing a contract.
The Construction Bond Trilogy: Bid, Performance, and Payment Bonds
Performance bonds don't work alone. They're typically part of a three-bond system that protects different stages and stakeholders in the construction process.
Bid bonds come first. When you submit a bid on a project, a bid bond—usually 10% of your bid amount—guarantees that you'll actually sign the contract and provide the required performance and payment bonds if you win. The good news? Bid bonds are typically issued at no charge by surety companies.
Performance bonds kick in once construction begins. As we've discussed, they guarantee you'll complete the work according to contract specifications. They protect the project owner from contractor default.
Payment bonds protect your subcontractors, suppliers, and laborers. They guarantee that everyone who provides materials or labor on the project will get paid, even if you run into financial trouble. Payment bonds typically remain in effect until all subs and suppliers have been paid in full.
On most bonded projects, you'll need both performance and payment bonds. They're usually issued together and the premium covers both—that 1-3% cost we mentioned earlier.
How Much Do Performance Bonds Cost?
The cost of a performance bond isn't one-size-fits-all. Most contractors pay between 1% and 3% of the total contract value, though rates can range from 0.5% to 5% depending on several factors.
Your personal and business credit scores play a huge role. Strong credit can get you rates on the lower end—around 1%. Poor credit or a limited track record? You might pay 3% or more. Financial stability matters too. Surety companies want to see that your business has healthy cash flow, retained earnings, and isn't over-leveraged.
Project size also affects pricing, but in a good way: larger contracts generally get lower percentage rates because they spread the underwriting work over a bigger premium. A $5 million project might cost you 1%, while a $200,000 project could run 3%.
Your experience and track record matter immensely. If you've successfully completed similar projects before and have a clean bonding history, you're a lower risk and you'll pay less. First-time bond applicants or contractors taking on projects larger than their usual work can expect higher premiums.
Some surety companies also charge escrow fees of 1-1.5% on top of the bond premium, plus one-time setup fees of $500-$750. Make sure you understand the total cost before committing.
How to Qualify for a Performance Bond
Surety companies evaluate contractors using the "Three C's": credit, capacity, and character. Here's what that means and what you'll need to provide.
For smaller bonds under $750,000, the process is straightforward. You'll fill out a simple 1-2 page application, provide a copy of the contract or bid invitation, and authorize a credit check. These bonds are underwritten quickly—sometimes within days—because they're primarily based on your credit and experience with similarly sized jobs.
Mid-size bonds from $750,000 to $1.5 million require more documentation. You'll need business financial statements for at least the prior year and current year, plus a personal financial statement showing your own assets and liabilities. The surety wants to see that both you and your company are financially sound.
Larger bonds over $1.5 million require the full treatment: CPA-prepared financial statements with construction accounting experience, a comprehensive contractor questionnaire, bank letters showing your line of credit, and detailed project information. The surety may also want work-in-progress schedules to track your current job performance.
Note that you don't work directly with surety companies. They partner with surety bond agencies and insurance brokerages who submit your application and advocate on your behalf. Finding an experienced bond agent who knows construction is crucial.
How to Improve Your Bonding Capacity
Your bonding capacity—the total amount of work you can have bonded at one time—determines the size and number of projects you can pursue. Here's how to increase it.
First, establish a bank line of credit. Surety companies love seeing this because it shows you have a financial cushion if cash flow gets tight during a project. Even if you never use it, having access to working capital is reassuring to underwriters.
Retain earnings within your company instead of distributing all profits. A strong balance sheet with solid working capital and retained earnings demonstrates financial stability. Limit large fixed asset purchases that tie up cash—lease equipment when possible instead.
Build your bonding history gradually. Successfully complete bonded projects on time and on budget, and your capacity will grow. Don't jump from $500,000 projects to $5 million projects overnight—surety companies want to see you take measured steps up.
Finally, maintain clean personal and business credit. Pay your bills on time, keep credit utilization low, and address any issues proactively. A single late payment or tax lien can significantly impact your bonding ability.
Getting Started with Performance Bonds
If you're ready to pursue bonded work, start by connecting with a surety bond agency or insurance broker who specializes in construction bonds. They'll assess your bonding capacity, explain what documentation you'll need, and connect you with surety companies that are a good fit for your business size and type of work.
Get your financial house in order before you apply. Organize your financial statements, gather tax returns, obtain that bank line of credit, and make sure your credit reports are accurate. The better prepared you are, the smoother the bonding process will be.
For small businesses, the SBA Surety Bond Guarantee Program can help. The SBA guarantees bonds for contractors who meet their small business size standards and may not otherwise qualify for bonding. This program can be a game-changer for newer contractors looking to break into bonded work.
Performance bonds might seem like an extra hurdle, but they open doors to larger, more profitable projects and demonstrate to clients that you're a serious, financially stable contractor. Take the time to understand how they work, prepare your business for bonding, and work with an experienced bond agent. The investment will pay dividends in the projects you can pursue and win.
