Posted by Regan Hupf, AssuredPartners
Surety bonds offer compelling advantages as a type of security against contract default when compared to guarantees offered by banks. The demand for surety bonds as a financial instrument as opposed to merely a statutory requirement has been gaining traction.
Most businesses with a leased facility or office space will have some sort of security deposit requirement. This information can be found disclosed in CPA prepared financial statements or available online for publicly traded clients, or otherwise via a conversation with the company’s CFO or controller.
There are key differences between the two instruments:
- A letter of credit is a guarantee by a bank that a beneficiary will be paid for goods or services provided.
- A surety bond is a guarantee in which a third party — often an insurance company — agrees to guarantee a party’s financial obligations in the event of default.
Surety bonds offer beneficial alternatives:
- Able to free up liquidity and allow cash to be preserved and put to better use
- Off the balance sheet – bonds are noted as contingent liabilities vs debt
- Bonds have no negative effect on credit or borrowing capacity
- Rates are lower than bank rates in most cases
- Bonds are typically written unsecured without collateral
- Higher level of investigation required to make payment for a bond claim
- Letter of credit may be held for an extended period of time before released
Often a letter of credit is a firm requirement, and a beneficiary may insist a letter of credit since it is more favorable to the beneficiary. Many times, a bond will be accepted. For the above reasons, it is always a smart idea to ask if posting a surety bond in lieu of a letter of credit is an available option as it has proven to be an advantageous alternative.