Performance Bonds: Essential for Successful Construction Project Completion
David Morey 
Do you want to keep your construction project from disaster?
All construction projects come with an inherent risk. Projects can fail, contractors can default, and money can be lost. Recent data shows that 70% of projects globally fail to meet their objectives.
Here’s the problem:
If contractors cannot complete the work or they have not done the job on time, someone has to pay the price, and this someone is most likely you, the project owner.
Performance bonds for construction are specifically designed to solve this issue. Bonds provide financial security, which guarantees the project to be finished even in the cases when things go from wrong to disaster.
What you’ll learn:
- What Are Performance Bonds and Why Do You Need Them?
- How Performance Bonds Work and Protect Your Investment
- The True Cost of Performance Bonds
- Performance Bonds Requirements
What Are Performance Bonds and Why Do You Need Them?
Performance bond construction is a type of financial guarantee. This guarantee ensures the contractor will finish their work following the contract terms and conditions.
In other words, it is a type of insurance for construction work. In case the contractor failed to complete the work on time, the surety company will step in and either have the work done or pay you back for the financial loss that you have had.
Before you get deeper into the performance bonds, you must know the three players in this field.
- The Principal: the contractor, who wants the bond.
- The Obligee: the owner of the project, who requires a bond.
- The Surety: a company that issues performance bonds.
In summary, you can transfer the risk of the contractor’s failure onto a financial institution, which specializes in underwriting and manages this specific risk.
Smart move, huh?
The construction industry is among the riskiest business out there. In this industry, companies fail at a rate of almost 14%, whereas all businesses fail below 12%.
So not only this but also understanding performance bonds is a crucial move in order to not only make smart business but also to protect your investment and have the project completed.
How Performance Bonds Work and Protect Your Investment
Do you know what the best part about construction performance bonds is?
They provide project owners with multiple layers of protection, which go well beyond just making sure that the project is completed.
Let’s talk about those.
Financial Security
Performance bonds give project owners insurance against a high financial impact of the contractor’s default. If the contractor cannot finish the job, defaults typically cost 1.5 to 3 times the subcontract value, according to the Surety & Fidelity Association of America.
If there was no bond in place, the project owner would need to:
- Hire a new contractor to finish the work.
- Spend extra money to finish the project.
- Cover for the delays and legal issues.
In this case, if a performance bond was taken, then the surety company would cover all of the previously listed issues.
Quality Control
Performance bonds not only guarantee that the project will be finished, but they also ensure that it will be done according to the project’s original specifications and to a good standard.
The surety company has the interests of ensuring the work will meet your requirements. If not, then they will either have the work done or cover the cost of the financial loss.
Risk Management
If you are asking for the performance bonds, then you are getting a risk protection on a higher level. Surety companies run a very detailed financial and operational review of every contractor before underwriting the bond.
If the contractor was not able to get a bond, then the chances are high that they will not be able to finish your project successfully.
The True Cost of Performance Bonds
There is one question that most project owners ask, and that question is:
“How much do performance bonds cost?”
So, let’s see how much does a performance bond cost.
Premium Rate
Performance bond premiums typically range from 1% to 3% of the total contract value. The actual cost will depend on:
- Contractor’s credit score and financial stability.
- The size and complexity of the project.
- Contractor’s track record and experience.
- Project duration and location.
Performance bonds under $100,000 could be as high as 2-3%. Large projects over $50 million may be around 0.5%-1% of the contract value.
Cost Influencing Factors
The contractor’s financial strength is the main factor in this bond pricing. The higher the contractor’s credit score, financial statements, and previous track record are, the lower the premium cost will be.
Project complexity and its risk are also significant factors, which affect the overall cost of the performance bond. For example, unique projects or technically challenging projects will cost more than a simple construction job.
Who Is Paying for Performance Bonds?
The contractor is covering the performance bond premium. However, the contractor is the only one who is paying it from their pocket. It is very common for a contractor to build the cost of a performance bond into their project bid. The project owner will pay for the performance bond indirectly through the contractor’s price.
But here’s the thing…
The cost of performance bonds is almost nothing compared to the possible cost of the contractor’s default. Surety companies have paid over $10 billion on contract bond claims since 1992 – money that would have otherwise come from project owners’ pockets.
Performance Bonds Requirements
Not every project requires a performance bond. Some do, some don’t.
Federal Projects
Miller Act requires performance bonds for all construction projects which are funded federally and are over $100,000. The law has been protecting the taxpayers from any form of contractor’s default since 1935.
State and Local Projects
Most states and local governments have their bond requirements. The amount may vary; however, most of the states require a performance bond for projects which are over $25,000 – $50,000.
Private Projects
Even private project owners are more and more frequently requiring performance bonds for the projects, which they are financing. For the larger projects, banks and other lenders will mandate a performance bond.
Best Practice
Even when it is not required by the law, a performance bond for any serious construction project is still a brilliant idea. For example:
- All projects over $500,000.
- Complex or specialized work.
- Projects with tight deadlines.
- Work by new contractors.
- Projects, for which a delay would be expensive.
It is important to know that performance bonds protect you not only from the risk of total contractor failure but also from partial completion of work, poor quality workmanship, and project delay.
The Common Misconceptions About Performance Bonds
Let me set the record straight on some of the confusion around performance bonds that I see all the time…
“Bonds Are Too Expensive”
Only 35.9% of construction businesses that started since March 2011 remained in operation by March 2022. The cost of a performance bond is nothing in comparison to a failed project’s cost.
“Small Projects Don’t Need Bonds”
The size of the project will not eliminate all of the risks. Small projects can fail as well, and the financial impact can be just as devastating in proportion.
“Bonds Slow Down Projects”
If we have to be honest, then performance bonds can speed up the project as you will be sure that you are working with financially stable and qualified contractors from the very beginning.
Making Performance Bonds Work for You
Performance bonds are more than just another requirement on a checklist. They are an investment in project success.
Work with experienced surety professionals who can guide you through the process and help you structure appropriate bond requirements.
Remember that the goal is not just protection. The goal is peace of mind knowing your project will be completed on time, on budget, and to your specifications.
Ready to Take the Next Step?
Performance bonds are not an optional accessory for your serious construction project. They are a must-have protection for every investor.
Performance bonds transfer risk, ensure quality, and provide financial security when things go from bad to worse.
The construction industry is inherently risky. Smart project owners use performance bonds to manage that risk and protect their investments.
Don’t let your next project join the 70% failure statistic. Make performance bonds a requirement, and make sure that your project is finished successfully.
