An advance payment bond, which can also be referred to as a cash guarantee, is a common occurrence in commercial contracts. The point of an advance payment bond is to ensure that when the company doing the work receives payment, they complete the job as promised. This type of bond also guarantees that the recipient of the payment will return it if they fail to deliver the promised goods or services.
Keep reading to learn more about what advance payment bonds are and how they work.
Advance payment bonds can apply to many different industries, such as the construction industry. The goal of an advance payment bond is to ensure the payer receives the work product they received payment for. It’s understandable that a business or contractor would want to receive payment upfront for a long term project, but it’s also understandable that a client may feel nervous about making a large payment before they receive the work product they’re paying for. An advance payment bond can protect the payer allowing the payee to receive payment before finishing their work, which can help them better manage their cash flow.
Some examples of companies that often need to take out an advance payment bond include:
● Travel agencies
● Auto dealership bonds
● Construction companies
● Collection agencies
● Health clubs
● Public notaries
● Durable medical equipment providers
This is where an advance payment bond can really come in handy. When the business receiving payment has an advance payment bond, the payer can rest easy knowing that if they don’t receive the work product they paid for that they can file a claim against the bond.
There are three parties involved in an advance payment bond, the surety, principal, and obligee. The surety is the company that issues and backs the bond—this is also the party who pays out claims to the victim. The principal is the party who buys the advance payment bond. The obligee is the party who requires the principal to hold the bond (this is often a state government or licensing board).
The way that an advance payment bond works is that if the payee fails to deliver the promised work product, then the payer can file a claim against the advance payment bond and the surety company that issued the bond will cover the loss if the claim is valid. The bonded company will have to pay the surety back for this amount.
Depending on the industry you work in and the state you run your business in, having an advance payment bond may be required in order to become licensed. This is a common requirement for contractors.
It’s easy to confuse an advance payment bond with a performance payment bond. A performance payment bond is a written statement given by the contractor that he will repay or settle the advanced cash paid by the owner related to the contract. An advance payment bond on the other hand ensures that the principal will perform his obligation as mentioned in the contract. If the contractor fails to complete the project as promised, the client can then file a claim against the advance payment bond.
How much advance payment bonds cost depends on quite a few factors including the required bonding capacity (the highest amount a claim can be filed against the bond) and the state of your business and personal finances.
In particular, your personal credit score plays a large role in how much you will spend to secure an advance payment bond. This is because your credit score is impacted by how often you make your debt payments on time. If you have a strong history of on-time payments and a good overall credit score, the surety can feel confident you’re likely to pay them back if a claim does end up being filed against your advance payment bond. Because of this, they’re likely to charge you less for your bond.
How advance payment bond pricing works is you pay a small percentage of the bonding capacity. The strength of your personal and business finances affects the rate you’re given. The stronger your financial history and business finances are, the lower the rate you’ll be offered. This is where your personal credit score (your business credit score can also be taken into account too) plays a major role. The higher your credit score is, the lower a percentage you’ll have to pay and the lower your bond premium (aka how much you’ll spend each bond term to secure the bond) will cost you. If you can, spend some time working on improving your credit score before you apply for a new advance payment bond or before you renew an existing bond so you can work towards a lower rate.