Bid bonds and performance bonds are both types of construction surety bonds that act as a level of financial protection for the client of a construction company, and help prospective clients to see the level of legitimacy and financial stability of a construction company. Although bid bonds and performance bonds are similar, they have some differences.
Bid Bond Definition
A bid bond is a construction surety that a construction company agrees to pay in order to get a construction project. It is called a bid bond because it is used by the client to pick from among various construction companies who are all competing to get the job -- each construction company makes a bid on the job and purchases a bond to back up that bid. In this bid, each construction company stipulates the costs and time frame under which the project will proceed. If the construction firm that gets the job ends up not being able to deliver, the value of that company's bid bond goes to the client to make up for trouble and lost time. The value of a bid bond is usually determined by the difference between the lowest bidder's price and the next lowest bidder's price.
Performance Bond Definition
A performance bond is something that a contractor purchases to act as a surety that the construction company will finish the project under the stipulations of the contract. If something causes the contractor to not be able to finish the project -- for instance, if the contractor goes out of business -- the surety agrees to pay for the completion of the contract. It may do this directly or through the client. Performance bonds can also be used to protect the interests of subcontractors who have agreements with the primary contractor.
It is not necessary to choose between a bid bond and a construction bond, as they cover different aspects of construction surety. By requiring all bidders to submit bid bonds, clients use bid bonds as a way of sifting out the unreliable contractors from the serious ones. For this reason, every bidder must submit a bid bond, regardless of whether or not he actually gets the job. On the other hand, a performance bond is something that only the winning bidder must submit. As the submission of a performance bond is part of getting the project under way, failure to do so can result in the contractor losing the job and the client collecting on that contractor's bid bond.
Although construction sureties like bid bonds and performance bonds place an added burden on construction companies, the existence of this system can be very beneficial to contractors who do their work well, manage their finances and meet expectations. The existence of bid bonds helps to protect serious construction firms from being undercut by unprofessional firms that quote unrealistically low prices. Similarly, performance bonds increase the total amount of available construction jobs by minimizing the financial risks clients face when they decide to hire construction contractors.