Written by Richard Zehr
BBA, CAIB, President, Zehr Insurance
Why Project Owners and Contractors Prefer Bonds
When project owners require financial security from a contractor, two instruments are often discussed: surety bonds and letters of credit (LOCs). While both are designed to protect the owner, they function very differently—and those differences can have a meaningful impact on a contractor’s credibility, cash flow, and ability to successfully complete a project.
A surety bond is purchased in addition to your commercial insurance policy and offers advantages that go well beyond simple financial backing, benefiting not only the project owner but also the contractor throughout the life of the project.
1. Third-Party Credibility: What Bonding Signals to Project Owners
A surety bond is not just a financial instrument—it is a third-party endorsement of the contractor’s character, capacity, and capital. Which is also known as The Three C’s of Surety Bonding.
Before issuing a bond, a surety company will underwrite the contractor on the basis of The Three C’s.
Character: Reputation and Integrity
- Does the contractor have stable and tenured team members indicating a strong business relationship amongst the team?
- Does the contractor have a strong reputation within the construction industry? This goes beyond Google reviews and may include interviews with references
Capacity: Ability to Perform Obligations
- This is the experience and operational performance of the company. Does the contractor own or have experience in operating the equipment required to complete a project? Building a multi-level residential complex is very different from road construction
Capital: Financial Strength
- What is the financial history of the business and is there enough cash flow from existing projects to support ongoing obligations to new projects or unexpected delays and expenses on backlog
When a surety issues a bond, it is effectively saying to the project owner:
“This contractor has been vetted and is capable of completing this project as agreed.”
A letter of credit does not provide this level of assurance. An LOC is purely a bank instrument—it confirms that funds are available, but it does not assess whether the contractor has the expertise, systems, or capacity to perform the work.
For owners, a bond provides confidence in both performance and financial stability.
For contractors, it enhances professional credibility and can be a competitive advantage when bidding work.
2. Improved Cash Flow: Bonds Do Not Tie Up Capital
One of the most significant advantages of a surety bond over a letter of credit is its impact on cash flow and borrowing capacity.
Letters of Credit
- Reduce available operating lines or credit facilities
- Tie up cash or collateral at the bank
- Can restrict a contractor’s ability to fund payroll, materials, or additional projects
- Are not a liquid instrument available to free up cash on another project
Surety Bonds
- Do not require cash to be posted upfront
- Do not encumber bank credit lines in the same way
- Allow contractors to preserve working capital for day-to-day operations
Construction projects are cash-intensive by nature. Using a bond instead of an LOC helps ensure that capital remains available to pay suppliers, manage labour costs, and absorb normal project fluctuations.
In many cases, contractors who rely heavily on letters of credit find that growth is constrained—not by opportunity, but by restricted liquidity. When liquidity is a concern for a business this impacts the ability to replace or expand aging equipment. Liquidity can also cause issues related to payroll and retaining or expanding talented team members within the organization leading to the inability to expand workload and secure new projects.
3. Support When Challenges Arise: A Surety Is a Partner, Not Just Security
Perhaps the most misunderstood advantage of a surety bond is what happens if unexpected financial or operational challenges arise during a project.
A letter of credit is binary
- If there is a problem, the owner draws on the LOC.
- Funds are removed from the contractor, often worsening the situation.
- There is no assistance, guidance, or recovery plan.
A surety bond works differently and the surety may step in as a partner or advisor for the contractor to work through a sudden decline in operational performance.
How a Surety Helps in Real-World Scenarios
If a contractor experiences cash flow stress due to factors such as:
- Delayed payments
- Material price escalation
- Labour shortages
- Unforeseen site conditions
When examining how the surety may assist you as the contractor, it is important to understand that the surety’s objective is project completion, not immediate payout.
Depending on the situation, a surety may:
- Provide financial support or advance funds
- Assist with restructuring project cash flow
- Help arrange subcontractor or supplier continuity
- Work collaboratively with the contractor and owner to complete the project
This proactive involvement often prevents default on the project altogether and results in a finished project with minimal disruption which is a far better outcome for all parties involved.
4. Alignment of Interests: Completion Over Liquidation
At its core, a surety bond aligns the interests of all parties to the contract.
- The project owner wants the project completed
- The contractor wants to protect their reputation and business
- The surety wants to avoid a loss by ensuring successful completion
A letter of credit simply transfers funds after a problem occurs.
A surety bond focuses on preventing failure and delivering the project.
Surety Bonds to Free Up Cashflow
While letters of credit may appear straightforward, they often come at the expense of cash flow, borrowing capacity, and long-term growth. Surety bonds, by contrast, provide:
- Independent third-party validation of the contractor
- Strong protection for project owners
- Improved liquidity for contractors
- A partner committed to successful project completion
For contractors looking to grow responsibly—and for owners seeking confidence beyond a balance sheet—surety bonds remain the gold standard of project security.
At Zehr Insurance we work closely with contractors seeking to free up cash flow through the utilization of surety bonds. Surety bonds are not meant only for large national contracting companies. Contractors of many sizes may benefit from the use of surety bonds. If you are considering a bonding facility, please contact our office.
Call Zehr Insurance brokers and see if we can help you with your insurance needs.
