Franchisees, Franchisors: Do You Need a Surety Bond?

Fledgling franchisees and franchisors across the nation have a lot to juggle, from the new financial and time commitments to the potential strain on family and friends. In some registration states such as California, Illinois, Maryland and Virginia, new franchisors have an additional challenge. When they submit their FDDs for approval, state examiners may deem that franchisors can’t take money from franchisees until the initial training program is completed or until the franchise commences operations. Franchisors, however, often have other two options:

  • They can put the money in an escrow account, or
  • They can purchase a surety bond.

Surety bonds are crucial risk management and mitigation tools that have become increasingly important in recent months, on the heels of new demands for consumer protection. The shock-waves of economic scandals and crisis have made proper bonding all the more important — not just from a legal standpoint but a competitive advantage one, too. Surety bonds can also serve as credibility-boosting agents with prospective consumers. They can also help franchisees set themselves apart from competitors in their sphere.

The Surety Bond Basics
In essence, surety bonds help ensure that companies follow applicable laws and regulations. They also give consumers and other stakeholders a way to seek economic redress in the event they’re harmed. Surety bonds are three-party agreements between a surety company, a principal (the company doing the work or performing a service) and the obligee (the recipient of the work or the entity requiring the bond).

Here’s a quick example. Health clubs, in most states, are required to post a surety bond with the state Attorney General’s office. The bond basically ensures that club members can recoup membership fees if the club shuts down unexpectedly. That’s an important benefit because many clubs charge large pre-paid membership fees. So, if the club goes belly up, members can file a claim against the bond and seek to recover their money.

Why Bonds Matter
Health clubs are one of hundreds of business types and industries that require surety bonds in order to operate legally. It’s important for franchisees to understand the costs and requirements going in. But it’s equally important for them to know the benefits.

Surety bonds aren’t always required for entrepreneurs. But these tools can go a long way toward boosting consumer confidence and creating some separation from competitors. The reality is that stamping the phrase “properly bonded” on a business card can make a world of difference for consumers hungry for protection and beleaguered by financial scandals and a shaky national economy. On top of that, surety bonds can protect franchisees themselves. There’s a whole vein of bonds geared toward insulating business owners from harm in the event their employees commit acts of theft or otherwise harm consumers. These fidelity bonds can be a life saver for franchisees.

Surety Bond Costs
It’s difficult to pinpoint an exact cost for surety bonds because it will vary based on the type of bond you want and your own financial standing. Purchasing a surety bond is somewhat similar to obtaining a loan, in that there’s an underwriting process involved. Surety underwriters will look at an applicant’s credit history, finances and other pertinent information before rendering a decision.

Bond amounts will also change depending on where you live and the type of bond. For an example of New York surety bonds, consider the health club bonds mentioned earlier. A health club in New York state is required to purchase a $50,000 surety bond if it offers consumers a 12-month membership. That bond amount rises to $100,000 for a contract of 12-24 months.

It’s important for franchisees to remember that they’re not shouldering the entire bond amount. Instead, bond purchasers pay a premium, typically 1 to 3 percent of the bond value. That rate will increase for applicants with credit or financial problems. Insurance companies and surety bond carriers can issue surety bonds. Some low-impact bonds can be processed within a matter of hours. Others might require a bit more time.

A Final Note
Franchisees should put together a complete financial application when the time comes to apply for surety bonds. New entrepreneurs can struggle at times to find competitive rates when they lack a significant fiscal record as a business owner. That’s where the franchisor can help make the difference.
At the same time, franchisees should explore all of their options when considering bonding companies. Rates can shift among providers, who will all bring a slightly different underwriting approach to the table. It’s best to shop around for the best rate while making sure to work with a professional, trustworthy surety agent.

To learn more about surety bonds go to