Letter of Credit Replacement Surety
Why You Should Replace Your Letter of Credit with a Surety Bond
It is a requirement of many businesses, big and small, to provide security to the government or other enterprises in the form of a Letter of Credit as a way of guaranteeing they will meet their performance obligations. However, keeping large sums of money tied up by a letter of credit restricts your access to cash and ultimately hurts operations. For most, this is not a preferred or viable option. By using a surety bond instead of a letter of credit your business is able to free up this capital, which may be crucial to your company’s operations.
To better understand this, let’s start by comparing a Letter of Credit to a Surety Bond.
What is a Letter of Credit?
A letter of credit is issued by a bank to the ‘beneficiary’ to serve as a guarantee for the performance of a construction or supply contract. In order to obtain an LOC, a bank often freezes the buyer’s liquid assets in the total amount of the LOC. The buyer is then unable to access these funds until the bank releases the LOC. If a buyer does not fulfill his obligations to the beneficiary of the LOC, the beneficiary is able to cash in the LOC to access the funds on demand without consultation.
What is a Surety Bond?
A surety bond on the other hand is a three-party agreement between a principal a project owner and a surety. The bond represents a promise by a surety or guarantor to pay the project owner a certain amount if the principal fails to meet some obligation, such as fulfilling the terms of a contract. If a principal does not complete his or her obligations, the owner can make a claim under the bond. At this time, the surety will complete a thorough investigation to determine the validity of the claim. Surety bonds are not on-demand instruments.
Reasons to replace your Letter of Credit with a Surety Bond today:
- Free up your cash
Surety bonds are issued in place of the LOC thus freeing up any cash that was being held by your financial institution as security.
- Free up your credit
LOCs are often issued under a company’s credit facility. By replacing the LOC with a bond this credit will be available for future needs.
- Re-invest & grow
With your cash back in hand you can use this new found liquidity to continue re-investing in the growth of your company.
- Minimize risk
Owners can decide to cash in an LOC at any time. With Surety Bonds, if the owner decides to make a claim against the bond, the bond company will first complete a full investigation of the claim. This involves listening to both sides of the argument before determining how best to move forward.
- Stronger defense
If a claim is made against a surety bond, the surety company will work with your business to help you defend the claim. They are on your side with your shared interest in mind.
- Rates & fees
Surety rates are often less than what a bank is charging for your LOC, which often includes hidden fees throughout the duration of the LOC.
- Improved financial statements
Typically bonds are not included on your financial statements, while outstanding LOCs are. This can help with future applications for additional credit and or surety needs.
How does this work?
In today’s market place, it has never been easier to obtain a bond. Surety Bonds are underwritten by Insurance companies commonly known as a “Bond Company”. There is a qualification process that the applicants must go through in order to qualify for a bond facility. This involves providing financial information about the company and its owners as well as information about the history of the company and its relevant experience. Bonds are underwritten based on the strength (financial and professional experience) and character of the company and its principals. The bond company relies on the indemnity of the corporation and does not usually require further collateral.