In the midst of tornado season and as oil spills into the Gulf of Mexico, small businesses nationwide look to operate in battered regions. A number of changes proposed by the Small Business Administration plan to help small and minority contractors land large contracts in disaster areas by increasing surety bond guarantee limits.

Plan Details
The SBA’s most significant proposals:

• Non-federal contracts and orders up to $5 million may earn a bond if the product will be made or service will be provided in the disaster area.

• The performance site need not be in the disaster area if a federal contract or order up to $5 million will directly assist the area.

• Agency heads who are involved with reconstruction efforts can request guarantees for contracts or orders up to $10 million.

Although the American Recovery and Reinvestment Act of 2009 included surety bond increases, these hikes pitched by the SBA plan to add to those in the act. Should these new limits take effect, the higher bond guarantee limits last for one year after the declaration of a disaster unless the SBA extends the duration for a particular disaster.

“These proposed changes are one more way we can help small businesses, particularly in the construction and service sectors, compete for and win critical contracting opportunities that help them grow their business and create jobs,” said Karen Mills, the SBA administrator, in a press release.

An office within the SBA
Since 1971, the SBA has worked with the surety industry so small service-sector and construction companies could get bonds otherwise unavailable in the commercial market. In creating this public-private relationship, the SBA’s Office of Surety Guarantees manages the Surety Bond Guarantee program. By backing a certain percentage of bonds, the SBA gives surety companies the confidence to issues bonds.

When contractors default on a project, the SBA recompenses the sureties a certain percentage of the bond amount. The Prior Approval program and the Preferred Surety Bond program guarantee 90 percent and 70 percent of surety’s loss, respectively. Last year the SBA raised the limit on bonds to $5 million from $2 million. In some cases, the SBA will guarantee bonds up to $10 million. These heightened maximums remain in effect through September 2010.

Surety bonds do not protect bond holders against a loss. Instead they repay the obligee when contractors default. The surety then seeks repayment from the contractor. With SBA surety bonds, the surety companies are actually the obligees and the government is the surety.

The SBA made it clear in its proposal that any insurance or indemnification costs in a bonded contract are not its responsibility, and therefore the SBA will not cover those costs. Businesses can find a list of recently declared disasters on the Federal Emergency Management Agency’s website.

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Small business owners have drained the Small Business Administration’s two most popular loan programs of excess stimulus funds, a shortage that could send loan volumes tumbling without government action.

Hoping to spur small business growth, the federal government earlier this year injected about $375 million into the SBA’s 7(a) and 504 loan programs. The influx aimed to curb fees on SBA loans and boost the administration’s loan guarantees to 90 percent for some programs.

Fighting a tight credit market, thousands of entrepreneurs flocked to the funding. As of Monday, the SBA had exhausted the entire $375 million allotment. Now, business owners nationwide are waiting to see if a crucial source of financial stability is gone for good.

“We are continuing to work with Congress on funds to continue these programs, which have helped engineer a turnaround in SBA lending following last year’s credit crunch and resulted in more than 40,000 loans to small businesses during these tough economic times,” Jonathan Swain, assistant administrator for communications and public liaison at the U.S. Small Business Administration, told reporters this week.

The government is looking for ways to keep the program upgrades going through mid-February. Initial estimates put the price tag around $100 million.

In the mean time, the SBA started a waiting list for companies that can afford to hold off for funding lines to be re-established. Companies with conditional approval can get a spot in the Recovery Loan Queue.

President Obama is expected to push Congress in the coming weeks to restart funding for these key SBA loan programs.

In all, the SBA has received more than $730 million in federal stimulus dollars.

Small business owners who work on projects requiring surety bonds have received a boost from the federal government.

The Small Business Administration can now guarantee bonds on contracts up to $5 million for small businesses that otherwise struggled to obtain surety bonds through traditional channels. This temporary increase – a full $3 million higher than the previous limit – will remain in place through September 2010.

There are even special cases where the SBA will guarantee all surety bond types on contracts valued up to $10 million, provided the contracting officer certifies that the guarantee is in the best interests of the government.

These temporary increases are aimed at helping spur recovery in the construction and service industries. Because of their size, small businesses are at times at a competitive disadvantage when competing for government contracts. These expanded guarantees provide an additional layer of financial security for both smaller firms and project owners – the SBA reimburses anywhere from 70 to 90 percent of the costs incurred if a contractor defaults.

“Raising the surety bond limit is a critical step in making sure small businesses in the construction and service sector have access to federal contracting opportunities that will help drive economic recovery,” SBA Administrator Karen Mills said in a news release. “These changes support small and emerging businesses nationwide, particularly construction contractors who have seen their markets hurt by a poor economy and lagging construction.”

Surety bonds are basically three-party agreements that guarantee a project will be completed. They also provide financial protection for project owners in the event of default or some other debilitating development. The SBA’s guarantee covers four types of common contract bonds:

Bid Bond – guarantees the bidder will enter into the contract and provide payment and performance bonds.
Payment Bond – guarantees the contractor will pay all laborers and suppliers.
Performance Bond – guarantees the contractor will follow contract and all applicable terms and regulations
Ancillary Bond – bonds that are incidental and essential to the performance of the contract.

Entrepreneurs interested in utilizing the program must qualify as a small business within their industry, as defined by the North American Industry Classification System (NAICS) Code. They will also have to meet the financial requirements of an individual surety company – the SBA does not issue bonds.

Contractors will have to provide financial documentation and credit histories when applying for a surety bond. Consumers can see a list of participating surety companies and agents here.

Bond costs vary depending on an applicant’s financial status and the individual surety. Contractors will be on the hook for a bond premium. The SBA also charges the applicant a fee of $7.29 per $1,000 dollars of the contract amount.