Prequalify Subcontractors and Protect Your Profitability

If you're a general contractor, the business acumen and financial strength — or weakness — of a subcontractor can affect your ability to deliver a quality project on time and within budget. Delays caused by a subcontractor's failure to complete work can lead to scheduling delays, cost overruns and even the dreaded "profit fade."

It's not always easy to identify unreliable subcontractors. A prequalification program can help you determine whether what looks like an ideal partnership is, in fact, a risky proposition.

Make Annual Assessments

State licensing agencies require contractors planning to bid on public projects to submit financial and other information for prequalification, and then they must annually maintain their status if they win the bid. Many general contractors use the same process to prequalify subcontractors before using them on larger construction projects.

You can ask for information from subcontractors in requests for proposals or during the request for qualifications process. But consider performing annual prequalification assessments of all frequently used subcontractors. You may want to ask for information even more often during tough financial times, such as those triggered by the COVID-19 pandemic. This process should provide insight into your subcontractors' current cash flows, backlogs, bonding capacities and succession plans.

Get the Information You Need

Two construction workers wearing hard hats and orange vests

In addition to soliciting general company information — for example, on ownership, management and certifications — ask subcontractors to submit the following:

Financial statements. Income and cash-flow statements and balance sheets can reveal unusual or concerning trends in profitability or liquidity. Work with a CPA to confirm that financial statements are complete and conform to Generally Accepted Accounting Principles. Be sure to review backlog levels relative to working capital and note whether subcontractors have enough cash to keep their businesses going and that their accounts receivable are collectable. Also make sure the business owners are maintaining enough equity in their companies.

Letter of bondability. This letter from a surety should outline both single-project and aggregate amounts it's willing to issue to the subcontractor as a performance and payment bond.

Line of credit letter. Issued by a bank or other financial institution, this letter conveys the subcontractor's financial stability by stating the amount of credit for which it has qualified.

Safety history. Supporting documentation should include OSHA record-keeping forms 300 and 300A (for time loss because of work-related injuries and illness) and experience modification rate verification from the subcontractor's workers' compensation carrier for the past two or three years. Also review any subcontractor's safety program to ensure it aligns with your expectations or standards.

Certificates of insurance. Ensuring a subcontractor has appropriate insurance coverage can help prevent defaults and delays. Your insurer should review the subcontractor's automobile, professional liability and workers' compensation policies, as well as any other coverage pertinent to the project.

Letters of recommendation. Don't just ask for references — follow up on them. Request references from general contractors of recently completed jobs similar in size and scope to the type of projects you do. Find out whether projects were completed on schedule and on budget. Were there safety, communication or other issues that would make a reference provider think twice about using the subcontractor again? Also ask for supplier references to ensure the subcontractor has a history of paying vendors on time and in full. Finally, if applicable, request a letter of good standing from a labor union.

List of current projects. Make sure you understand a subcontractor's current commitments — including contract values, locations, square footage, estimated dates of completion and staffing levels. Doing so will help you avoid making the mistake of partnering with a subcontractor who's overextended and doesn't have the labor or financial resources for your project. One way to learn about a subcontractor's capacity is to ask how many workers it has hired in the past six months. A high number could indicate unsustainable growth.

Minimize Your Risk

A comprehensive subcontractor prequalification process can give you a clearer picture of a potential project partner's financial stability and professional reputation. If your due diligence reveals uncertainties, you could look elsewhere or take steps to minimize your risk. For example, you might require performance bonds or contract value limits. Contact us for help with this important process.

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