Why Financial Stability Matters When Choosing a Subcontractor
For general contractors evaluating subcontractor bids, the lowest number on the spreadsheet isn't always the best number for your project. In fact, that rock-bottom bid might be the most expensive decision you make—especially if it comes from a financially unstable subcontractor who can't finish the job.
Financial stability isn't just a nice-to-have characteristic for subcontractors. It's a fundamental requirement that directly affects your project schedule, budget, quality, and reputation. Yet many general contractors don't adequately assess financial health until after problems surface—by which point the damage is done.
Let's explore why subcontractor financial stability matters so much, what warning signs indicate trouble, how to evaluate financial health effectively, and what questions you should be asking before signing those subcontracts.
The True Cost of Financially Unstable Subcontractors
When a subcontractor's financial foundation starts cracking, the problems multiply quickly—and general contractors bear most of the consequences.
Project Delays and Schedule Disruptions
Financially stressed subcontractors struggle to maintain adequate cash flow to purchase materials, make payroll, or maintain equipment. The result? Delays that cascade through your entire schedule.
Common scenarios:
Materials aren't ordered on time because the sub can't pay suppliers
Crews don't show up because paychecks bounced
Equipment rentals are returned when payments lapse
The subcontractor suddenly declares bankruptcy mid-project
According to construction industry data, replacing a failed subcontractor typically adds 4-8 weeks to project schedules while you find a replacement, get them up to speed, and address any substandard work the original sub left behind. On a project with liquidated damages of $5,000 per day, an 8-week delay costs $280,000—far more than the savings from that low bid.
Quality and Workmanship Problems
When subcontractors face financial pressure, quality suffers. They cut corners to reduce costs, use cheaper materials than specified, reduce crew sizes beyond what's adequate, or rush work to move on to the next paying job.
The construction industry sees this pattern repeatedly: a subcontractor underbids to win work they desperately need, realizes mid-project they can't make money at the bid price, and starts cutting corners to minimize losses. By the time quality issues surface, they've moved on or disappeared entirely.
Payment and Legal Issues
Financially unstable subcontractors create payment nightmares:
Mechanics' liens: When subs can't pay their suppliers or lower-tier subcontractors, those entities may file mechanics' liens against the property—putting the owner's title at risk and your payment in jeopardy.
Bond claims: If the sub is bonded, you may need to file claims to get the work completed, involving weeks of paperwork, disputes, and legal maneuvering.
Payment disputes: Cash-strapped subs often dispute payment terms, delay invoice submissions, or claim extras to generate desperately-needed cash flow.
Collection efforts: If you've paid a sub who then doesn't pay their suppliers, those suppliers may look to you for payment (depending on state mechanics' lien laws).
According to construction financial data, payment-related disputes cost GCs an average of $25,000-$75,000 in legal fees, administrative time, and carrying costs—even when the GC ultimately prevails.
Reputation Damage
Your reputation depends on delivering projects on time, on budget, and to quality standards. When a financially unstable subcontractor fails, it's your company's reputation that suffers, not theirs.
Building owners don't care why the project is delayed or over budget—they care that you, as the general contractor, didn't deliver as promised. Architects don't care why quality is substandard—they care that the building doesn't meet their specifications.
One bad subcontractor can cost you future projects with that owner, referrals to other potential clients, and your standing with the design team. The reputational damage often exceeds the direct financial costs.
Increased Insurance and Bonding Costs
When problems with subcontractors lead to claims, your experience modification rate (EMR) increases, driving up insurance premiums. Surety companies notice subcontractor failures on your projects and may increase bonding costs or reduce bonding capacity.
Over time, a pattern of subcontractor problems makes you appear to be a higher risk, even though the underlying issue was the subs' financial instability rather than your project management.
Why Subcontractors Fail: Understanding the Root Causes
To identify financially at-risk subcontractors, it helps to understand why construction companies fail financially.
Undercapitalization
Many subcontractors start businesses without adequate capital reserves. They're skilled tradespeople who don't understand the cash flow demands of running a contracting business. When they encounter normal business challenges—delayed payments, unexpected costs, equipment repairs—they lack the financial cushion to weather the storm.
Industry data suggests that under-capitalized companies represent the highest failure risk, particularly in their first five years of operation.
Poor Financial Management
Some subcontractors excel at their trade but struggle with financial management:
Inaccurate estimating leading to consistent losses
Failure to track job costs in real time
Poor accounts receivable management letting receivables age
Inadequate cash flow forecasting
Weak financial controls allowing waste and fraud
These companies may appear busy and successful while slowly bleeding money on every project.
Overexpansion
Rapid growth strains working capital. Subcontractors who expand too quickly often find themselves unable to finance the receivables and materials needed for multiple concurrent projects. They rob Peter to pay Paul, delaying material purchases on one project to pay labor on another.
Eventually, the juggling act fails and multiple projects suffer simultaneously.
Economic Shocks
Even well-managed subcontractors can face financial distress from external factors:
Material cost escalations that outpace contract adjustments
Client bankruptcies leaving large receivables uncollected
Tariffs and trade policies affecting material costs
Labor shortages forcing wage increases beyond what contracts allow
Economic downturns reducing work volume
The difference is that financially strong companies can absorb these shocks, while weak companies spiral into crisis.
Red Flags: Warning Signs of Financial Instability
Smart general contractors watch for warning signs that indicate a subcontractor may be financially stressed:
Behavioral Red Flags
Aggressive low bidding: Consistently bidding 15-25% below market rates suggests either unrealistic estimating or desperation for work at any price—both indicators of future problems.
Payment pressure: Requesting payment in advance, pushing for early payment before work is complete, or demanding payment on incomplete work ahead of schedule all signal cash flow problems.
Scope disputes: Constantly claiming extras, disputing scope boundaries, or looking for change orders on straightforward work often indicates the sub underbid and is trying to recover losses.
Communication problems: Unreturned calls, missed meetings, vague responses about schedule or progress, or difficulty reaching decision-makers suggest the company is distracted by bigger problems.
Crew changes: High turnover, unfamiliar crews showing up, or different foremen on consecutive days indicate payroll problems or inability to retain qualified workers.
Operational Red Flags
Material delivery problems: Suppliers requiring cash on delivery (COD) instead of extending credit indicates the sub's credit accounts have been closed due to non-payment.
Equipment issues: Using old, poorly maintained equipment, or renting equipment short-term rather than owning indicates inability to invest in the business.
Insurance lapses: Any lapse in required insurance coverage is a critical red flag—insurers don't cancel policies without reason, usually non-payment.
Bonding problems: Difficulty providing required bonds or switching surety companies suggests bonding capacity issues.
Subcontractor churn: Constantly changing which lower-tier subs or suppliers they use indicates they've burned bridges due to payment issues.
Legal and Credit Red Flags
Mechanics' liens: Any history of mechanics' liens filed against properties where they've worked indicates payment problems with their subs or suppliers.
Litigation: Active lawsuits for payment collection, breach of contract, or defective work signal ongoing problems.
Bankruptcy: Any bankruptcy history, even if resolved, deserves careful scrutiny about current financial health.
Credit reports: Poor credit scores, high debt-to-equity ratios, or concerning trade references all indicate financial stress.
Tax liens: IRS or state tax liens demonstrate inability to pay payroll taxes—one of the most serious financial red flags.
How to Evaluate Subcontractor Financial Stability
General contractors should implement systematic processes for assessing subcontractor financial health before awarding contracts.
Prequalification Process
Establish formal prequalification requirements for all subcontractors above a certain contract value (typically $50,000+):
Financial statements: Request audited or reviewed financial statements for the past three years, including:
Balance sheet showing assets, liabilities, and equity
Income statement showing revenue and profitability
Cash flow statement showing sources and uses of cash
Notes explaining significant items or changes
Key financial ratios to calculate:
Current ratio (current assets ÷ current liabilities): Measures ability to pay short-term obligations. Healthy contractors maintain 1.5-2.5 or higher.
Quick ratio (liquid assets ÷ current liabilities): Measures immediate liquidity without relying on inventory sales. Should be above 1.0.
Debt-to-equity ratio (total debt ÷ total equity): Measures leverage. Ratios above 2.0 indicate high leverage and increased risk.
Working capital (current assets - current liabilities): Absolute dollars available for operations. Should be adequate for the contract value you're considering.
Credit and Reference Checks
Bank references: Contact the subcontractor's bank to verify account standing, typical balances, and creditworthiness. Banks won't disclose specific numbers but will confirm the relationship is in good standing.
Supplier references: Call 3-5 major suppliers to ask about payment history, credit limits, and any payment issues. Suppliers often provide candid assessments.
Surety references: If the sub has bonding capacity, contact their surety to verify bonding limits and claims history.
Trade references: Contact other general contractors who've recently worked with the sub to ask about performance, payment issues, and whether they'd hire them again.
Background Research
Credit reports: Obtain commercial credit reports from Dun & Bradstreet, Experian, or similar services showing payment history and credit score.
Lien searches: Check county recorder offices for any mechanics' liens filed by or against the subcontractor.
Court records: Search for lawsuits, judgments, or bankruptcy filings. Many counties offer online access to court records.
Contractor licensing: Verify licenses are current and check for any disciplinary actions or complaints.
Insurance verification: Request certificates of insurance and verify coverage directly with insurance companies—don't rely on certificates alone.
Bonding Capacity Assessment
For larger contracts, require payment and performance bonds. A subcontractor's ability to obtain bonding provides independent third-party validation of financial strength.
Bonding indicators of financial health:
Surety companies conduct thorough financial reviews before issuing bonds
Bonding capacity (maximum contract value they can bond) indicates financial strength
Single-project bonding limits show per-project capacity
Aggregate bonding limits show total work-in-progress capacity
If a subcontractor can't provide required bonds, that's definitive evidence of financial problems—surety companies don't reject viable contractors.
Red Flag Matrix
Create a scoring system weighing various financial factors:
Green Light (Low Risk)
Positive working capital exceeding 25% of contract value
Current ratio above 2.0
Profitable for past 3 years
Clean credit and lien history
Adequate bonding capacity
Strong references
Yellow Light (Moderate Risk)
Marginal working capital (10-25% of contract value)
Current ratio 1.2-2.0
Profitable 2 of past 3 years
Minor credit issues resolved
Some bonding capacity
Mixed references
Red Light (High Risk)
Insufficient working capital (<10% of contract value)
Current ratio below 1.2
Losses in recent years
Active liens or legal issues
No bonding capacity
Negative references
Use this matrix to guide decisions about which subcontractors to hire and what risk management strategies to employ.
Risk Management Strategies for Working with Subcontractors
Even after careful evaluation, general contractors should implement risk management practices to protect against subcontractor financial failures.
Contract Provisions
Joint check agreements: Pay certain suppliers directly rather than through the sub to ensure material suppliers get paid.
Lien waivers: Require conditional and unconditional lien waivers from the sub and all their suppliers/lower-tier subs before making payments.
Payment timing: Structure payment schedules to maintain leverage—never pay ahead of work completion.
Retention: Hold 5-10% retention until final completion and lien waiver period expires.
Termination rights: Include clear termination provisions for cause, including financial instability indicators like missed payroll or unpaid suppliers.
Assignment prohibition: Prevent the sub from assigning the contract without your approval—prevents sale to weaker entity.
Payment Controls
Progress verification: Never pay based on invoices alone—walk the job and verify work is complete as claimed.
Documentation requirements: Require detailed backup for payment applications including certified payroll, supplier invoices, and lien waivers.
Payment application review: Take time to review applications thoroughly rather than rushing to meet payment schedules.
Suspicion investigation: If anything seems off—invoice amounts that don't match work in place, pressure for early payment, incomplete documentation—investigate before paying.
Monitoring and Early Detection
Regular site presence: Frequent job site visits reveal problems early:
Material shortages
Reduced crew sizes
Equipment problems
Substandard work
Communication check-ins: Regular calls or meetings with subcontractors help identify emerging problems before they become critical.
Supplier monitoring: Maintain relationships with key suppliers who may provide early warning if the sub's payment slows.
Financial check-ins: For large, multi-year contracts, request updated financial statements annually to monitor continued financial health.
Contingency Planning
Backup subcontractors: Maintain relationships with multiple qualified subs in each trade. If one fails, you can pivot quickly.
Completion bonds: Require bonds on larger contracts so the surety completes the work if the sub defaults.
Contingency budget: Include financial contingencies in your budget to cover potential replacement costs.
Acceleration provisions: Build contract provisions allowing you to bring in additional subs to accelerate work if the original sub falls behind.
The Value of Financial Strength: What Strong Subcontractors Offer
While it's important to identify and avoid financially weak subcontractors, it's equally valuable to recognize and partner with financially strong ones.
Reliability and Predictability
Financially stable subcontractors deliver predictable results:
They show up when scheduled because they can afford crews
Materials arrive on time because suppliers extend credit
Equipment is maintained and available because they invest in their fleet
They finish on schedule because cash flow doesn't constrain operations
This predictability allows general contractors to build realistic schedules and meet commitments to owners.
Quality Focus
Subs with strong finances can afford to:
Hire and retain skilled craftspeople by paying competitive wages
Invest in training and development
Use specified materials rather than cheaper substitutes
Take time to do work right rather than rushing to the next job
Stand behind their work with meaningful warranties
Quality costs money in the short term but saves money over the building's life—and protects your reputation.
Problem-Solving Capability
When challenges arise—and they always do—financially strong subs have resources to respond:
They can absorb small unforeseen costs without immediately claiming extras
They can accelerate work when schedules compress without financial strain
They can provide engineering support for complex details
They have relationships with suppliers who'll expedite critical materials
Weak subs turn every problem into a claim; strong subs solve problems collaboratively.
Long-Term Partnership
Financially stable subcontractors become long-term partners who:
Provide pricing predictability from project to project
Understand your standards and expectations
Give you priority when schedules get tight
Invest in relationship-building and mutual success
The value of these partnerships exceeds any premium you might pay for financial stability.
Risk Mitigation
Strong subs carry appropriate insurance, maintain bonding capacity, and have demonstrated ability to complete projects successfully. They represent far lower risk than marginally capitalized competitors.
For general contractors, this risk reduction translates directly to:
Lower contingency requirements
Better relationships with owners who don't experience problems
Fewer insurance claims and stable premiums
Stronger surety relationships
Real-World Case Studies: When Financial Instability Strikes
These scenarios illustrate why financial stability matters:
Case Study 1: The Low-Bid Disaster
A general contractor awarded drywall work on a $6 million medical office building to a subcontractor who bid $385,000—nearly $120,000 below the next bid. The GC thought they'd found exceptional value.
What happened:
Work started fine for the first three weeks
Suddenly crews disappeared—the sub couldn't make payroll
Materials stopped arriving—suppliers cut off credit
The sub filed bankruptcy four weeks into a 12-week schedule
Consequences for the GC:
Paid $175,000 to a replacement subcontractor to complete work
Eight-week schedule delay triggered $200,000 in liquidated damages
Dealt with mechanics' liens from the original sub's unpaid suppliers
Spent $45,000 in legal fees resolving claims
Lost the owner as a repeat client
Total cost of the "savings": Over $420,000 plus relationship damage
Had the GC performed basic financial due diligence, red flags would have been obvious—the sub had been operating for only 18 months, had negative working capital, and was bidding desperately to generate cash flow.
Case Study 2: The Progressive Decline
A general contractor had worked successfully with a mechanical subcontractor for years. Recently, subtle changes appeared:
The sub started requesting early payments
Different crews showed up
Material deliveries occurred later in the day (COD deliveries after the sub scraped together cash)
Communication became spotty
The GC dismissed these changes as growing pains from the sub's expansion into adjacent markets.
Reality: The sub had overextended into new markets, straining working capital. They were robbing Peter to pay Paul across multiple projects. Eventually, they couldn't sustain the juggling act and defaulted on three projects simultaneously.
Lesson: Even long-term partners' financial health can deteriorate. Regular monitoring, even of trusted relationships, protects against sudden failures.
Case Study 3: The Value of Due Diligence
A general contractor evaluating bids for metal framing on a $4.2 million project received three bids:
Subcontractor A: $245,000 (lowest)
Subcontractor B: $285,000 (middle)
Subcontractor C: $312,000 (highest)
Before deciding, the GC conducted financial prequalification:
Sub A: Newly formed company, no financial statements available, couldn't provide bonding, negative references from suppliers
Sub B: Established company but recent financial statements showed losses two consecutive years, high debt-to-equity ratio (3.5:1), struggling working capital
Sub C: Strong balance sheet, profitable past five years, adequate bonding capacity, excellent references
Decision: The GC awarded the contract to Sub C despite the $67,000 higher bid.
Outcome: Sub C completed work flawlessly, on schedule, with zero payment disputes. Nine months after bidding, Sub A went out of business amid multiple contractor disputes. Sub B laid off 40% of their workforce due to financial problems.
The GC's "extra" $67,000 cost was actually savings compared to the problems avoided.
Questions to Ask Before Hiring a Subcontractor
General contractors should ask these direct questions during the bidding and negotiation process:
Financial Health Questions
"Can you provide audited financial statements for the past three years?"
"What is your bonding capacity, both single-project and aggregate?"
"Do you have a line of credit, and if so, what's the available balance?"
"What percentage of your annual revenue does this project represent?"
"How many projects of similar size are you currently managing?"
Payment and Cash Flow Questions
"What are your standard payment terms with suppliers?"
"Have you ever had mechanics' liens filed against projects you worked on?"
"What's your largest current receivable, and how long has it been outstanding?"
"Do any suppliers require COD payment from your company?"
Risk Management Questions
"What insurance coverage do you carry, and who are your insurers?"
"Have you had any claims or lawsuits in the past five years?"
"Can you provide payment and performance bonds for this project?"
"Who are your banking references?"
Operational Capability Questions
"How many full-time employees do you have?"
"Do you own your equipment or rent as needed?"
"What's your employee turnover rate?"
"How many projects have you completed in the past year?"
Reference and Track Record Questions
"Can you provide references from three general contractors you've worked with in the past year?"
"Can you provide references from three major suppliers?"
"Have you ever defaulted on a contract or failed to complete a project?"
Evasive answers, reluctance to provide information, or inability to answer basic questions about their financial position should raise immediate concerns.
Learn More About Partnering with Financially Stable Subcontractors
Financial stability isn't a luxury—it's a fundamental requirement for subcontractors who'll protect your project schedule, budget, and reputation. While evaluating financial health takes time and effort, that investment pays dividends through reliable performance, quality work, and avoidance of the catastrophic costs that financially unstable subs create.
The lowest bid is rarely the best value. Smart general contractors look beyond the bid number to assess the true cost of doing business with each subcontractor, including the risk they bring to the project. By systematically evaluating financial stability, implementing appropriate risk management strategies, and building relationships with financially strong partners, you protect your projects and your business from preventable disasters.
About HD Construction
HD Construction operates from a position of financial strength that provides security and peace of mind for our general contractor partners. With zero debt, strong cash reserves, and bonding capacity to $10 million, we bring stability and reliability to every project. Our financial foundation allows us to invest in skilled craftspeople, modern equipment, and advanced technology that delivers quality results on schedule. We maintain transparent financial practices and welcome thorough due diligence from potential partners.
