The structural reality of subbing
Federal subcontracting is often the first paid federal revenue for a small AI firm. It is also where small firms take the most bruising. The prime holds the customer relationship, signs the contract, issues the invoices, and controls the work share. The sub does the work and waits for payment. Power asymmetry is real and structural — it is not a sign of a bad prime; it is the nature of the arrangement.
Prime-sub relationships are governed by flow-down clauses. Key clauses: FAR 52.227-14 (data rights), 800-171 for CUI, and payment terms. Some primes flow down requirements that are operationally impossible for a small firm — read every clause before signing.
Understanding the mechanics up front prevents a lot of bad outcomes. The goal is not to distrust primes; it is to contract carefully, deliver cleanly, and know when to walk.
Work share expectations
Subcontractor work share on federal contracts typically ranges:
10-20%
minor sub providing specialized capability. Common for niche AI capability on a large services prime contract.
20-40%
significant sub. Sub team is a named piece of the proposal and has direct performance obligations.
40-50%
major sub. Approaches the Limitations on Subcontracting rule (see below).
50%+
rare on prime-set-aside contracts due to LOS compliance.
Work share is negotiated in the Teaming Agreement (TA) before proposal submission. The TA should be specific about scope, estimated labor hours, rates, and dollar value. Vague TAs — "sub will perform tasks to be defined" — are how subs get squeezed down after award.
The Limitations on Subcontracting rule
FAR 52.219-14 (Limitations on Subcontracting) applies to small business set-aside contracts. For services contracts, the small business prime must perform at least 50% of the cost incurred for personnel. For supplies, 50% of the manufacturing. For construction, 15% of general and 25% of specialty.
What this means in practice: on a small business set-aside services contract, a sub cannot take more than 50% of labor cost. If your firm is the sub, and the prime is pushing you toward 60% work share on a small business set-aside — that violates LOS and puts the contract at risk.
Rate pressure
Prime-Sub Relationship — Key Risk Factors (frequency in real subcontracts)
Primes typically pressure sub rates in three ways:
- Below-market rate negotiation. "We need your rate at $180/hr to fit the price-to-win." Below-market rates should be justified by volume, long-term commitment, or strategic value — not just prime pressure.
- Labor category conversion. Your "Senior ML Engineer" gets proposed as prime's "Data Analyst" with prime's lower labor category rate, and you see a fraction of the nominal billing rate.
- Overhead passthrough claims. Some primes charge subs administrative fees or overhead on sub-pass-through, reducing effective rate. This is sometimes legitimate (CAS-covered primes have genuine overhead on sub-handling) and sometimes pure margin extraction.
Defend your rates with labor market data and insist the proposed labor category maps to your actual labor category. Contract for a rate, not a rate "subject to prime discretion."
Invoice cycles and payment terms
Federal primes invoice the government monthly. The government pays the prime (DFAS for DoD, typically 30-45 days after invoice). The prime then pays the sub — usually Net 30 after prime receives payment, meaning actual sub payment is 60-90 days after work performed.
Common issues:
"Pay when paid" clauses
are common in subcontracts. Sub payment is contingent on prime receiving payment. This shifts collection risk to the sub.
"Pay if paid" clauses
are more aggressive. If the government does not pay the prime, the prime does not pay the sub. Enforceability varies by state. Avoid when possible.
Dispute holdbacks
Some primes hold back sub invoices during disputes with the customer even when the sub's work is not in dispute. Contract explicitly against this.
Slow-pay primes
A few large primes are notorious for Net 90 or longer actual payment despite shorter contractual terms. Check references before signing.
The Prompt Payment Act requires prime-to-sub payment within 7 days of prime receipt of government payment under some circumstances, but practical enforcement is limited.
Teaming agreement essentials
A good TA locks in at minimum:
- Scope of sub work (specific statement of work).
- Estimated labor hours, by labor category.
- Labor rates, by category.
- Work share percentage (as a range or target).
- Exclusivity (can the prime use another sub for the same scope? Can the sub team with another prime?).
- Term (survives through proposal submission and award, expiring if no award within X months).
- Confidentiality.
- Cost sharing for proposal effort (often zero — each party bears its own costs).
- Definitization clause (commitment to negotiate subcontract in good faith post-award).
A TA is not the subcontract. After award, the subcontract gets negotiated — and that is where the TA's specificity or vagueness pays off or punishes you.
The subcontract itself
The subcontract is a binding agreement with flowdown clauses from the prime contract. Key provisions:
- Scope, schedule, deliverables. Must match the TA (or better).
- Payment terms. Net 30, Net 45, pay-when-paid — negotiate the tightest terms possible.
- Flowdown clauses. Mandatory federal clauses flow from prime contract to sub (FAR 52.219-8, 52.203-14, etc.). Non-negotiable.
- Termination for convenience. Primes can terminate subcontracts with notice. Negotiate for wind-down funding and notice period.
- Dispute resolution. Mediation, arbitration, or litigation — specify venue and governing law.
- Audit rights. Primes often require audit rights over sub records. Negotiate reasonable scope.
- Intellectual property. Who owns what? Government has rights under data rights clauses; prime and sub allocation varies.
When to walk
A sub should consider walking from a prime relationship when:
- The prime refuses to sign a TA with specific scope and rates.
- The prime demands exclusivity without offering anything in return.
- "Pay if paid" is non-negotiable.
- The prime's payment reference checks come back badly.
- The prime is squeezing work share below the TA target by 30%+ after award.
- The customer relationship is destroyed by prime mismanagement, pulling sub performance down with it.
Walking is painful and takes known costs — proposal effort, relationship damage, customer confusion. But staying in a bad relationship costs more over time. Build a reputation for professional, clean exits when the situation requires.
Building a portfolio of prime relationships
A small firm should aim for 3-5 active prime relationships over time. Single-prime dependence is dangerous — if that prime has a bad quarter, loses a recompete, or restructures, the sub's revenue evaporates. Diversified prime relationships also mean the firm can compare rates and terms across primes, which is a negotiation lever in itself.
Bottom line
Federal subcontracting is the fastest path to first federal revenue for a small AI firm, and it is where power asymmetry plays out. Contract specifically, understand the Limitations on Subcontracting rule, negotiate rates and payment terms carefully, and build multiple prime relationships. Walk when the relationship turns exploitative — professionally, without burning bridges. The goal is long-term: today's sub relationship is tomorrow's teaming network when your firm is ready to prime.
Frequently asked questions
10-50% typical. Minor subs at 10-20%, significant subs at 20-40%, major subs approaching 50%. Small business set-aside contracts have Limitations on Subcontracting (50% for services) that cap sub work share.
Pre-proposal agreement between prime and sub locking in scope, estimated labor, rates, and work share. Not the subcontract itself — the subcontract is negotiated after award and should match the TA.
Typically 60-90 days after work performed. Government pays prime 30-45 days after invoice; prime pays sub Net 30 after prime receives payment. Actual terms vary by subcontract.
Pay when paid: sub is paid when prime is paid. Pay if paid: sub is paid only if prime is paid (shifts credit risk to sub). Avoid pay-if-paid when possible; pay-when-paid is common.
FAR 52.219-14. On small business set-aside services contracts, the small business prime must perform at least 50% of the cost incurred for personnel. This caps sub work share on set-aside contracts.
When TA specificity is refused, exclusivity is demanded without reciprocation, pay-if-paid is non-negotiable, payment references are bad, work share is being squeezed post-award, or prime mismanagement is destroying the customer relationship.