When it comes to deciding whether to hire employees or contractors for your agency, there are two considerations: what you should do and what you must do.
Many agency owners think that employees and contractors are interchangeable and it is merely a business choice which type of labor to use.
The reality is that there are rules that govern the classification of employees versus contractors.
And the hard truth is that many agencies regularly misclassify contractors who really ought to be employees. This is something that Gini Dietrich and I have discussed on our podcast in the past – and we are definitely advocates of hiring employees when it makes sense.
Let’s look at both the business and regulatory decisions that must be made before deciding whether to utilize contractors or employees.
The business case
Setting aside legal considerations, there are a number of business considerations that go into the contractor vs employee decision.
Flexibility
The most common reason that agencies hire contractors is for the flexibility it allows.
Adding a contractor requires little more than a simple contract (which too many agencies don’t even do).
If projects go away or times get tough, parting ways with a contractor is just as easy (logistically if not psychologically).
It also tends to be easy to ramp up or down a contractor’s time (and cost) assuming they have the bandwidth available.
Finally, when a new project comes along or something else drives the need for additional labor hours, you can often add a contractor within a day or two while hiring an employee generally takes at least a month or two.
Expertise
Some contractors are hired for specialized skills that an agency doesn’t need enough of to support a full-time (or perhaps even part-time) employee.
Moreover, some specialists prefer to hang their own shingle and don’t want to be someone else’s direct employee.
In these cases, a contractor is often the best business solution.
Of course, there are benefits to having expert specialists in-house, too, especially from a business development perspective.
Client perspective
While most clients only care about the quality and timeliness of the work being done, some may perceive a contractor-laden agency as “less than.”
Some agencies combat this by portraying contractors as employees – or at least leaving that impression with clients – which may help the business case but can lead to problems discussed later on in the regulatory section.
Cost effectiveness
The cost favorability of contractors versus employees tends to shift based on the total amount of time being used.
When just a few hours per month are needed, contractors often make better business sense. While the per-hour cost is often higher, it comes with less overhead.
On the other hand, once you start using a contractor for 20 hours per week or more, the math usually shifts toward making employee status more favorable. At that point, the per-hour cost difference has a bigger impact.
In addition, agencies tend to be loathe to ask more of contractors since it typically costs more to do so, while full-time employees can be asked to do pretty much anything that helps the business out. That often means more help with business development, R&D, and other agency growth activities.
Long-term impact
Having employees enables you to build a sustainable culture more easily, and it often provides more opportunities for the owner to extract themselves from day-to-day activities.
Employees are also more likely to grow and develop in ways that the agency needs, as opposed to contractors who must look at things through the eyes of the overall marketplace rather than simply one client’s approach.
In addition, a contractor-centric agency can complicate succession planning as well as potential M&A opportunities.
The regulatory requirements
Unfortunately, the business case isn’t the only consideration in determining which kind of labor to hire.
In the United States, there are strict rules governing whether an individual may be classified as a contractor (often referred to as a “1099” because of the tax form used to report their pay) or an employee (often referred to as a “W2” for the relevant tax form).
The Internal Revenue Service has detailed guidance, and California has led the charge in cracking down on classifications using the ABC test.
Of course, you should always consult with legal and accounting advisors familiar with all of the relevant laws and regulations (including state and local).
That said, here are a few things that you ought to be considering:
The Duck Test
The old saying goes, “If it walks like a duck and talks like a duck, it’s probably a duck.”
That’s pretty good advice in the effort to classify individuals as employees versus contractors.
If you refer to someone as an employee, they probably are. If you list them on your website as an employee, they probably are.
If you treat them similar to other employees – including things like performance reviews, raises, time tracking (when not paid hourly), control over how/when they work, etc. – then they probably are.
True contractors
There are, of course, many legitimate contractors out there and many agencies utilize them properly.
Some signs that someone is a legitimate contractor (and not a misclassified employee) might include:
- They have other clients
- They have a website
- They are soliciting for other clients
- They have a business name and entity
- They have a proper contract in place
If you have contractors who only work for your agency and aren’t making any effort to generate other business, that’s not a good sign.
The type of work
The actual work being done matters, too. This is becoming especially important in some states that have begun to become more aggressive at enforcing contractor versus employee rules.
If you have contractors that do the exact same work as other employees, it is much harder to claim that they are properly classified.
If you have contractors that are doing the core work that your agency has been hired by clients to do, it is much harder to claim that you are in the right.
That’s why hiring contractors for limited-use specialties is a lot safer.
Making your decision
I won’t claim that it is always an easy question about whether to hire help as a contractor or employee.
And there’s a lot of gray area.
From a regulatory standpoint, most agencies who misclassify contractors never get caught. That makes it a hard sell to convince owners that they need to be strict about their own classifications.
On the other hand, those businesses that do get found to have misclassified contractors can face significant and costly penalties.
Even if you satisfy the legal requirements, you still need to figure out whether the business case supports one or the other. Sometimes it is clear-cut, but often this, too, has some gray area.
If you have never hired an employee before, you can find lots of resources from SAGA on the topic, including a podcast, webinar, and article.
Ultimately, you need to weigh the pros and cons of each option and then make your own decision.