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Article published in Issue Number: 061201

Employee or contractor?

By Ken Musante, Humboldt Merchant Services

Recently, I had the opportunity to discuss strategy with some business partners. They were determined to increase the scope and growth of their business and were evaluating their options.

The partners had successfully cultivated leads from a specific channel and had outgrown their capacity to service the increased lead volume. Additionally, leads were coming from geographically diverse areas. They needed to bring in some help but were struggling with whether they should work with an independent contractor or hire a direct employee.

This article presents factors we considered in evaluating their strategy.

The hiring hurdles

Hiring an employee is risky. There are many items to consider when deciding whether to become an employer, including:

· Health insurance: If you own a corporation and are offering health insurance to yourself, you may be required to offer the same health insurance to full-time employees. You may have obtained a high-quality (and high-cost) policy, thinking you or your family members were the only ones the insurance would cover.

If a new person is added to your health insurance and has many claims, either from dependents or directly, your premiums will likely increase.

· Workers compensation insurance: Workers compensation can be very costly on an hourly basis. Depending on the type of work being done, add up to $1 per hour in costs for employees in light industrial offices. And should claims be submitted for on-the-job injuries due to carelessness, bad luck or deliberate fraud, your premiums could skyrocket.

· Taxes: Payroll taxes are an employer's responsibility. Contractors are responsible for all of their own taxes; you do not have to deduct anything from their earnings. But you must do so for employees. Payroll taxes include social security tax, federal and state withholdings and, possibly, local withholdings.

· Management time: When working with contractors, there is no hourly out-of-pocket expense during the training period. If the newly procured contractor is a slow learner, the contractor will make less money, but he will not cost the employer an hourly wage.

With new employees, however, it is critical that management understand what new staff members will be doing from the minute they walk in the door.

Having insufficient work, training material or direction not only wastes the employer's resources, but it also may be an enormous de-motivator for high-achieving employees.

The last message you want to send is that wasting time is OK. By having plans for newly hired staff, you demonstrate the importance of their time and your resources, and set the stage for high expectations.

Hiring new employees requires intensive management time. Be prepared and organized. And have a variety of tasks for new employees that include:

  • Shadowing your own practices and activities (or the activities of your more experienced existing staff)
  • Terminals and instructions for new employees to read through and work with so that they have an activity to complete should it be impossible for experienced staff to work one-on-one with them
  • Beginning tasks such as filing or data input that allow new employees to actually be productive while learning an area of the business
  • Specific sales calls or installs to attend so you can demonstrate how to handle field calls appropriately.

By having a range of tasks planned, you will accommodate different learning styles and ensure that new staff members are engaged and contributing quickly.

· Potential lawsuits: Though lawsuits can be filed by an employee or a contractor, the laws pertaining to employees are more protective. Employers have a greater burden in looking out for the welfare of employees than they do for contractors.

· Office expenses: You need to provide a place for employees to work. PCs, cell phones, office supplies, desk phones, business cards, coffee, janitorial service, parking and building access are all necessary and added expenses. Further, you will likely need to have some type of car or driving allowance.

· General liability insurance: Though you will need this regardless of whether you hire employees or work with contractors, your general liability insurance expense will be greater with employees.

· Payroll processing: Direct employees will need to be paid in accordance with very specific tax and withholding laws. If they are hourly employees, strict adherence to overtime laws is required. Typically, this function is outsourced to a payroll processing company, but this is an added expense.

The cons of contracting

Given all the management requirements and expenses in hiring employees, you may conclude you only want to work with contractors. While that may be the appropriate route, here again, there are a number of factors to consider.

· Do you have leads, or are new recruits expected to develop their own? If you have a ready supply of leads, it may behoove you to hire employees.

Contractors can set their own schedule; if you are a direct employer, you set the work hours and dress code. Consequently, you can better manage leads through an employee and ensure consistency in the customer's experience.

Further, contractors may be doing business with several acquirers. While you could contractually preclude them from doing so, it is much easier to police this type of action with employees.

· Long term, employees may be less expensive. Initially, an employee is far more expensive than a contractor. But a committed and determined contractor may be looking for equity ownership and may have an outlook much like yours.

If everyone were just like you, who would you find to work for you? An employee, on the other hand, may appreciate the guarantee of a regular paycheck and company-provided health care.

· If a relationship doesn't work out, it is sometimes easier to part ways with an employee. When staffers leave your employ, for whatever reason, they are not expecting further compensation. Typically, contractors have clauses that allow for compensation in perpetuity.

Considering the expense involved, it is ill-advised to hire staff just to release them once they have built up suitable commissions.

However, because you have invested in their training and development, you do not have the continuing liability of commission expense once they leave your employ.

You also can maintain control of cell phones and numbers assigned to employees, as well as their business records, e-mails and voice mail. Contractors have an easier time maintaining control of their leads and existing customers when they move on.

· Misclassifying an employee as a contractor can lead to severe penalties. Federal and state laws contain clear definitions of these terms, and if you treat an employee like a contractor through your oversight, direction or policies, you could end up owing back taxes to the government and back wages and vacation pay to the employee.

This is a very expensive way to go. Speak to an attorney before determining whether any of your staff can even qualify as contractors.

The thought process that goes into the employee-versus-contractor decision is very complex. Ultimately, my business partners decided to hire an employee. Once they made that decision, however, the work had just begun.

They had to write a job description so they could properly advertise for the position. They also had to put together an employee handbook, which was not required when they, the owners, were the only ones working for the company.

Obviously, this is a lot of upfront work, but it was the best decision for their particular situation. I hope this article helps you select the right strategy for your business.

Ken Musante is President of Humboldt Merchant Services. Contact him by e-mail at or by phone at 707-269-3200.

Article published in issue number 061201

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