Here's how you can decide whether to hire contractors or full-time employees for your startup and avoid government fines.
As a startup founder, you know what it's like to juggle tasks. In the early days, it can make you feel invincible, but at some point you'll need to hire people to help you move your vision forward.
For many companies, especially startups, the question of whether to hire a contractor or full-time employee for a given position can be difficult to navigate. It can be hard to understand the differences between the two and keep your company in compliance with governmental regulations.
When you find yourself in a hiring position, it is essential to have a clear understanding of what you're looking for in a candidate and how you plan on hiring them.
Here are some tips to help you better navigate the process.
Why the differences matter
The criteria for hiring and the costs associated with each type of hire are radically different between full-time employees and independent contractors, according to Matt Mickiewicz, co-founder and CEO of Hired.
To start, full-time employees fill out a Form W-2 when filing taxes, indicating that their employer withheld things like Social Security and Medicare on their behalf. Contractors utilize a Form 1099 for miscellaneous income and will receive a full, untaxed paycheck. Contractors will have to pay into federal and state services on their own, and their employer will not pay into things like Social Security tax on their behalf.
An unsettling trend in many technology companies is to hire employees as independent contractors for the financial benefits, but treat them as full-time employees. As Kurt Olender, managing partner of OlenderFeldman LLP, points out, this presents a major problem.
"The manner in which they are engaged is dictated by what they do, not how you would like to classify them," Olender said.
The department of labor and the IRS impose certain requirements for classifying independent contractor versus full-time employees. If you satisfy the criteria (behavioral control, financial control, or type of relationship) for one or the other, Olender said, regardless of how you want to classify them, the government will classify them in alignment with the requirements.
So, if you hire someone as an independent contractor, but they fulfill the government's requirements for a full-time employee, the government will classify them as a full-time employee. This can lead to fines for failing to follow the necessary protocol associated with that particular classification.
"It gets ugly fairly quickly," Olender said.
Employee misclassification is huge issue, especially in tech hubs like California and New York. Make sure you take the proper steps to keep your company compliant. According to Olender, one of the main dangers in hiring is not having appropriate documentation in place, regardless of whether you hire a full-time employee or contractor.
Hiring full-time employees
When you hire a full-time employee, you aren't hiring someone to get a job done, you are choosing someone to be a part of your team. You could end up working closely with this person for a long time, so Mickiewicz recommends looking for someone who is a great cultural fit and who is passionate about the company's mission.
Hiring full-time affects the employee as well. According to John Jersin, CEO of Connectifier, that label can increase expectations of commitment and loyalty.
"The conventional wisdom is that full time employees are more invested than contractors and in this case, the conventional wisdom is generally right," Jersin said.
In general, full-time employees will have a greater interest in the success of the company as its success is more tightly tied to their success as individuals. This grows exponentially with the addition of equity shares as compensation.
Because of this, it's a good idea to delegate all work around core differentiators in your product to full-time employees, if you can. Full-time employees will want your company to be successful and will work hard to make sure your value proposition is fully fleshed out in the product or service, because its success or failure comes back on them.
The same goes for developing software or other technology that requires ongoing maintenance and development, Olender said. This limits the exposure of the intellectual property (IP) to eyes outside the company.
If you aren't looking to bring someone on as a full-time employee, independent contractors are a great option to spread out the work load and fill in the gaps. Also, companies whose work ebbs and flows throughout the year would do well with contractors.
Mickiewicz said that independent contractors are often used by hiring managers at bigger companies when they can't get approval for headcount. It can take a while for jobs to officially open up and to get the approval necessary to fill them.
"Contractors can serve as an interim fill-in for that while the bureaucratic paperwork shuffling happens in the backend," Mickiewicz said.
If what the employee is doing is standard, or easily transferrable, you can hire them as a contractor. If you need a higher level of control and integration into your team, you should hire them full-time.
It's important to make sure you vet the contractors before hiring to make sure you setting yourself up to be in full compliance.
"What you like to see is that the independent contractor has their own corporate form, whether it's an LLC or corporation," Oldender said. "That they have to maintain their own expenses and overhead, they have to use their own equipment, they have other customers throughout the course of their provision of services."
That way, if the government decides to look into your employment of a contractor named "Bob" you can prove that you didn't hire Bob, you hired a company that provided Bob to do the work for your project.
While contractors can add some muscle to your team in times of need, they can also cause some headaches with keeping things in order.
"Having contractors can affect efforts at coordination since an employer isn't actually allowed to require contractors to work at certain hours or perform specific activities that don't relate directly to the work products they are required to produce," Jersin said.
Contract to hire
It's becoming an increasingly popular model at some companies for all employees to start as contractors and work their way to a spot as a full-time employee. This hiring model is commonly referred to as "contract-to-hire."
"The decreased sense of commitment at the beginning provides an easier path to ending the relationship by either the employer or the contractor if the fit doesn't seem right," Jersin said.
The move from contractor to employee can be see as an affirmation of one's passion for the company, but the model is controversial. Some people think that contract-to-hire is a bad move for tech companies.
"People that will accept a contract-to-hire offer often don't have anything else on the table, or it's a last resort for them," Mickiewicz said. "I would generally caution against it as a strategy. California, especially is an at-will employment state, so if you do make a hiring mistake you can let someone go relatively easily."