Friday, December 07, 2012

SOP Friday: Hiring vs. Outsourcing Technicians

(Nothing in this article changes my long-standing advice that an administrative assistant should be your first hire.)

One of the decisions you need to address when you are a very small company is the question of hiring "W2" employees vs. hiring contractors (1099 employees). When you get larger, there is no question that you will have W2 employees. When you first start out, you simply can't afford that. So when is each appropriate and how do you make the transition?

One note on the terminology: Is the U.S. tax code, a W2 is a form that employers give to their employees at the end of the year. It lists all the wages paid for the year as well as the taxes withheld, and all other deductions that were taken from the employee's base pay. We sometimes refer to these as "W2" employees. In this article, I will simply refer to these folks as employees.

Contractors or outsourced help are paid without withholding taxes and other deductions. Businesses are required to file a "1099" form to report how much they have paid to workers who are paid in this manner. Businesses are required to file a 1099 for any person to whom they have paid $600 or more during the year. I will refer to these folks as contractors.

Hiring Your First (Tech) Employee

One of the classic struggles for small businesses is hiring your first employee. Employees cost a lot of money! Depending on your tax rates, plus workers compensation and other employee-related expenses, it costs about $1.25 to $1.50 for every dollar earned by an employee. So, for example, an employee who earns $17/hour will cost the employer about $25/hour.

If you make a commitment of 20 hours a week (or 30 or 40), you quickly realize that labor will always be your largest expense. A $25/hr expense times 40 hours is $1,000/week. And PLEASE note that you need to pay this from your profit. You cannot calculate your first employee's expense based on your revenue. You need to have enough excess profit to pay that $1,000/wk - because it's every week. Week after week. And if you're not billing the work, or you're not signing new managed service agreements, that $1,000 gets harder and harder to pay.

If you don't have the excess profit to pay this expense, you might find yourself taking the money from your own income and making it the employee's income. That might be fine as a temporary expense. But you need to be aware of it beforehand so you can adjust your personal budget.

And also note: It is very common for a company to make no more profit with an employee than they did with just the sole proprietor. Any employee needs some management. Coordinating with someone else takes time from service delivery and marketing. You might end up doing more work for more clients, but taking home the same profit at the end of the year.

My personal experience was along these lines. In 2000 I was so busy I couldn't see straight. I hired someone full time. We went through a training period, which was not intended to be profitable. Then we caught up on the work in short order. Then we added one big client who consumed a bunch of time.

Then I realized that I was spending all my time keeping my employee fully occupied. I was doing sales. But he couldn't work enough hours to feed both of our families. I had basically turned over 90% of the work. What I needed to do was to double the workload and do 50% of it.

Paul was an awesome employee and a good friend. But I had to let him go because I couldn't sustain the deal.

I don't recommend hiring a full-timer right off unless you've got a new, big client who will pay for most of that expense.

Hiring Part Time Employees

Next, I hired someone on an as-needed basis. The basic deal was: If I bill the client for your time, I pay you for your time. This worked well. My goal was 10-20 hours a week. I found someone who was strictly a beginner and strictly desktops. No server work. No Exchange. No firewalls. Just Windows and Office.

So this guy was an employee, but did not have regular hours. Just like they do at McDonald's, Staples, and all the big stores. Eventually I had enough work to give someone a sustained 20 hours per week. So now I had a half-time employee. I could count on him being available at least 20 hours and he could rely on at least that much income.

This was sustainable. It was fair to everyone. I didn't get an employee with an MCSE this way, but I got a Microsoft Certified Professional who was willing to work for a living.

When Tech #1 got to a sustained 25-30 hours/week, I hired a second part-time tech. I wanted to make the first tech full time, but it just couldn't happen. One person can only run around and scratch out so many hours. I could get more billable hours from two 20-hour techs than from one 40-hour tech.

Eventually they both grew to be full-time positions. After that we normally hired full time techs because we had a little more flexibility in scheduling with each new hire, so we could get lots of work done with everyone running in a different direction.

Hiring Sub-Contractors

The other way to go is to hire contract labor (when working on a client job, these are sub-contractors).

With contract labor, you give them a flat fee or flat hourly rate. They are completely responsible for the taxes, etc. You absolutely must have a contract with these people. Why? Because the government will come after YOU for all their taxes, social security, federal unemployment, state unemployment, etc.

Thanks to [insert virtually every large technology company] ripping off their employees and treating employees as if they are contracts, the IRS has written specfic rules to define who IS and IS NOT an employee. Start here:

There are specific criteria for determining whether someone is legally a contractor or an employee. I discussed this in the book Service Agreements for SMB Consultants because you need to spell these criteria in your service agreements. Well, you also need to spell them out with your contractors. You can clarify the items Uncle Sam is looking for and avoid future problems.

A few key points:

1) They are not an employee. You pay them money and they are responsible for taxes, insurance, mileage, meals, etc.

2) You need to figure out fair pricing. Fair is whatever the two of you agree on. Having said that, you want to come up with a proposal that you can offer up.

Based on discussions with the folks at SMBTN, we do a 30/70 split. Here's how that works. If you brought the work (it's your job) and they bring the labor (the sub performs the work), then you keep 30% and they keep 70%.

So, if you charge $100/hr, then it's pretty simple. You pay them $70/hr.

Now, if you have to work together, they need some training, they need assistance, etc., then you might drop this to $60/hr. But I wouldn't go below that.

If they're really just not worth $60/hr, go find someone who is.

The next step in your evolution is to simply state a price and pay it as an hourly. So you might pay $60/hr until you're sure they'll work out, then move to $65 and $70.

One of the best ways to find talent is to join the local IT Pro User Group. I have hired (and been hired by) many people in the local Sacramento IT Pro group. When I need an extra three people that I am sure can follow a checklist, I call members of my group.

Hiring Strategy

So this is more of a discussion about business strategy than an actual SOP (Standard Operating Procedure). But, really, you should decide what you want to do regarding employees and contractors. I'm amazed at how many arrangements I've heard of out there.

Of course you need to adjust wages for your area. But the fully burdened cost of an employee is probably going to be solidly in the 1.25-1.50 range we talked about before. Keep that in mind.

Contractor give you flexibility, but you need to have them available when you need them. So that's a point for employees.

Also remember that anyone with less than 35-40 hours/week is probably going to be looking for another job on the side or a fulltime job. So even if they're "loyal" to you, they might disappear. You can't blame someone for wanting to be fully employed!

Comments welcome.

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About this Series

SOP Friday - or Standard Operating System Friday - is a series dedicated to helping small computer consulting firms develop the right processes and procedures to create a successful and profitable consulting business.

Find out more about the series, and view the complete "table of contents" for SOP Friday at

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Next week's topic: Employee Onboarding

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