The short answer of course is – it depends. A founder must balance the following needs:
- Cash burn
- Ability to control and command
- Administrative burden
- Culture & commitment.
This blog post isn’t a technical one about the nuances about the law – we’ll get into that in future posts discussing financing terms, vesting, 83B, QSBS, etc. – but is more of high level advice that I have gathered from years of working with founders. A good lawyer is technically sound and communicative, a great lawyer is your consigliere.
Benefits of hiring independent contractors, or consultants
One of the biggest benefits for companies of hiring an independent contractor is that alleviates expenses related to wage and unemployment tax as well as employment benefits. Further, independent contractors are not owed a minimum wage so a company can pay them in all equity. Further, you needn’t provide the independent contractor with a space to work, supplies (i.e. a laptop) or any licenses. For an early stage company, where burn rate and building a longer runway is key, the savings can be company saving. Further, the company can make it clear in their agreements that independent contractors will pay their taxes not the company.
Further, a company may only need someone to work on a certain facet of the company part time. Early stage companies that need a bit of marketing help but not enough to hire a Head of Marketing can instead hire a fractional CMO and compensate that person less than they would a full-time senior marketing hire. A fractional CMO is also likely to do a better job than a UX designer wearing the CMO hat for 15 hours a week. Further, while you could hire a part-time employee you may lead your company into hiring a less quality person as quality people may be engaged in full time employment (there are exceptions of course) and/or you run into the tax and other expenses mentioned above.
There’s always a downside…
Unfortunately, there are a few cons to hiring an independent contractor, here are some notable items:
- A company does not have them full time, so if you have an urgent request with a quick turnaround time the contractor may have other items queued ahead of your request.
- They’re not necessarily part of the core team and may not have the same sense of loyalty, despite having equity in the company. An employee is expected to be heavily invested in the company whereas an independent contractor may have multiple clients and a more mercenary-like relationship with the company.
- If you’re not paying them cash, you probably have to give them a bigger piece of equity. This is a balancing act between cash and equity compensation.
- There may be a lack of command and control and ability to direct as to how the independent contractor performs their work as the law generally desires that independent contractors not be treated like a standard w2 employee. The reason you want to limit the direction and method as to how the work gets done is because that may move an independent contractor closer to being deemed an employee by regulators.
Benefits of hiring employees
The benefits of hiring employees are numerous, with a major benefit being that you can direct them and how they work. That means they align with your preferred organization methods, work in the office, if desired and nothing is out of scope simply because it wasn’t initially laid out in a statement of work.
Further, you can ask them not to work for anyone else, like a freelance job or moonlighting. However, use your best judgement when making these requests. If they need another job to support their life, ensure that they are not working for direct competitors and that they are still able to perform in their role for your company. A happy employee makes for a better performing employee.
Finally, employees likely have more loyalty to your startup company if you hire well. They’re emotionally and financially invested in the success of what you are building. The company provides benefits, colleagues, a sense of purpose and community. They are responsive to emergency requests. They are all in.
Of course, there are cons…
Briefly – the cons are essentially the inverse of the benefits discussed above for independent contractors.
- The administrative and tax costs are higher than if you hired an independent contractor. You must withhold taxes from their paycheck to pay on their behalf and pay unemployment and wage taxes.
- You likely will need to comply with workers’ rights laws, especially if you are above 25 employees.
- There is a higher cost in cash and overhead with employees. You need to pay for their equipment, office space, and licenses amongst other items. This raises your burn rate.
So, what should you hire?
I generally advise my clients to hire independent contractors at the start as they are relatively cash poor and equity rich unless such contractor will perform a core function for the company at which point it should consider bringing in an employee or another founder to fill that role. However, limiting burn is key at this stage.
As the company grows and raises substantial capital, I generally recommend that a client switch from independent contractors to employees so it can build its company’s culture with people who are bought in to the company’s mission. These employees are likely to be more responsive and push to achieve the company’s goals.