Contractors becoming employees

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Contractors becoming employeesWhen an entrepreneur learns that they can sell products and services for less than it costs them to produce and deliver them, they start a business. Many start as a sole trader and incorporate a limited company later. Initially it’s just them as shareholder, director and employee.

When demand rises for those products and services, a point comes when more effort is needed. Entrepreneurs often engage contractors – sole traders who provide their services for a fee. Whilst it’s quite difficult to make a margin on contractors, it’s a logical step to help the entrepreneur grow turnover.

Ultimately though, entrepreneurs want to reduce costs and bring those contractors in-house to control their activities. At that point those workers become employees.

Practical problems

This action of changing contractors to become employees is fraught with practical problems.

First there’s the question of contracts. Hopefully the period of contracting was covered by a business-to-business or business-to sole-trader contract. And hopefully that contract covered things like who owned the right to the products and services produced by the contractor. Either way, there’s a change in the form of contract. It’s not just a case of telling a payroll company to pay them.

Second, there’s the whole issue of rewards. You must agree a salary. But that salary is not the daily rate they were previously charging. As a contractor, the worker was responsible for their own Employers National Insurance payments, and their own sick pay, holiday pay, pension and loss of income insurance. Now all that transfers to the entrepreneur. There is also the fact that the reason daily rates for contractors are so high is that they don’t expect to be employed every day of the year. Most contractors have quite long lean periods without work – for which they must be compensated when they do work.

All in all, one could take the daily rate, multiply by 261 for the number of working days in a year – and then halve that to get the equivalent salary. For someone being paid £450 a man-day, that equates to a salary of £58k.

So now the problem comes.

Someone earning £450 a day is not going to look favourably on a salary of £58k. They’ll do the maths and determine that this equates to a daily rate of £225. How then does a manager persuade that contractor to come on board?

The solution lies in the concept of total reward.

Calculating total reward

One reason that the entrepreneur wants the worker to come in-house is that they want to reduce costs. They can do that because the contractor is not overpaid by the amount representing profit. All firms strive for profit, and the contractor’s is no exception. Another reason is that it typically costs more to transact with a contractor’s firm, to set up contracts and agree specifications, performance and quality. Employers avoid this cost by controlling employees’ activities directly though a contract of employment.

Total reward more than pay aloneBut ultimately the real reason entrepreneurs want workers in-house is for development. Contractors take the money. They don’t typically invest in their own skills. They don’t take a fortnight out a year, pay course fees and invest time at home to learn new skills and acquire new knowledge. As a result, contracting is a relatively short-lived form of occupation. Once one contractor looses their skills, they will need to be replaced with another in a race to the bottom.

Entrepreneurs need a sustainable firm – if only to sell it once they’ve built it – and sustainability means maintenance and growth of skills and knowledge from the staff body. A savvy contractor will appreciate coming in-house for this alone.

Total reward is then a valuation of the complete package of employment benefits offered by the entrepreneur. It includes salary, pension, health insurance, holidays, sick pay and security of employment year by year. It also includes a value for personal development and sometimes that comes from opportunities for different work – often considered of huge value.

Contractors becoming employees

When discussing terms under which contractors would come in-house, those entrepreneurs about to become managers should make the calculation and illustrate the benefits. Using total reward, it’s not too difficult to show that £450 a day equates to £58k salary when one considers the other half of the package.

Now, that’s not the whole story of course. Managers should be open to transitional arrangements. Perhaps short term elevations in salary or guaranteed bonuses could be used to bridge and soften the transition to having previously relied on a high cash amount.

Those transitional arrangements should also cover off differences in contract terms – but that’s another story and opportunity for another blog!

If you are looking to offer contractors opportunity to join your firm to become employees, talk to us. We can help make the transition smooth.

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