Should I Hire a PEO?

Background

Startups have many near-term priorities, including developing their minimum viable product, establishing annual recurring revenue, building the pipeline, and engaging investors. But to enable sustainability and scalability and satisfy future acquisition & investment diligence, the startup must also ensure they are building a sustainable business that can grow & stand the test of time, meet the needs of their customers & stakeholders, stay nimble & adaptable, and comply with local laws & regulations.

Evolution Equity Partners provides reference material and advice to its portfolio companies to optimize a startup's chances of achieving a successful exit to enable smart and streamlined growth as part of its Centers of Excellence effort.

Purpose

This paper provides considerations on the decision to establish and outsource certain key business enabling functions: Human Resources-as-a-Service (HRaaS).

Generally, it will discuss Professional Employer Organizations (PEOs) that offer HRaaS, and, specifically, will:

· Summarize the services a PEO offers (benefits administration, payroll, HR services)

· Describe what to look for in a PEO

· Identify prominent PEOs in the US

· Identify rough costs

· Discuss how a PEO helps with compliance

· Consider alternatives to PEOs, and;

· Describe what’s necessary to implement.

[1] “Business enabling” functions are the essential ‘back office’ functions such as Payroll, Benefits, Human Resources, IT, Facilities, Finance, Security, etc.

Background on PEOs

Professional Employer Organizations (PEOs) emerged in the United States in the 1970s as a response to the growing need among small businesses for comprehensive HR services, such as payroll administration, employee benefits, and regulatory compliance.

Initially, PEOs operated as “employee leasing” companies, whereby they would hire a small business’s employees and lease them back to the business, effectively taking over the role of employer-of-record. This allowed small businesses to outsource many of their HR functions to the PEO, which could provide these services at a lower cost due to economies of scale.

Over time, PEOs evolved to become more sophisticated and comprehensive, offering a wide range of HR services and becoming more integrated with their clients’ operations. Today, PEOs are an important and growing segment of the HR outsourcing industry, serving hundreds of thousands of small and mid-sized businesses across the United States.

In addition to providing HR services, PEOs also offer a range of other benefits to small businesses, including access to better health insurance and other employee benefits, as well as expertise in compliance and risk management. By partnering with a PEO, small businesses can focus on their core competencies and strategic objectives, while leaving the day-to-day management of HR functions to the PEO.

Potential PEO Services

The most common services that a PEOs offer are:

• Payroll administration: This includes processing payroll, calculating taxes, and generating payroll reports.
• Employee benefits administration: PEOs find and manage employee benefit plans such as health insurance (medical, dental, and vision plans), retirement plans, and other voluntary benefits.
• HR services: This includes services such as employee onboarding, compliance management, employee handbooks, and HR policies & procedures.
• Employee training and development: PEOs can offer employee training and development programs to enhance their skills and knowledge.
• Recruiting and hiring assistance: PEOs can provide recruiting and hiring assistance, including job posting, applicant screening, and interview scheduling.
• Time and attendance tracking: PEOs can help you track employee time and attendance, including scheduling, time off requests, and overtime.
• Performance management: PEOs can provide tools and resources for performance management, including performance reviews, goal setting, and employee feedback.
• Risk management: PEOs can help manage risks associated with employment, such as workers’ compensation insurance and unemployment insurance.
• Compliance management: PEOs can help ensure that your company is in compliance with federal and state employment laws and regulations.

Not all PEOs offer the same services, and the startup may choose to enlist only a subset of them. The most common services used are HR services, benefits administration, time and attendance tracking, and performance management.

Macro Considerations When Considering Hiring a PEO

Before shopping for a PEO, get a feel for the maturity of your current HR processes, and know your employee headcount & future growth plans. Those things will shape your discussion with PEO candidates, and help you choose a PEO that aligns with your business needs and goals.

Once you understand your business needs, contact 2–4 PEOs to determine fit, e.g., if the PEO has experience in your industry if they can offer the services you require (benefits, payroll, HR services), and evaluate their costs (look for a PEO that offers transparent pricing and is upfront about all fees associated with their services).

Look for a PEO that offers compliance support, including assistance with regulations related to payroll, taxes, and benefits. Compliance support is a critical aspect of HR management, since failing to comply with federal and state regulations can lead to fines and legal issues.

The PEO you choose should also have the technology infrastructure that aligns with your business needs (e.g., do you want both computer & smartphone accessibility for employees; what does their administrative reporting offer you and your CFO?).

Some of the Prominent PEOs in the US

There are many PEOs operating in the US; some of the most prominent ones include: ADP TotalSource, FrankCrum, G&A Partners, Insperity, Justworks, Oasis Outsourcing, Paychex, PEOple Premier, TriNet[1], Zenefits.

These PEOs offer a wide range of services, including HR administration, payroll processing, employee benefits, compliance assistance, and risk management. The services offered and pricing structures can vary significantly.

Cost, and Cost Avoidance

The cost of hiring a PEO can vary based on several factors, such as the size of your company, the specific services you require, and the level of customization needed.

PEOs typically charge a fee based on a percentage of the startup’s payroll or a flat fee per employee per month. The exact cost can vary, but it is typically around 2–15% of payroll. Some PEOs offer scalable pricing options, which means that as your business grows and your HR needs change, the cost of the PEO services can adjust accordingly.

In 2023, typical PEO service fees, per-employee, per month, are in $175-$200 range for payroll, benefits, and HR services. There is often a one-time set-up / implementation fee of $1000-$3000.

It’s worth noting that hiring a PEO can eliminate the need for a full-time HR staff member or team, which can be a significant cost savings for a startup. And, it’s important to consider the potential cost avoidance that a PEO can provide through improved HR efficiency, reduced risk of compliance violations, and access to better employee benefits (since a PEO can negotiate favorable rates, because of their scale, with benefit providers).

Compliance

Compliance is about conforming to law, regulation, policy, standards, or rules, relative to employee pay, benefits, hiring, etc. It’s important to have a clear and well-executed compliance program because it reduces the risk of legal issues, fines, and penalties, and allows your company to focus on its core business operations. And, when others are considering your company — whether it’s as a customer, investor, or buyer — they usually ask about your compliance program; having one is often a ‘gate’ to doing business with you, and having a good one is often a differentiator to someone considering acquiring you since it constrains their risks.

Hiring a PEO can help with compliance in several specific ways:

· Expertise: PEOs have HR experts who are well-versed in federal, state, and local employment laws and regulations. They can provide guidance on compliance-related issues and ensure that your company is meeting all legal requirements.

· Recordkeeping: PEOs can help with recordkeeping, which is crucial for compliance purposes. They can ensure that your company is keeping accurate and up-to-date records related to employee hours, wages, and benefits.

· Reporting: PEOs can help with compliance-related reporting, such as tax filings and regulatory reporting requirements. They can ensure that your company is meeting all reporting deadlines and submitting accurate information.

· Training: PEOs can provide compliance training to your company’s employees and managers. This can include training on topics such as discrimination and harassment prevention, workplace safety, and wage and hour laws.

· Risk assessment: PEOs can assess your company’s HR practices and identify potential compliance risks. They can then implement policies and procedures to minimize these risks and keep your company in compliance.

Is There a Downside to Hiring a PEO? Why Not Just Hire a HR Person?

While hiring a PEO can offer many benefits for small and medium-sized businesses, there are also potential downsides to consider.

The quality of service provided by a PEO can vary, and if you choose a PEO that doesn’t meet your expectations, it can be time-consuming to switch to a different provider. And as a third-party provider, a PEO may not have the same level of communication and collaboration with your company as an in-house HR team; when you hire a PEO, you are outsourcing many aspects of your HR management, which means that you may have less direct control over certain decisions and processes.

Additionally, PEOs can’t replace all enabling services. For example, PEOs typically do not offer Employee Stock Ownership Plan (ESOP) management services, as this is a specialized area that requires specific expertise. However, some PEOs may work with outside firms that specialize in ESOP management and provide support to clients who offer ESOPs as part of their employee benefits package. In these cases, the PEO would likely work closely with the ESOP provider to ensure that all HR and payroll functions related to the ESOP are properly managed.

Hiring an HR person can be a good solution for companies that can afford an in-house HR team, though many small and medium-sized businesses may not have the resources to hire an experienced person with a broad range of expertise (e.g., in areas such as payroll, benefits, compliance, and risk management), especially when you consider salary, benefits, and the cost of any necessary training or professional development. In contrast, hiring a PEO can provide immediate access to a team of HR experts with a broad range of expertise. PEOs can also provide scalable services that can adapt to a startup’s changing business needs and reduce the risk of compliance violations.

Overall, it’s important to carefully evaluate the potential benefits and drawbacks of both options to determine which one is the best fit for your specific business needs.

Implementation Expectations

There is an upfront time commitment to ‘initialize’ the PEO so they can subsequently take on the services the startup signs up for. The person on point for the startup with the PEO needs to have access to sensitive internal information (e.g., personnel & salary information), know the startup’s philosophy for benefits, and have a feel for the startup’s budget for services & benefits.

PEO onboarding for basic services might look like this:

· Payroll services — Provide sufficient personal information on each employee so that each person is strongly identified and accounted for, he/she receives the authorized compensation amount, their pay is sent to the appropriate place (e.g., bank), and is done according to local laws, regulations, and policies (including local tax and unemployment rules).

· Benefits — The startup will have access to a large variety of benefits to choose from that are pre-negotiated between the PEO and 3rd party providers (usually at favorable rates), and will need to first decide: 1) which categories of benefits to offer its employees (e.g., medical, dental, and/or vision insurance), whether to offer a retirement savings plan (e.g., 401k)); 2) what class of plans[2] to offer, from which employees will later choose from among several specific plans within that class, and; 3) how much the company will contribute monthly for each benefit. #1 & 2, above, are company-philosophical/culture ones, and #3 is directly related to company affordability/budget. And all of these decisions have implications on company reputation, as they affect recruitment and retainment.

More generally, after committing to using the PEO, the PEO will suggest scheduling two or three conversations with you to align expectations for HR support and provide training on their administrative platform. Good PEOs will maintain a senior relationship with you during the first 1–2 months, to ensure a smooth transition. After that, your startup can reap the benefits of HRaaS, knowing that your company’s employees are receiving services from specialists in areas offered by the PEO, and that those services can scale with your company.

International Implementation

While PEOs are primarily a US construct, there are similar organizations that operate internationally. Outside of the US, they are often known as an Employer of Record (EOR) and are typically used by businesses that are expanding into new markets or hiring employees in countries where they do not have an established legal entity.

Global Employment Organizations (GEO) are like EORs in that they help companies manage HR functions for employees in multiple countries. GEOs provide a range of services, including compliance with local labor laws, payroll processing, and benefits administration.

Timing, Hybrid Options

Certainly, a startup doesn’t need a PEO when there are just four people who are in the beginning of bootstrap phase. But before long, the founder or his/her designee will find themselves spending an increasing amount of time performing the essential administrative tasks that underpin a functional and growable company. While this often happens when there are 10–20 employees, here are a few signs that a founder should look for, for timing the enlistment of HRaaS.

Do you find yourself managing HR tasks at the expense of critical startup functions such as MVP development, initial revenue generation, and investment pursuit? Do you lack expertise in managing HR tasks, such as compliance with employment laws, benefits administration, and payroll processing? Are you experiencing rapid growth and need to scale HR operations quickly? To attract and retain key talent, do you want to offer competitive employee benefits packages but lack the resources to do so? Ultimately, a startup should consider hiring a PEO when it becomes clear that managing HR tasks in-house is no longer feasible or time-effective.

And making a decision to enlist a PEO does not lock you in permanently to HRaaS; you can later move all HR functions ‘in-house’, or even establish a hybrid posture where: a company HR team executes certain functions and leverages the expertise or capacity of a PEO as needed, or; certain employees are employed/paid by the company whereas others are employed/paid by the PEO or EOR. In other words, HRaaS can be implemented (or de-implemented) gradually, all at once, or in a hybrid manner and across regions, to best address company needs and local regulations.

[1] Evolution Equity Partners uses TriNet as its PEO.

[2] On the “class of plans” point, the scope & deductions of health benefits that a startup signs up for through a PEO often differs by sector (e.g., what’s offered to employees of finance-oriented company might differ than what’s offered to a manufacturing-oriented company). You PEO onboarding representative can recommend a best-commercial-practices class of plan.

Written by: Philip Quade