According to Moody’s Investors Service, U.S. companies are hoarding almost $1 trillion in cash but are unlikely to spend on expanding their business and hiring new employees due to continuing uncertainty about the strength of the economy. With conditions likely to remain challenging for the foreseeable future, this does not bode well for traditional recruitment agencies that rely on placement fees for the bulk of their revenues. To make matters worse, direct hire firms are faced with clients negotiating reduced fees and increases in contract-to-hire requests. Now what?
Even in the most challenging market environments, opportunities exist. For recruitment agencies, one attractive alternative is adding contract staffing to generate recurring revenue, diversify the business mix, and reduce risk. Here’s why. While placement fees provide large “pops” of income, they are a one-time occurrence, unpredictable, do not guarantee future cash flow, and are not scalable. Compare that to contract revenue, which provides a steady revenue stream over time, is predictable, is a generally dependable source of future cash flow, is scalable and compounds as more contractors are put to work.
Contract staffing can provide consistent cash flow to smooth over the valleys created by placement fee droughts. It also allows recruitment firms to diversify into the contract-to-hire business, which is growing across all industries. These additional service offerings can be used to penetrate deeper into existing accounts and generate new business by becoming a single source provider for all contingent and direct hire needs. Finally, the predictable and compounding nature of contract revenue increases the market value of a recruitment business and the potential for a lucrative exit in the future.
W2, 1099, or Corp-to-Corp – Choosing the Right Model
Unlike direct hire, contract staffing requires that the recruitment firm assume employer of record responsibilities associated with placements made. This involves making decisions on how to classify contractors. Specifically, contract workers can be designated as W2 employees, 1099 independent contractors, or Corp-to-Corp (C-to-C). With W2 employees, the recruitment firm is responsible for payroll, taxes, unemployment, workers compensation, insurance, hiring costs, benefits, expenses, etc. If workers are designated as 1099 independent contractors, the recruitment firm is not responsible for the aforementioned.
However – and this is a big however – deciding to engage someone as a 1099 vs. W2 worker is a crucial decision. That’s because in an effort to collect unpaid taxes, the IRS has increased audits of companies that use 1099s, and plans to continue these audits moving forward. When deciding to hire someone as a W2 or 1099 worker, consider the following:
- Does the contractor have more than one source of income? (i.e. Your recruitment firm’s assignments are not their sole source of income)
- Will the contractor convert to a direct hire? (certain to trigger audit)
- Is the contractor performing the same work as in-house staff?
These are just a few scenarios. More information on hiring staff as W2 vs. 1099 vs. C-to-C is available from your local American Staffing Association Chapter. For a practical guide from the candidate perspective, see http://www.biztaxtalk.com/node/3.
Using workers from another staffing firm, or people independently incorporated, is known as Corp-to-Corp (C-to-C). Corp to Corp limits the legal exposure and administrative tasks compared to W2, and provides immediate access to a pool of qualified talent that can be put to work immediately. This model allows a staffing firm to essentially outsource talent recruitment to a partner and focus on managing the relationship and needs of clients. C-to-C is a great option for recruitment agencies entering the contract staffing business. In certain situations, it is possible to negotiate to pay the partner staffing firm when payment is received from the client. It goes without saying that it is important to choose a partner that can be counted on to provide top talent. Otherwise, your firm’s relationship and reputation with clients will suffer.
Cash Flow and Back Office Administration
Other key considerations to plan for when entering the contract staffing business are having adequate cash flow to pay contractors, and handling increased administrative workloads for payroll and billing. Maintaining the necessary financing or cash reserves is essential, since contractors typically need to be paid before income from clients is collected. As a contract business grows, a significant amount of working capital is required. There are many sources of financing available, such as a bank line of credit, funding companies, complete back office outsourcing firms, and private financing. If the administrative work involved with contract staffing is an obstacle, funding companies and back office outsourcing firms can provide everything from receivables funding to payroll, billing, collections, benefit administration, client credit checks, and more. For firms that choose to perform their own contract staffing administration, it is best to hire an experienced back office administrator if one is not already in-house. Otherwise, it can take one to two months to lay down the necessary groundwork to properly manage a contract staffing service.
As with any new business opportunity, research is essential. The best place to start is the local American Staffing Association (ASA) Chapter, National Association of Personal Services Chapter (NAPS), or TechServ Alliance Chapter (formally NACCB, for IT staffing only). All three organizations provide a wealth of information, capable staff, and offer a variety of resources such as standard contracts, business forms, and legal information to get a business started. Next, join a local group of staffing company owners that don’t compete with your new business to learn from their experiences and share lessons from your own. Once the research and business planning is complete, it’s time to contact existing clients about the new offerings and explain how your firm can provide a broader set of services.
The final step in starting a contract staffing business is scaling operations. Review the firm’s existing technology infrastructure and software. Does it support contract staffing? Does it include back office capabilities needed to run timesheet and expense management, payroll, billing, and reporting? Will timesheet and expense approval, billing and customer reports be processed manually or via a paperless online system? A wide variety of technology solutions are available today ranging from client server, hosted, and entirely web-based cloud computing services. Both the ERE vendor watch and ASA supplier directory are excellent sources for researching software options. Look for a solution that’s easy to use and handles day-to-day operations extremely well, otherwise the administrative team will find other means to get the job done and productivity will suffer. Make sure to ask vendors whether their system was designed for direct, contract, or high volume temp staffing, since feature sets will typically map to the requirements of a specific business.
As uncertainty surrounding unemployment and the lack of new full-time jobs continues, recruitment agencies relying solely on non-recurring revenue streams are at risk. Adding contract staffing to a firm’s existing portfolio of services is a logical extension of the business that exploits its core competencies and creates a recurring revenue stream to offset periods of low placement fees. It’s a win-win, and in many cases a no-brainer.