Managing a human resources department and all of the tasks that go with it, like employee onboarding, payroll processing and benefits administration, can be difficult for many small and midsize businesses. Being skilled in all of these areas requires in-depth knowledge and support that may be difficult to come by. To help with this, many businesses partner with a professional employer organization (PEO). PEOs can take on many HR responsibilities and relieve some of the stress, making it easier to keep your business operating smoothly. However, while there are a lot of benefits to partnering with a PEO company, there can also be some downsides.
Before turning over your HR department’s keys to an outside service, it is important to understand the pros and cons of using a PEO compared to offering the same services in-house.
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What are the pros of using a PEO?
When choosing a solution to manage your HR processes, it’s essential to consider the pros of using a PEO and evaluate whether those benefits are the best fit for your business. Your PEO options will depend on your business’s size and goals. The best PEO services offer many employee HR-related services, such as payroll processing and payroll tax management, health insurance, workers’ compensation insurance, and retirement savings plans.
1. A PEO can save you money.
The annual return on investment associated with cost savings alone is one of the most common factors that small business owners assess when deciding whether to use a PEO, according to the National Association of Professional Employer Organizations.
NAPEO’s research found the estimate of the expected ROI for PEO clients, based on cost savings alone, is 27.3% per year. This estimate is based on the cost savings of businesses that entered into co-employment agreements focused on five areas:
- HR personnel costs
- Health benefits
- Workers’ compensation
- Unemployment insurance
- Other PEO services, like payroll and retirement plans
An ROI of 27.3% means that for every $1,000 spent on PEO services, the average business owner would save roughly $1,273, resulting in a net benefit of $273 for every $1,000 spent.
2. A PEO can protect you from legal risks.
PEO benefits offer several risk protections. For one thing, the IRS charges small businesses billions of dollars every year in payroll fines. A good PEO service can protect your company against this issue. Reputable PEO services are insured for mistakes they might make in your accounting and payroll. If something is off, the PEO eats the cost rather than you. You should confirm that your chosen PEO offers this guarantee before you commit to using the service.
Similarly, PEOs reduce your risk with HR compliance. HR failures can lead to fines and even lawsuits. The average lawsuit for Family Medical Leave Act (FMLA) violations is around $80,000. That’s just one common mistake. Even discounting penalties, HR issues can hurt employee retention and drive up turnover costs. When the work is properly outsourced, that insurance provides a layer of protection. Since you are not directly responsible for these problems when they arise, you are not on the line for their costs.
Indirectly, PEOs insulate your company against certain risks by saving you time. The resources you aren’t putting into PEO services are free to be reallocated. That can empower you to improve margins and/or cash flow, and both of those outcomes give you additional risk protection. The time your PEO saves is potentially more valuable than the direct spending you can cut for these services. This is why proper outsourcing is one of the best ways for a small or midsize business to improve its overall ROI.
3. A PEO can manage your workers’ compensation program.
The pro of using an employer organization is that it takes care of time-consuming tasks like vetting and purchasing workers’ comp policies, according to Bryan Bowles, founder and CEO of Transactly.
“Prior to utilizing a PEO, we had to manually sit through the annual audits, which consumed a significant amount of our accounting staff’s time,” Bowles told business.com. “In addition to the time savings, we’ve noticed a significant cost savings as compared to purchasing a policy directly.”
PEOs have experience with workers’ comp programs, so they have policies in place for situations you may not have yet encountered at your business. One example of this is return-to-work programs that help employees transition from medical leave back to work through modified, low-risk or light-duty jobs.
4. A PEO can improve your employees’ experience.
PEOs add value to your business by providing a great employee experience. Since a PEO handles much of the grunt work of human resources, it allows you to focus on your company’s culture and employee management.
Additionally, PEOs may allow you to offer employee benefits that typically wouldn’t be affordable for a small business, according to Samantha Reynolds, marketing manager for Helpside. These include “not only traditional benefits like health, dental and vision insurance, but also conveniences like online access to paycheck stubs, direct deposit and assistance with verifications of employment.”
Employees of businesses that use PEOs are more likely to experience:
- Higher levels of employee engagement
- Improved trust in their employers
- More confidence in the business’s approach to company growth
- Higher employee retention rates
FYI: Employee retention rate = (Number of employees on the last day of a given period ÷ Number of employees on the first day of the given period) x 100
5. A PEO can help attract and recruit top talent.
Considering all of the ways that a PEO can improve the employee experience, it is clearly an opportunity to empower your recruiting efforts. The employee benefits you offer, which your PEO manages for you, make your business more attractive to new recruits. Whether it becomes a focal point of your recruiting efforts is up to you, but every improved benefit is an upgrade to your investment in employee satisfaction, and potential hires notice these things when they compare companies.
Additionally, your outsourced HR can handle a chunk of the recruiting and hiring workload, making the process substantially more efficient. You’re likely to retain good employees by having a better working environment, and you have more resources to go after top talent that can make the whole business run better. It’s a major win-win.
6. A PEO can bring peace of mind.
Outsourcing, when done right, comes with a unique opportunity for business operators’ peace of mind. The risk management and efficient handling of administrative tasks let you rest assured that you are compliant with regulations and the busywork of your company is in good hands. You aren’t losing out to bloated HR or benefits management, you’re investing in employee satisfaction, and you’re doing right by your company with the right tools for these integral jobs.
Did you know? Partnering with a PEO can bring you peace of mind against economic struggles as well. According to the NAPEO, PEO clients were 32% less likely to have experienced an overall negative effect on business from the pandemic, relative to similar small businesses.
What are the cons of using a PEO?
It’s important to conduct extensive research before partnering with a PEO. Business owners need to understand that they will be entering into a co-employment agreement with the PEO, which means relinquishing some control over their businesses. Here are some PEO disadvantages to carefully consider before deciding to use one.
1. You may experience delayed communication and conflict resolution.
A PEO doesn’t only manage the HR of your company. They have many other clients. Since there’s no exclusivity, your business may not receive the personal, in-depth attention it needs. This separation can cause communication to be more delayed than if you had an internal employee managing your HR.
2. A PEO owns your payroll data.
Another potential con of a PEO is that it owns your loss run and payroll data, according to Jon Brodsky, CEO of YouNow and former CEO of Finder.
“Because the PEO would own the data, we would have had to start from scratch when we were ready to get insurance and benefits on our own, which would have likely meant higher rates for us,” Brodsky said. “So, we decided to take the short-term pain of administering our own healthcare and receiving slightly less-than-favorable rates on our insurance in order to have the best long-term potential cost savings for Finder.”
3. You may be responsible if your PEO makes a mistake.
PEOs are responsible for administering payroll and filing payroll tax returns, which can be one of the most significant benefits of partnering with one, according to Tammy Dain, co-founder and CEO of Rabble.
“Since employees are considered co-employees of both the PEO and your business, the IRS still considers you liable if there are any errors in those filings,” Dain said. “Thus, it’s incredibly important that you have verified the PEO’s practices with regards to taxes. It is completely within your right to audit the payroll tax returns that the PEO has filed on behalf of your employees.”
The IRS currently offers a voluntary certification program for professional employer organizations, which ensures tax liabilities remain entirely with the PEO rather than your business. To reduce the risk of payroll mistakes, partner with a known leader in the payroll space.
4. You lose control over internal processes.
A PEO can control nearly every aspect of HR, saving you a lot of time and energy. However, it can also cost you some level of control. PEOs aren’t ideal for businesses that want complete control over their HR processes. One partial way around this is by partnering with a PEO solution that offers customization rather than preconfigured service bundles. This allows you to maintain control over certain processes and still receive assistance with others.
What does a PEO do?
A professional employer organization is an outsourcing company that provides human resources for small and midsize businesses through co-employment agreements. These are some ways a PEO simplifies your business’s HR duties:
- It reduces the number of administrative and HR tasks your business must handle itself.
- It helps you adhere to federal regulations, reducing your compliance risk.
- It offers comprehensive benefits for all employees.
By partnering with a PEO, small business owners gain more control over their companies because they have more time to lead and focus on driving employee performance, according to Brian Michaud, president of ADP’s smart compliance solutions and former senior vice president of ADP TotalSource.
“A PEO offers built-in protections and helps ensure holistic compliance, from payroll to HR (i.e., discrimination and harassment) to insurance,” said Michaud. “PEOs allow owners to focus on knowing and executing on their business, rather than needlessly worrying over potential fines and lawsuits that can come unexpectedly.”
Bottom Line: PEOs manage many HR-related services, such as payroll processing and payroll taxes, health insurance, workers’ compensation insurance, and retirement plans like 401(k)s.
What are some in-house HR benefits?
For some businesses, keeping human resources in-house is the better choice. Managing your own HR department offers you more control over your workplace policies. An in-house HR team is completely dedicated to your business, and you can hand-select HR professionals who understand and act in the best interest of your business. In-house HR can improve the employee experience by providing the following:
- Face-to-face interactions
- Fast execution of technical operations, like policy and compliance changes
- In-person assistance with recruiting, interviewing and training new employees
What are some in-house HR disadvantages?
Human resources departments are costly to run, and the additional salaries of an entire department can be a burden to small businesses. If your business has grown at a manageable rate and needs little HR management, hiring and maintaining an in-house HR team may be unnecessary. Here are three disadvantages of in-house HR:
- It’s time-consuming. Maintaining HR duties in-house takes up time and manpower that many small businesses simply can’t afford.
- It may cost more than a PEO over the long term. While standard payroll services or human resources may seem affordable initially, you must account for long-term sustainability. Employing knowledgeable and experienced HR workers to ensure labor law compliance, administer benefits, and draft company policies and procedures can cost business owners more out of pocket than they would like.
- It’s not easy to find top talent. Finding quality employees may be difficult, especially for small businesses. Top employees usually seek numerous high-quality benefits, such as medical and dental insurance and a 401(k)-plan match, that small businesses can’t always offer.
By partnering with a PEO, businesses receive access to a team of experienced HR professionals and a wide range of support that may otherwise be out of reach for small organizations. Alternatively, keeping HR services in-house can raise employee satisfaction by providing face-to-face interactions, which can strengthen the bond between the employee and employer. Consider the size and needs of your business when making the final decision between using a PEO and keeping HR work in-house.
Additional reporting by Skye Schooley. Some source interviews were conducted for a previous version of this article.