What Is a PEO?

By Joshua Stowers,
business.com writer
| Updated
Jul 01, 2020
Image Credit: fizkes / Getty Images

If your small business needs HR support but isn't ready to hire an in-house HR specialist, a PEO may be able to help. Find out what a PEO is and what it can do for your business.

  • A professional employer organization (PEO) provides comprehensive human resources services for small and midsize businesses.
  • The partnership between a business and a PEO operates under a co-employment arrangement, which means the PEO becomes a co-employer of your employees.
  • A PEO can free up time and resources for a company, allowing an employer to focus on growing their business. This is one of the key benefits that newer businesses tend to appreciate about PEOs.

A full-time human resources team to handle payroll, benefits management and a host of other tasks is an investment many small businesses can't afford. That's where professional employer organizations (PEOs) step in.

PEOs are great options for small businesses with understaffed HR teams because they take all of the necessary HR responsibilities off their plates. Businesses that work with a PEO enter into a co-employment arrangement. This means that while businesses are still responsible for running their own operations, their employees are technically also working for the PEO and reported under the PEO's employer identification number (EIN).

PEOs operate in every state and provide numerous services and employee benefits to small and midsize businesses. These services can help increase a business's growth, financial success and employee satisfaction.

According to a recent study published by the National Association of Professional Employer Organizations, small businesses that use a PEO have 40% higher revenue growth and are 16% more likely to report an increase in profitability. Additionally, PEO clients' employee turnover is more than 10% lower than non-clients' turnover.

 

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What is a PEO?

A professional employer organization is a third-party human resources provider that assumes co-liability for its client's workforce. From managing unemployment and payroll taxes to providing workers' compensation insurance, PEOs offer numerous employee benefits that can provide more HR stability for your small business.

How does a PEO work?

PEOs allow small and midsize businesses to outsource their HR and administrative needs. It's best to think of PEOs as independent companies that manage daily HR functions and employee benefits, such as payroll, tax compliance, 401(k) plans, health insurance and workers' compensation.

The partnership between a business and a PEO is known as co-employment, which means that the PEO becomes a co-employer of your business. While you continue to manage your employees' work and daily responsibilities, the PEO manages compliance, legal and HR-related policies. This co-employment arrangement relieves small business owners of some liabilities and allows them to focus their time on growing the company and generating revenue.

Many small business owners may cringe at the idea of a co-employment agreement, but it's not as daunting as it may sound. Your business remains the primary employer, while the PEO handles specific HR tasks set forth in the service agreement. This allows the PEO to manage employee benefits, payroll, and tax and government-related filings.

How much does a PEO cost?

While the cost of a PEO varies, most have one of two cost structures: 

  1. Per employee: Some PEOs that bill per employee also charge a base fee. They are usually monthly costs that you negotiate directly with the PEO.

  2. A percentage of payroll: With this cost structure, you pay a percentage of your total payroll for each pay period. This percentage includes workers' compensation, employer practice liability insurance, and local, state and federal taxes.

The cost of a PEO is not fixed because it depends on the company and its services, according to Matt Diggity, CEO of Diggity Marketing.

"Generally, there are two methods of charging – per employee or payroll percentage," he said. "Charges per employee mostly range between $1,000 and $1,500 per year. This approach has a benefit that while devising a business's yearly financial plan, you have an accurate expense of [your] PEO."

Payroll percentage, on the other hand, continuously changes according to your payroll amount that month. It's important to remember that PEO costs vary based on service offerings, the number of employees you have and the negotiated rate. These costs are usually less than those of hiring your own team to manage your human resources.

PEOs can also charge for their services in other ways, such as by retaining the Section 125 benefit as a co-employer or with SUTA taxes, according to Michael Roloson, director of business development at PEO Focus.

"If you take into account all fees across the board, you can get a better picture of the total costs," Roloson said. "It's important not to evaluate purely on costs. Entering into a PEO relationship is about adding value and efficiency to your organization."

Roloson believes that by first identifying the PEOs that can bring the most value to your business, you will then be in a better position to negotiate contract terms.

What is the difference between a PEO and a staffing company?

A staffing company provides temporary employees, while a PEO is a full-time co-employer. The staffing company usually handles business operations, including day-to-day management, production, marketing and sales. PEOs typically manage employment operations, including tax affairs, HR services and benefits administration.

Roloson said that a PEO does not provide any workers, but rather partners with its clients as they enter into a co-employment partnership where both parties employ the workers together.

"Through the co-employment model, the company can then leverage the PEO for their HR expertise, payroll, administrative technology and employee benefit programs," he said. "The company can still dictate the culture that it chooses to instill as a small or medium-sized business while also gaining access to the expertise and economies of scale that a larger partner can bring to the table." [Read related article: What Services Can a PEO Provide to Your Small Business?]

What is it like for an employer switching to a PEO?

Depending on the size of your business and what the PEO offers, switching to a PEO can be a good thing. Most PEOs provide an implementation representative to assist with the onboarding process, according to Shraga Jacobowitz, managing partner of ARC PEO Consultants.

Jacobowitz said there are a few stages to this onboarding process:

  1. Company decisions (health insurance plans, funding strategies and other HR policies)

  2. Employee data input and online portal building

  3. Orientation meetings with employees

  4. Employee enrollment in HR platforms

  5. Training on how to use the online portal (e.g., payroll processing, reports and transactional items)

A PEO can free up time and resources for employers, allowing them to focus on growing their businesses. This is one of the key benefits of a PEO in a business's early stages of growth.

A PEO also plays a decisive role in managing a company's employee affairs, according to Tim Uittenbroek, founder of VPNMash. "Mostly, the small and medium-sized businesses need the services of a PEO, and the PEO model provides the suggestions and recommendations to facilitate the employee."

PEOs can offer unique pricing on certain healthcare benefits, sometimes lower than what your business would pay outside of the PEO, according to Nicholas Tzoumas, president of ClearscopeHR.

"At the same time, in addition to the costs associated with these premiums, workers' compensation premiums and payroll processing, there are also administrative costs assessed by the PEO," Tzoumas said. "When comparing PEO versus non-PEO options, employers (or their benefits consultant) need to compare the costs inclusive of the PEO admin fees."

What are the pros and cons of using a PEO?

While there are a lot of benefits with outsourcing human resource activities, there is some control that you surrender. 

PEO pros

  • The administrative and professional processes of human resources are completely transferred from you to the PEO. This covers many routine tasks, including payroll and recruiting.

  • Depending on the size of your organization, switching to a PEO can free up a lot of time for a business owner.

  • PEOs are able to provide and negotiate reasonably affordable benefits and insurance coverage. With a large pool of employers, PEOs can use their numbers to obtain lower group insurance costs.

PEO cons

  • Because the details of human resources are handled entirely by the PEO, there is little control over how you influence things. SHRM cautions that the addition of the PEO can create an extra step in communicating basic messages, as some PEOs require that all communications go through them, even if the matter could have been handled yourself.

  • Also depending on your organization's size, PEOs can become more expensive than forming internal human resource teams and processes. Additionally, it can become expensive to leave a PEO due to the number of individual services performed by the PEO that will subsequently be redirected to your company.

  • The PEO has full control over the benefits and insurance. There is no flexibility outside what plan the PEO has available at the time. Though these may lead to lower rates, the coverage may also be inferior.Tzoumas believes that once a business reaches a size of 20 to 50 full-time employees, the HR functions become too important to outsource and more advantageous to handle in house.

Depending on the size of your business and the services your prospective PEO offers, opting for a PEO over in-house HR might be a beneficial move for your small or midsize company. Generally, the relationship between a business and a PEO is established as a co-employment agreement. The PEO usually handles tax withholdings, employee wages, HR services and benefits administration, so you can focus on managing your employees and running your business. [For more information on PEO services, check out our review of The Best PEO Service Providers of 2020.]

Joshua is a staff writer based in New York City. He is a former entrepreneur who started a fashion and art, print and digital publication called Elusive Magazine, serving as the features editor for several issues. Previously, he worked in product development for DirectTV and for a content agency that wrote for Verizon and Google. He is a New Jersey native in love with the city lights and skyscrapers.
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