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How Should I Pay Freelancers?

A guide for employers working with freelance consultants

· Freelancing

Nearly 60M American adults are now working as freelancers, and it's changing how we think about employment, work, and fair pay. I've been both a freelancer as well as an employer of freelancers, and it's personally a model that's proven to be successful for me in the context of starting new companies. For companies, freelancers provide resource flexibility, which is crucial when you don't have historical business trends to make projections on. For freelancers, freelancing provides more flexibility with your life, as well as provides a potential opportunity to work more and make more vs. in a salaried job.

That being said, freelancers still make up a minority of U.S. workers (~36% in 2018), and we're all still figuring this out as we go. Here are some tips for employers when working and compensating freelancers.

Make sure your freelancer is actually an independent contractor.

A freelancer or independent contractor is someone who sells their services to companies on a non-employee basis. Independent contractors are not employees, and therefore, by law, are exempt from benefits as well as pay their own employment taxes. For companies, it's attractive to hire independent contractors because they don't add the overhead, payroll taxes, and compliance issues that a full-time employee would require.

That being said, the "independent contractor" loophole is often exploited by businesses as a way to avoid paying benefits to people who are basically full-time employees by definition. The IRS defines an independent contractor by the following criteria:

  • Behavioral control - Worker has the right to control how the work is done. 
  • Financial control - Worker is responsible for the financial aspect of their business. 
  • Relationship - Worker and employer's implied and established relationship. 
TL;DR: An independent contractor is an experienced subject-matter expert who probably works outside of your office unless they're coming in for a meeting. They are working on specific projects or tasks for a limited period of time. You pay them an agreed upon amount, which is only a fraction of their total income.

As an entrepreneur, I've found freelancers to be a great way to start and grow my businesses at the early stages. Startups require subject-matter experts, but for experienced talent, joining an early-stage startup can be really risky. Also, I'm often hiring freelancers to see if it's viable for the business to grow in a direction that requires their skills. By hiring SMEs as contractors to do a specific project, it gives us an opportunity to explore the idea of working together full-time, IF the project works and the business is able to continue operating in that direction. No one has to put all their eggs in one basket, and a freelance arrangement can be easily cancelled if the intended direction is not viable within a certain period of time. This is also beneficial to the freelancers vs. moving your family, your healthcare benefits, etc. all over to a new company that you end up leaving in 3 months because your skills are no longer relevant due to a pivot.

Think about what you're not paying.

As an employer of freelancers, it's important to consider what you're not paying and passing onto them. Independent contractors, unlike employees, take on their own cost of business. Some of the added costs that a freelancer has to take on:

  • Self-employment taxes - Freelancers must pay 15.3% of their net income (earnings after expenses) in self-employment taxes. In a full-time employee situation, the employee pays 7.65% of their salary and the employer pays a matching 7.65%. 
  • Healthcare benefits - Freelancers generally do not receive healthcare benefits from their companies. In my experience as an employer in California, the average full-time employee cost me about $700 in month in benefits cost. 
  • Office expenses - Freelancers are usually paying for their own computer, office space, software, etc. Some of these costs can really add up. For example, freelancers who do photography or video have probably invested a lot of money into their equipment. 
  • Vacation time - Note that freelancers also do not get paid vacation. As such, any vacation time they're taking is time they're not getting paid anything. 
  • Business development - Freelancers are usually working for multiple companies as a time and will be let go more quickly than your average full-time employee. They live gig to gig, which also means they have to find gigs. All of the business development and marketing is on their own dime, and this cost will vary significantly based on their skills and network. 
  • Continuing education - Companies will often invest in their employees' continuing education in the form of reimbursing for classes, paying to attend conferences, etc. As a freelancer, the cost of continuing to grow in your profession is on you.
  • Bonuses and equity - Depending on your arrangement, freelancers may not be receiving the incentive pay or equity that a full-time employee may receive. 

So what is fair pay for a freelancer?

I operate from a viewpoint that most employers are good people and want to pay a fair wage. That being said, we're capitalists, and I understand the employers' need to minimize cost and maximize results. There is no right answer to this question, since employment is based on supply and demand and markets are always fluctuating based on that supply and demand. However, here are a few suggestions on how to go about it:

Competitive Market Rate Approach

When I want to find the market rate for something, I'll usually ask 3 comparable freelancers what they charge and then take the average as the fair market rate.

Or you can go on a marketplace site for freelancers like Upwork or Freelancer and see if those rates can help you determine what is fair. Note that these sites have a lot of overseas freelancers, for whom the financial situation is completely different due to costs of living, opportunity costs, and tax regulations. If your job requires a US resident or experience specific to the US market, it is entirely unfair to compare them to an overseas freelancer since their rates are not even within your consideration set.

Full Time Equivalent Approach

If you're not able to find the competitive market price for a freelancer because there is no equivalent on marketplace sites or within your network, another approach is to base compensation on what a full-time equivalent would make for this job since there tends to be more public data available on salaries. Here's the calculation:

  1. How much is the annual pay for a full-time employee to do a similar job? If you don't know, look up the role on websites like PayScale, GlassDoor, or Comparably to see what the market rates are for this role. Try to find the number that includes total compensation - including bonuses and stock options.
  2. Take that number and multiply it by 1.16 (7.65% for the additional self-employment taxes + 8.33% for the equivalent of about 1 month additional pay for 2 weeks vacation and 2 weeks severance) 
  3. Add $20,000 (~$700 per month in benefits + ~$1,000 per month per employee on office expense, perks, and continuing education)
  4. Take that number and divide by 2000 to get the hourly rate.
Note that subject-matter experts can often charge a premium if they're in demand so this equation isn't always relevant, but it's a good starting point for conversations.

Other things to consider...

If you're a startup without that's pre-funding or have other financial constraints, it may be difficult to pay anyone their market rate, regardless of what you think they're worth to your company. Some additional suggestions to consider:

  • Deferred compensation: This is essentially a loan from the freelancer to your business. They perform the services now, but then you're accruing interest on the payment until you pay them in full. Note that if you are going for investment, some early-stage investors may be deterred by the liability on your balance sheet, especially if it's substantial.
  • Equity: If the freelancer really believes in your business, there may be an opportunity to pay in part or in full in equity in your company vs. cash. 
  • Commission: If you're working with someone in a revenue role, there may be an opportunity to pay them with a percentage of sales generated vs. upfront cash. 

Contact us if you need help!

This is what we do! If you're looking to hire subject-matter expert freelancers who understand the complexities of new ventures - you're in the right place. Please contact us to get a quote.