You Do The Work, They Do The Paperwork

More small outfits are choosing to farm out the drudgery of human resources

When Robert G. Teal co-founded Silicon Valley startup Quinta Corp. in 1996, he cringed at the time and expense it took to hire and retain employees. At his banker's suggestion, he signed up TriNet Employer Group Inc. to assume most of the human-resources tasks of his fledgling disk-drive developer. TriNet helped hire Quinta's workforce and recruit qualified engineers. And it set up a benefits program that took advantage of TriNet's group discounts, allowing Quinta to match larger companies' packages. Today, TriNet handles everything from payroll to benefits for 100-employee Quinta. As for Teal, he never had to learn many of the distracting details of being an employer. "We focused on product development and technology," he says. "That has been one of the greatest benefits."

Across the country, entrepreneurs and small-business owners are turning to professional employer organizations (PEOs), as companies such as San Leandro (Calif.)-based TriNet are called, to be their human-resources managers. Billing themselves as "co-employers" PEOs check references, set up 401(k) plans, and even do the dirty work of firing while generally exercising no more than a veto over key personnel decisions. More than 2.5 million workers are hired through such arrangements, up from 200,000 a decade ago, according to the National Association of Professional Employer Organizations. Most are full-time, permanent employees, not temps.

For a small business, the potential benefits are obvious. Imagine if someone else screened job candidates you interviewed, and sorted through health and retirement plans--and then ran them. What small-business owner would not gladly give up scrutinizing compliance with federal and state employment laws? Sometimes, PEOs even save a company money. A PEO typically charges 3% to 6% of net salary. But passing along the lower costs of group benefits or handling administrative chores efficiently can result in net savings.

Yet for all the benefits, small-business owners need to understand a PEO doesn't necessarily protect them from legal liability on some employment issues. Most PEOs insist that for legal purposes they are the "ultimate employer" and have the final right to hire, fire, and discipline employees. At the same time, PEOs claim to be "co-employers" in other areas. So, while the PEO is generally responsible for paying wages and taxes and handling benefits, the business owner can still face liabilities involving on-site actions such as discrimination or safety violations.

MONIKER. What's more, small companies that sign up with a PEO can find they are now subject to laws covering larger employers. Case in point: The federal Family & Medical Leave Act exempts companies with less than 50 employees. Since, technically, the PEO is the employer and over the threshold, some PEOs require that clients take back a worker after a leave. But some don't. And if a worker is not retained, the owner could be sued along with the PEO as the joint employer. There's no hard and fast way to deal with such issues, other than for the client and the PEO to agree up front about how to handle them--for example, by sharing the cost of benefits during the leave. "It's important to know which responsibilities you are keeping," says Gregory L. Hammond, an Akron (Ohio) attorney specializing in PEOs.

PEO is actually a new name for employee leasing, which started in the mid-'60s as a way for small-business owners to evade federal rules requiring equal pension treatment for employees. The workers, legally speaking, were leased from another firm. After Congress closed the loophole in the 1980s, the industry began marketing itself as outsourced human-resources departments.

PEOs struggled for respectability in the early 1990s. Some companies ran into trouble over insufficient insurance. Others went into bankruptcy after taking on too many clients with high benefit costs they couldn't control. A few well-publicized failures stuck some small companies with unfunded workers'-compensation or health-benefit claims. Scam operators skipped town with clients' payrolls.

Today, small companies that do their homework are taking less of a risk. Some 15 states regulate the industry, ranging from simple registration to rules requiring minimum net worth and background checks of firm principals. In January, 1996, the Institute for Accreditation of Professional Employer Organizations began issuing credentials for firms that pass a review of audited financial statements, liquidity ratios, and other standards. So far, 16 of the country's 2,000-odd PEOs, representing 15% of the dollar payroll processed by PEOs, have passed muster. The group won't say how many have applied.

A host of new corporate players have helped to make PEOs more reliable, too. Payroll processing firms such as Paychex Inc. and temporary-help agencies such as Kelly Services Inc. have gotten into the business. Insurance giant CNA and security-guard company Wackenhut Corp. this year acquired or started PEOs. And longtime industry operators such as Vincam Group in Coral Gables, Fla., have gone public, backed by major Wall Street firms.

Finding a PEO can be as simple as looking in the phone book under "employment service--employee leasing" (table). But choosing the right one is harder--and crucial. In addition to credentials and financial health, it's important to understand the range of services a PEO offers and its compatibility with your company. Some specialize in small companies (up to 20 employees), some in midsize (up to 600), while others focus on particular industries.

As a rule, PEOs can benefit smaller companies the most. When a workforce reaches 100 or more, a business owner can justify a full-time administrator for payroll and benefits. But an employer needs 200 to 400 workers before the purchasing power for health care and other benefits starts to equal a PEO's.

Vitty A. Marcinkevicius, owner of Royal Care Holdings Inc., in Saratoga, N.Y., is one happy PEO user. In 1989, his pharmaceutical-services firm hired a PEO now owned by NovacareEmployee Services, a PEO unit of Novacare Inc., in King of Prussia, Pa. But Marcinkevicius was more than a little apprehensive about letting an outsider control areas so critical to his company, even after his attorney and accountant researched the idea and approved the PEO. "This was a major change for us," he says. "[It] was affecting every employee and their families, including management. A wrong guess could have caused a substantial blow to our staff and our business."

SOLD! The next hurdle was selling the concept to his 60 employees. At first, there was some resistance, says Marcinkevicius. But the mood improved once the staff realized that onsite management wouldn't change, and the PEO would introduce or improve health-care coverage, a 401(k) plan, insurance options, and access to a credit union.

Marcinkevicius' initial concern that employees would be less loyal if paychecks came from someone else turned out to be unfounded. He says Royal Care retains the "right to hire and fire," while Novacare gives Royal Care managers guidance in performing employee evaluations. And the PEO seamlessly handled an acquisition Royal Care made last May that brought 47 employees to a staff that now totals 270. Novacare even helped to meld the companies' vacation policies. The few glitches, such as occasional errors on deductibles as health plans changed, were quickly corrected.

Still, using a PEO can require a lot of adjustments. As your co-employer, PEOs don't just do benefits administration, either, warns attorney Hammond. "The number one impediment to a PEO not doing its job properly is the customer, because the customer wants the benefits but not the intrusions," he says.

Since the PEO is assuming responsibility and liability, it may require you to buy new equipment, revise procedures, or improve safety. "We make a living out of being a good, cost-effective employer," says Vincam CEO Carlos Saladrigas. "The key is not simply that you aggregate but that you manage better." Vincam has a physician and 40 nurses on staff and fields inspectors to help clients meet safety standards.

That's one of the pluses of using a PEO, says Carol Soulliere, who in 1993 hired Vincam for her family-owned Utica (Mich.) paving company, Soulliere Decorative Stone. Vincam instituted drug testing, training sessions, and surprise job-site safety checks of the company's 120 employees. That has improved the caliber of workers in the seasonal business and has dramatically reduced turnover, claims Soulliere. Vincam also holds safety and management seminars that Soulliere attends and has given her advice on discipline procedures. Once, it even cautioned her not to discharge an employee who lacked a disciplinary history. The person eventually quit. "They won't bend rules but will work with you to make sure you understand why you have to do something a certain way," explains Soulliere.

Indeed, hiring and firing can be so touchy that Vincam recently put a worker on its own payroll because the company felt the client hadn't sufficiently documented the reasons for termination. Disputes also arise when clients want to hire someone that the PEO thinks lacks proper qualifications or has a background-check problem. "We have said, `You cannot hire this person,"' says Saladrigas.

Be careful about PEOs that claim to save you money. Sometimes they can. Soulliere figures she comes out ahead by about $30,000 a year because of Vincam's more favorable rates on worker compensation and unemployment insurance. "And that's without the headaches" of having to do the paperwork, she says.

WAGE BASE? Still, if a PEO promises big savings, ask how that's going to be attained. Typically, PEOs charge 3% to 6% of an employee's pretax salary (excluding benefits), or as little as 1% in some competitive markets, such as Florida. Some that serve high-salary clientele charge per paycheck. TriNet charges $20 to $150 per employee for each pay period, depending on the services. A key point, says attorney Hammonds, is to be clear about what the PEO is calculating as the wage base: just wages, or wages plus taxes, or wages, taxes, and benefits. Contracts generally run about a year. Experts recommend a 30-day breakup clause.

To small-business owners such as Russell West, a franchisee of a Schottzsky's Inc. Deli outlet, there are other savings to consider. "When I first opened, I wanted to do everything myself," he says of his 14-employee operation in Hapeville, Ga., which now uses Novacare. "But this takes the load off small-business operators like myself." The deal does provide better benefits to his workers. And best of all, West gets a benefit of incalculable value to small owners: more time to concentrate on running his business.