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10 Things to Review Before Working with a PEO (if you must)

“So, what do you all do?” If you’re a business owner, it’s not the time to answer that you run payroll, update 401k contributions, audit your workers’ comp, get insurance quotes, check timesheets, pay vendors, close your monthly books, and organize open enrollment. “Oh, and I run a software company.” If you spend too much time on that stuff, you need help to get it off your plate. Many turn to a PEO to tackle these things for them. We’ll review the PEO model with 10 tips for you to make your own decision.  

We believe (here goes our “Credo”) that PEOs (Professional Employment Organizations) can be a good option for some small businesses, but are not necessarily a good option for every company. We believe that PEOs are great for brick and mortar companies that have predictable employment patterns and static/predictable jobs. Companies like a barber shop, a Mexican restaurant, an electronics store, and other similar companies in the hospitality or retail space can often really benefit from using the PEO model. 

However, it makes less sense for companies to use PEOs when they are experiencing rapid, dynamic growth. Growth-oriented companies like venture-backed startups, many nonprofits, and professional services firms are usually not great candidates for the PEO model because they have the time, resources, manpower, and skill level to do much of the same work themselves that a PEO does (albeit better), without incurring the cost of a PEO. If you do end up going the PEO route, it is important to know what you’re getting into when you sign up. Here are 10 things to review in a PEO:

1. Check Blanket Insurance Coverage

PEOs usually offer blanket business insurance policies for their clients. This coverage isn’t always with the best insurance carriers nor does it offer the most comprehensive coverage.  You may end up having to purchase additional coverage in order to account for gaps or high deductibles. Keep a close eye on these policies, as well as their deductibles, exclusions, and “fine print.” For example, any requirement(s) that you notify the PEO within a certain timeline if you suspect a potential claim.

2. Review PEO’s EPLI Policies

Similar to #1 above, many PEOs offer blanket Employment Practices Liability Insurance (EPLI) coverage. EPLI covers claims like wrongful termination, sexual harassment, and discrimination. However, the EPLI policies that PEOs procure and provide for their clients often have deductibles that are extremely high. Sometimes the deductibles are what the cost of a common EPLI claim would be! If this is the case, you might as well not even consider your company as having EPLI – or you should consider purchasing additional EPLI coverage on top of what the PEO provides. Review the PEO’s details of your coverage limits.

3. Consider PEO’s Workers Compensation Policy

PEOs often provide workers compensation coverage to their clients. Small businesses should make sure that their employees are classified correctly. Sometimes PEOs will incorrectly classify your employees because they don’t know any better. And they should also watch out for high administrative fees associated with the workers compensation coverage. Companies using a PEO should also review if they have to pay their workers compensation premiums up front or if the policy calculates premiums throughout the year (e.g. a Pay-As-You-Go policy). If it is an upfront premium, you will need to undergo a workers comp audit at year’s end and possibly need to pay more on top.  

4. Negotiate Fixed Health Insurance Rates

PEOs can sometimes offer small companies competitive insurance rates. These rates can be equal to or better than what those companies could get if they went through an insurance broker who works directly with insurance companies. However, small businesses should review that the PEO does not pull a “bait and switch” on them and increase rates or administrative fees after the company’s first year with the PEO. Companies should try asking for multi-year rate guarantees whenever possible – and they should ask what typical renewal rates look like for companies that are of similar size to them. In a best case scenario, also ask to speak with a client that can tell of their experiences.  

Small businesses should also be cognizant that if they decide to leave a PEO, their new insurance could be rated based on the company being a “large business” (because of their claims experience with the PEO). And once you let a PEO know that you’re leaving them, don’t expect the folks at the PEO to be as helpful as they were when they were signing you up for their services. 

5. Review PEO Fees, Markups, Upcharges, and Splits 

PEOs tend to mark up their product and tack on all sorts of fees, like set up fees, admin fees, usage fees, and enrollment fees. Sometimes they will bundle these fees into other costs and sometimes they will put them right in front of your face in their proposal or contract. These added fees often go straight into the pockets of either the PEO salesperson or the PEO itself.

They will usually charge a base fee for their services, plus a fee per employee per month (PEPM). The PEPM fee can be a flat amount per head (for example $49/mo. per employee), or a percentage of wages paid (for example, 2.5% of wages paid in a pay period). For a company of 20 employees on a PEO, a $400 base fee + $1,125 PEPM fee, you have a standard regular payment of $1,525 per month. Hidden fees can also occur, for example when off-cycle payments need to be made.

Negotiate these fees down as much as you can and wherever/whenever you can. It’s also important to note that as businesses get larger in size, the fees start to become exorbitant. E.g. your large business suddenly becomes a cash cow for the PEO. But you don’t get anything “more” for those fees. Another example, if you paid $1,525 when you were the small company above and grew to 45 employees in a year, your monthly fees become $3,150. That’s roughly $38,000 a year, the same as a junior professional.

In addition to pocketing these fees, the PEO may be getting commission payments or overrides on the insurance you have with them. They may get a fee split on 401k fees or vendor partner kickbacks. They may be (legally) taking additional money out of your pocket without you knowing by engaging in something called scooping.  Lastly, note that many PEOs are so large that they tend to not budge on modification requests made regarding their service agreements. So, consider this before you hire an attorney to review the PEOs contract.  

6. Consider the PEO’s HR/Payroll Resources 

We often hear from companies who review and use PEOs that they chose to go with them because of the amount of resources that the PEO has. That is kind of like going to a library because of the number of books that the library has. Try to determine which resources your company will need from the PEO. See whether or not you will use them. Check whether or not they are effective and/or applicable to your company, industry, location, and line of business.

Access to a virtual training library is great, but only if the trainings aren’t from 1999. Access to a template document library is only valuable if those templates are up to date and applicable to your company. (And if you understand how, when, and why to deploy them). What we’re trying to say here is: you might only use 15% of what’s available, but you’re paying for 100% of the service. Think about the effectiveness of your investment when considering a PEO. 

7. Rethink Co-Employment 

Companies should make sure that they understand the co-employment relationship that exists between the PEO, the company, and their employees.  Remember, with co-employment, the employee is employed by the company AND the PEO.  They should make sure that they are able to explain this to employees as well as candidates they are recruiting.  While co-employment isn’t necessarily a bad thing, there can be downsides to it that aren’t immediately recognizable.  This could include having to explain to employees why their W-2 has a different company name on it. And why employee reference checks or mortgage verification requests can run into to issues related to who the employer of record is. And why an employee’s offer letter has the PEO’s name on it.  

8. Review PEO Usage

In order to get the most out of a PEO, your company MUST have someone managing and interacting with the PEO. Depending on the size of the company, it’s usually someone senior or administrative. They’ll need access to salary and pay information.  We’ve found that the designated person usually has very little experience (or interest in) payroll, benefits, and HR.  This setup can sometimes lead to disaster, or at least significant frustrations on the side of the company.

Many small businesses think that they can sign on a PEOs dotted line and then never have to touch payroll, benefits, or HR again. This is definitely not the case. A PEO is only as valuable as the time that you are willing to devote to it.  A general rule of thumb related to PEOs is that if you employ an HR person or team AND you are using a PEO, you’re probably losing money somewhere (or not being as efficient as possible).    

9. Screen the PEO’s Vendor Partners 

Different PEOs use different vendors for their services (like 401k, insurance, HR materials, perks, and discounts, etc.). Companies that are using a PEO should understand who the PEO vendor partners are. Find out what sort of value these can provide. Sometimes these vendor partners only provide value to companies who have employees that are in certain locations. What good is a discounted membership to a Boston-based gym chain or a bike share in New York City if the bulk of your employees are based in California and Texas?  What good is a PEO with advantageous insurance rates if your employees can only access an expensive 401k plan that eats their gains in admin fees?   

10. Review the PEO Limitations for Yourself

When engaging with a PEO, make sure to ask them what sort of limitations they have as far as their system and service are concerned.  You may get an honest response and you may not. Some PEOs can run international payroll and some can’t. Some will not touch independent contractor relationships like processing payments for 1099s and consultants, and some will. We find that some will not touch business insurance, while others will provide referrals or basic coverage. Some will give you direct access to an HR professional. Others will force you to jump through various hoops in order to talk to a true HR professional.  Some PEO systems will sync up with your bookkeeping and accounting system, and some won’t. 

A common limitation that we see is that you have to play by the PEOs rules.  This isn’t a good thing if your PEO is a massive bureaucracy.  For example, we recently came across a PEO that takes two weeks to convert a worker from independent contractor status to employee status. As a point of reference, most competent companies (not using this PEO) could accomplish this task in roughly 15 to 20 minutes. 

So, what is it that you all do?

The idea is that you can finally do what you do, and not have to manage more. Before engaging with any PEO, review them. We recommend trying them out. It’s not always possible to do this directly. For example, you can’t say to a PEO “let me try out your insurance and your product and see how good it is.” But you can check references, do a search on social media, or look at review sites. 

Sites like G2 can give you insight into the service. Glassdoor can give you insight into how well the PEO itself is functioning (by way of internal employee reviews). And sites like Reddit and Yelp can give you unvarnished opinions into how employees of PEO clients perceive the PEO.  Or you can even call into the PEO itself to see how long of a wait you get. Or how competent and professional the people on the other end of the line are. 

These are just a few tips on how you can get the most out of a PEO. It’s important to remember that not every tip above applies to every PEO. Believe it or not, there are some good ones out there.

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