Should you ditch solo 1099 work and hire employees?
There is going to be a cap on the amount you can make if you are a solo 1099. Eventually, you will get the bright idea that you can hire your own employees and make a profit off of their work!
» How it works
Well, as a former W2, you were on the reverse side of the situation with your employer. Now, you want to be the employer! You can be the next Booz Allen or Deloitte!
The same business model applies. You hire someone and say, bill them out at $100/hour. If they bill 1860 hours per year, which is the amount of working hours after 10 federal holidays and a little over three weeks of vacation. You will earn $186,000 in revenue.
Say you pay them $100,000 in salary, $10,000 in health benefits, $5,000 as a 401k match, and maybe a $5,000 bonus for doing great work. There is also another $7k in employer FICA taxes that you pay, so overall, the cost of your $100,000 employee in year 1 is $127,000.
Your gross profit is $186,000 - $127,000 = $59,000! That is awesome!
However, now that you’re employing someone, your administrative burden goes up. You have to set up payroll, pay taxes on behalf of the employee, make sure your accounting is set up, get a health insurance program running, etc.
I estimate from my own business this will cost you about $8,000 - $10,000 per year, most of which comes from hiring a good accountant/bookkeeper.
Those costs don’t rise that much with the number of employees you have but as soon as you hire one employee, you will likely start incurring those fees.
So now you’re down to $47,000 - $49,000 in profit in year one. That is still really good.
Hire four employees and you’re making $200,000k per year without doing the actual billable work. Pretty impressive!
» How/when to hire employees
My partner and I have hired a total of three employees, two of which are currently with us at the time of this writing.
There are three core things you need in place when you hire an employee.
The first is you need billable work for them to perform. Remember how you had to find billable work for yourself as a 1099? Well, now you need to get a prime to sub-contract out another project or position to your company.
I don’t have a good system for this. In our case, my partner and I each did really good work for our government clients. When the government needed a new position filled, we told our primes that we’d like to fill them. Because the government client liked us and the prime knew it, they were open to letting us fill the spots with our own employees.
Our first employee worked with me directly on the same project, in the same type of role. I was able to manage his work and get him up to speed.
My partner was in a similar position with the first employee we hired for his project.
If you don’t have the work, you can’t hire anyone.
The second thing you need is, well...the employee! Again, I don’t have a good system for this. We sort of lucked into finding our employees.
My partner was friendly with the guy that ran a job fair for separating Navy nuclear /submarine officers. He let us take a look at the resume book he had for attending candidates and we e-mailed a few that we thought would be a good fit for the work.
One of them accepted our offer and worked for us for a year before finding a better paying job that aligned more with his interests. The traitor! Just kidding, we’re still friends and stay in touch.
The second hire was a referral from a friend of my partner.
The third hire was a referral from our second employee.
Overall, it has been kind of random! We have paid for access to job boards and such and while a lot of the resumes are intriguing, the stars have to line up to actually get to the point where you are hiring them.
The third is you need at least a few months of cash saved up to pay your employee. Remember how you needed two months of expenses saved up when you transitioned to becoming a 1099? It’s the same thing here. You are not going to get paid for at least two months after your employee starts due to Net-30 (or greater) terms. Weirdly, your employee still wants to be paid during that time.
I estimate for every $100k salary employee you hire you need at least $25k saved up to make sure you can pay them.
You are also going to need all the administrative infrastructure in place to hire your first employee.
This is not a “core” requirement because I don’t think you need to worry about this until you have figured out the other elements I mentioned. But it is mandatory and a non-trivial amount of effort.
» The risks
The profit from hiring employees is attractive if all goes well. However, hiring employees come with a new set of risks that are different from the ones you face as an employee.
First, you are now responsible for making sure that employee has billable work! Remember all the things that could go wrong for you as a solo 1099?
Well, all those can happen to your employee too. A project gets canceled, security clearance issues lead to delays, etc.
As a 1099, hopefully you saved enough money to cover your own expenses while you were in-between projects. But if you’re making $50k in profit off your
employee per year, that profit may only cover a few months of your employee’s salary. And that assumes you did not pull out any of the profit for yourself for that first year AND that your employee was fully billable that first year!
Second, you are now responsible for the quality of your employee’s work. As a solo 1099, you just had to manage your own work. As an employer, you have to make sure your employees are doing good work for the client. And you have to do so in a way that ensures the employee maintains good morale. Otherwise they will find a new job. You probably wanted to go 1099 because you had experiences with sucky managers. Now you might be the sucky manager!
If your employees do poor work, your reputation as a business might suffer. Not saying it will happen, but it’s a risk, and mitigating this risk will take new skills that aren’t necessary as a solo 1099.
Those are the two main risks that my partner and I have dealt with directly. There are other risks like getting sued by your employee or them stealing your work by becoming a 1099 themselves (particularly if they read this book) but I don’t have experience with those. You will need to get a different book!
» The pain-in-the-ass (PITA) factor
I like my company’s employees and my partner and I have certainly made some money from hiring employees, but it does come with some headaches.
First, finding good employees is hard. I did a recruiting sprint recently with no luck. The labor market for high quality employees is tough and it’s a tough sell to convince someone to work for your unknown company. While you may not like being an employee of Raytheon, at least they have a brand and a good compensation package.
Second, if you do convince an employee to work with you, you still have to make a compelling offer. Fortunately as a small business with virtually no overhead (office space, administrative employees, etc.), you can probably pay a competitive salary and benefits package. However, those eat into your profits so you constantly have to balance your profit margin with being competitive. Or else, employees will leave for a better offer eventually.
Employees don’t stay forever. They get bored, they’ll get better offers, they’ll move to another city. So even if you successfully hire an employee or two, you’re never done. You have to make sure it’s worth it to your employees to keep being your employee as long as possible while balancing this with your desired profit margins.
Third, setting up the administrative stuff is a PITA. It took several months to find a great accountant at a price that we felt comfortable with to manage our books for us. We spent a non-trivial amount of time setting up our company health insurance plan. Things like that, while not difficult per se, are just annoying. It’s the cost of doing business though if you want to hire employees.
A note for those that want to hire employees with security clearances: you need to get what is called a Facility Clearance (FCL). This will allow you to administratively manage your employees’ clearance.
To get one, you need an organization to sponsor your company. This will likely be the prime on an existing contract. Once we persuaded the prime to sponsor us, it took about six months to get approved.
Then you need a Facility Security Officer (FSO) to manage everything after you get your FCL. You can hire someone part-time to do this but again, it costs money. If you have a business partner, one of you can be the FSO and the other the assistant FSO.
I’m the assistant FSO at my company. But you need at least two people since you’re not allowed to manage your own clearance.
This is just an example of a unique PITA administrative task that comes with hiring employees with security clearances.
» Should you hire employees?
I don’t know. I’ll say in my experience, it has been financially worth it, but not as much as a I initially thought.
If I had a clear path to growing the company to say, 15-20 employees, the numbers become more interesting relative to the PITA factors and the risk, but it turns out I don’t have a particular talent for recruiting, so it’s not realistic at this time.
My recommendation is to exhaust the other methods of increasing your income first before you try hiring employees. They’re not mutually exclusive but you may find that you have achieved a comfortable lifestyle that works for you without hiring employees.
If you think you will be good at finding work, recruiting employees, and managing employees, then go for it! Just don’t expect it to become the magic money machine you’re dreaming of overnight.
If you have questions feel free to reach out to me directly at email@example.com. I can also add you to my informal mailing list in case I have updates or news or whatever.
This article is an excerpt from Chapter 13 (How to increase your income as a 1099) of my book.
You can read more about it here:
Going 1099: How to become a solo federal sub-contractor and gain control of your working life, earn more money and unlock more free time