Got It Covered

In the late 1990s, Seth Miller was looking for a way to provide better benefits at Miller Systems Inc., the small Boston IT consulting company he founded in 1995. "We just couldn't get dental insurance being the size we were," says Miller, 32. "But to compete for the best people, we needed to have big-company benefits."

In 2000, Miller joined a professional employer organization, or PEO. A PEO takes over management of a small company's HR tasks and becomes a co-employer to the company's employees. The typical PEO client is a small business with 16 on-site employees, according to the National Association of Professional Employer Organizations (NAPEO), the national trade association that represents the $43 billion PEO industry.

PEOs are increasingly popular because they manage all the HR paperwork while offering entrepreneurs access to better employee benefits through economies of scale, says Milan Yager, executive vice president of NAPEO. He says, "Entrepreneurs can focus on the business of their business, while the PEO focuses on the business of employment."

A 2002 Society for Human Resource Management report concluded that companies with fewer than 10 employees that hired a PEO saved roughly $5,000 per year in time and labor costs. Companies with 10 to 19 employees saved more than $10,000 per year, and companies with 20 to 49 employees saved $18,700 annually.

Today, Miller's 16 employees have benefits including dental insurance and a 401(k); his PEO also handles payroll, so Miller can focus on building his business. "I think it makes a lot of sense for smaller companies," he says. Annual sales at Miller Systems topped $1.5 million in 2003.

While this arrangement sounds perfect, you have to understand what youre getting into. The "co-employment" relationship is controversial with labor proponents, who see it as a way for small employers to shun responsibility for their employees. In fact, some small employers have signed on with a PEO thinking they're no longer accountable for employees at their work site-a huge mistake, says David Curtis, a labor and employment law partner with Gardere Wynne Sewell LLP in Dallas, who says courts hold small employers liable along with the PEO when problems arise. "You can't contract away [responsibility]," he says.

The co-employment arrangement could also obligate your company to laws that cover large employers. For example, if a small company with eight employees signs with a PEO that manages 4,000 employees, that small company could in fact be considered to have 4,008 employees, says Jim Craig, an employment partner with Ford & Harrison LLC in Tampa, Florida."That's a real danger." The aggregation issue could require you to comply with regulations such as the Family and Medical Leave Act (FMLA) and the Americans With Disabilities Act, which usually don't affect companies with fewer than 50 and 15 employees, respectively. It's an issue the courts still need to address.

Patricia Thorp, 48, learned the hard way after signing with a large PEO five years ago. Thorp, founder and president of Thorp & Co., a 19-employee PR firm in Coral Gables, Florida, was surprised to find she was obligated to provide 12 weeks of unpaid leave under the FMLA to one of her employees. While she says her PEO experience has been good-she's proud that five employees are fully vested in the company's 401(k)-having to comply with the FMLA put a strain on the business.

In addition, when you sign with a PEO, your employees are lumped with the thousands of employees the PEO manages across many small workplaces-great for attaining aggregate health benefits, but potentially not so good under Title VII laws that forbid employment discrimination based on color, race, religion, gender or national origin. Youíre entrusting the PEO to administer your hiring, firing and sexual discrimination policies. What if the PEO doesn't do it well? Your company could face a Title VII discrimination suit.

Do your homework, because only 23 states require licensing, registration or regulation of PEOs. Some PEOs have been sued, and others have gone out of business, leaving small employers scrambling for coverage. This happened to Miller a few years ago when his former PEO went under. "We had 60 days to find a new benefits provider," he says. "Check on the stability of your PEO." Miller signed with another PEO and says he'll reevaluate its cost-effectiveness as the company grows. "The management fees from the PEO might start to add up when you have a certain number of employees," he says.

When researching PEOs, ask for references, and ask a lot of questions. How will this expose my company to more liability? How will it change my obligations under current employment laws? Who underwrites this PEO? It's wise to consult an attorney since PEO contracts can be 50 pages. Curtis suggests working an addendum into the contract that clarifies each party's role and answers all the "what ifs." For example, who's responsible if an employee files a job discrimination claim? Don't be afraid to ask for a 60-day trial period, either. "The good PEOs will let you," Curtis says.

Also be aware that you may encounter morale issues with employees who think you're shifting them to a large, faceless organization. "You're injecting a third party into the process. It waters down the one-on-one relationship," Craig says. Explain why it's to their benefit, and designate a point person in the office to answer basic questions. Finally, ask employees at least once a year about their PEO experience.