Should I Hire My Friends for My Business?

Q: My business is getting busy and I'm having trouble keeping up with demand. A couple of my friends suggested I hire them, but I'm not sure if I should. I know there are a lot of legal things you have to do when you're an employer, but I'm not sure what they are. Also, I don't want my business to get in the way of our friendship. But I really need the help. What should I do?

A: Hiring your friends can definitely be a double-edged sword. On the one hand, you can work with people you know you like and you don't have to face the daunting task of recruiting and hiring strangers. On the other hand, will you still like them if they flake off work? And will they like you if you have to lay down the law? Just like a partnership between friends or family, it's best to enter into this relationship with all the rules established first.

So before you hire anyone, make sure you lay out some ground rules, including working hours, pay rate, behavior policies (like no cussing or erratic driving in front of customers), uniform rules and termination policies (that is, whether your business relationship can be terminated "at will" by either one of you or whether notice is required).

Your next move will be to cover your legal tail, which is an extensive process and one best supervised by some knowledgeable professionals, like an accountant, an attorney or an experienced employer who can act as your mentor. If you hire employees, you'll have to obtain an Employer Identification Number from the IRS. All your employees will need to fill out a Form I-9 to verify that they're legally eligible to work in the United States.

Then it's time to tackle payroll taxes. Your employees will need to complete a W-4 form, which indicates an employee's filing status and withholding allowances. You'll need to get Publication 15, Circular E from the IRS to know how much you need to withhold from employees' paychecks. You'll also need to withhold Social Security and Medicare taxes--collectively, these are known as FICA (Federal Insurance Contributions Act) taxes. Much more information on all these taxes can be found in the Employment Taxes section of the IRS Web site.

Once you get done figuring out payroll, you'll need to make sure you comply with the law regarding things like overtime pay, what hours a minor can legally work, safety and Workman's Compensation insurance.

As you've probably already gathered, hiring employees is a very complicated business. One alternative is to hire your friends as independent contractors. This essentially means they're working under contract for you--you're only in charge of the result of the work, not how they do it. So say you're a Web designer and you need a friend to do some coding for you. You can't say when and how he'll do the coding; you can only say what you need, when you need it and how much you'll pay for the work. As independent contractors, your friends are not bound to you as employees and as such, they're responsible for their own tax worries. This can actually be helpful to your friends because if they don't make a certain amount in a year, they may not have to file any taxes at all. (This amount is $4,700 in 2002 if their parents still claim them as a dependent; it's $7,700 if they're under age 18 and they claim themselves as a dependent while no one else does.)

But be aware that the IRS is very, very diligent in scrutinizing this area because people sometimes try to use it as a tax dodge. So you'll want to make sure that your independent contractors are really independent contractors and not employees in disguise.

A final alternative which may have crossed your mind is paying your friends "under the table." This might, at first glance, seem like the best choice. You don't have to pay taxes, nor do your workers. You don't have to bother with paperwork; you can just throw your buddies some cash when they're done working. But this is also illegal, and you don't want to start out your entrepreneurial career this way. It may be tempting, but you'll be better off in the end just growing your business more slowly without employees.

Next Step
When we told you to get an accountant and an attorney, we weren't kidding--they're integral parts of every business. Read Keith Lowe's excellent series on hiring professional vendors: Keep Your Banker Informed, Developing a Solid Relationship With Your Attorney and Why You Need an Accountant.