For many business owners, subcontractors are a vital part of doing business. A good subcontractor expands your abilities and allows you to take on work that you might not otherwise be able to handle.
Subcontractors are important because they are often more cost-effective for contractors than hiring employees to do the same tasks. With a subcontractor, the contractor does not have to pay for tools, workers' comp, liability insurance, and taxes on behalf of the subcontractor.
We may think of subcontractors most commonly in the construction trade, but they can be found in different businesses and industries. In this article we'll take a look at subcontracting work, its pros and cons, and a few of the factors that you need to take into consideration when hiring a subcontractor.
What Exactly Is a Subcontractor?
A subcontractor is a person or company hired by a main contractor to do a specific job on a larger project. Subcontractors charge for their services and are often freelancers who work for themselves. Whereas a contractor has a good general understanding of all the factors involved in a project, a subcontractor is more of a specialist. An electrician doing the wiring for an apartment building project is one example of a subcontractor.
Note that if a contractor hires their subcontractor to be a full-time employee, or even part-time, they’re no longer considered subcontractors. A subcontractor is not the employee of a contractor.
Types of Subcontractors
A subcontractor can be employed in just about any profession, but here are some of the more common jobs that may require the help of a self-employed subcontractor:
- The construction industry: There are many areas where a construction company might need a subcontractor, including excavation work, framing, drywall, electrical, plumbing, and more. Sometimes subcontractors will go into partnership with contractors to ensure they get consistent work.
- Food service: A food service company might hire subcontractors to cook or serve food, create menus, manage restaurants or banquet halls, or more.
- Landscaping: A large landscaping company could hire gardeners, arborists, pond technicians, excavators, and day laborers to create beautiful gardens for clients.
- Information technology: There are many freelancers in the IT world, including web developers, network administrators, cyber security experts, data analysts and much more. Although some companies hire in-house talent to do this work, subcontractors are common.
- Marketing: Companies contract with marketing agencies for a range of services; even creating a single commercial can require a lot of different skill sets and expertise from writers, directors, camera operators, costumers, prop wranglers, and location scouters.
The Pros and Cons of Subcontracting
As is true of every job, there are benefits and drawbacks to being a subcontractor, as opposed to going into business as a general contractor. Here are a few of them:
- You get to do what you love: As a freelance subcontractor, you can focus on an area you're passionate about, rather than having to handle all the "big picture" details that come with contracted projects. So, for example, if you love working with heavy machinery, a career as an excavator might be more to your liking than general contract work.
- You maintain your independence: Subcontractors generally are not 9-to-5 office workers. A freelance graphic designer, for example, might work out of their home at hours that allow them to manage childcare and family obligations.
- You avoid client problems: As a subcontractor, you work directly with the prime contractor, who pays you, gives you direction, and assesses your work. This person acts as a buffer between you and clients, and often there is no need to interact with clients for any reason. Since client management is a skill that takes time and energy, some subcontractors are happier with little client interaction.
- You manage your own business administration: This can be either a "pro" or a "con" depending on your likes and dislikes. As a subcontractor, you keep your own books, whether you use an old-fashioned ledger or software such as Intuit's QuickBooks. You also serve as your own human resources department and are responsible for any marketing needed to obtain jobs.
- You manage your own business administration: Yes, we listed this as a "pro," and it does keep you in the loop and give you more control over your business. But it also takes up time and may require you to hire your own subcontractors—such as an accountant to help at tax time or a web designer to create a site for your business.
- You must pay business and tax expenses: As a subcontractor, you are a small business owner, and thus while you can claim expenses including travel and equipment on your taxes, you must also take care of paying into social security and for business insurance. When you’re an employee, your employer takes care of pulling Social Security and Medicare taxes out of your paycheck, and matches what you pay into the system. When self-employed, you pay what an employee would pay, but also the matching amount that the employer would normally pick up.
- There's no benefits package: When you are employed by a business, you receive a package of benefits that probably includes paid vacation time off, partial or full health insurance costs, and more. As a subcontractor, you don't have that luxury. You'll need to find and pay for your own health insurance, and vacation time, if you take it, may revolve around when you are least busy with work.
The Differences Between Contractors and Subcontractors
The primary difference between contractors and subcontractors is who they work with. Contractors work for clients, either corporate or individual, and subcontractors work for contractors.
But there's more to the picture than that. A contractor takes on a whole project, while a subcontractor works on part of it. So, contractors may have a broad base of knowledge in a number of areas. A building contractor, for example, needs to know a little about electrical systems, plumbing, drywall installation and more in order to properly plan how to manage a construction project.
Subcontractors, meanwhile, are specialists. Their knowledge base might not be broad, but it will be deep. So the plumber may not know much about electrical systems, but they will have a comprehensive understanding of the detailed plumbing needs for a given structure.
Another difference: in any large project, the contractor is the one responsible for glitches or problems. This person needs to be able to answer to the client if something goes wrong. That includes substandard work or issues related to a subcontractor's role in the project.
So if the electrician does a poor job, it's still the contractor's role to take that information to the client, if necessary, to determine how to handle the situation. The subcontractor will have to answer to the contractor, but not to the client.
The same is true of payment. Usually, the subcontractor is paid by the contractor, rather than the client. The contractor then bills the client for the work of the subcontractor, marking up the cost to allow for his or her supervisory role.
Finally, there are differences in how contractors and subcontractors generally find work. A contractor runs their own procurement process for getting projects. They'll most likely bid on large projects—which may be corporate or government contracts—and need to have a good sense of where these projects will show up. Once a project is contracted, the contractor needs to be skilled at client management, or have someone on staff who can serve as client representatives. A subcontractor usually finds jobs through their relationship with contractors, so it's important for subcontractors to network effectively and maintain connections in professional associations.
Employees vs Subcontractors
There are several differences between an employee and a subcontractor. A subcontractor is someone who sets their own hours and chooses the work they want to do. They get paid by the contractor for their services, and have to pay their own taxes, provide their own tools and supplies, and do not generally receive health insurance, benefits, or vacation time from an employer.
An employee, on the other hand, has set wages, hours and projects, which are determined by the employer. Their employer also deducts taxes from their paycheck. An employee may also receive benefits such as health insurance, 401k, PTO and other perks.
Insurance for Contractors and Subcontractors
Both contractors and subcontractors may need insurance to protect themselves and their business. Even a small, one-person freelance electrician's shop should have liability insurance so they’ll be covered if they are sued by a client for property damage or medical costs.
Business Owners Policies
Many subcontractors and smaller contractor firms purchase business owners policies (BOP insurance). These policies are geared toward smaller businesses making up to roughly $5 million annually and can be customized to the needs of a specific business. They feature several types of insurance bundled together: In addition to liability, BOP insurance will have business interruption insurance and property insurance.
Errors and Omissions Insurance
Another type of insurance that may benefit contractors and subcontractors is errors and omissions insurance, also called E&O insurance or professional liability insurance. This is a specific liability insurance type that covers contractors if you make a mistake that is costly. For example, a marketing company hires a freelance web designer, who accidentally creates a web page that doesn’t allow for purchases—costing the client significant resources until it’s discovered. E&O insurance may cover those costs.
Cyber Liability Insurance
For those in the tech sector, cyber liability insurance will cover you for data breaches or other cyber challenges. If you are hacked, for example, and important health data is stolen, cyber liability may cover you if you’re sued by a client. It may also cover direct financial loss from a hack or data loss.
Not exactly a type of insurance, surety bonds are an important consideration for contractors more than subcontractors.
A surety bond guarantees that a contractor will fulfill the terms of their contract. If they don’t, the surety will find someone else to complete the project or reimburse the client for their financial loss.
Sometimes, a client requires a contractor to have a surety bond before they will do business with them. One of the benefits of surety bonds is that they allow smaller companies to compete for larger jobs, because clients know they are covered financially by the surety if the job goes poorly. Like a line of credit, a surety bond needs to be repaid by the contractor eventually.
Experienced contractors often have both insurance and a bond in place. Their general liability insurance may be for up to $1 million, and protects against multiple types of claims, while the surety bond would be for less, since it must be repaid.
Workers’ Compensation Insurance
Few subcontractors operating as sole proprietors or small businesses will need to think about workers' comp insurance, but subcontractors and contractors with three to five employees or more, depending on the state they live in, are required to carry workers' compensation insurance. This applies to almost all states, from New York to California, with the exception of Texas.
If you fall into that category, Hourly has you covered for both workers' compensation insurance as well as payroll solutions. Hourly’s platform syncs payroll and workers’ comp, so premiums are based on actual wages—and not a guess. Their goal is lower audit risk, faster payroll runs, and better claims and safety services for small businesses everywhere. Hourly is also a licensed insurance agent with products underwritten by various insurance companies.