Professional employer organizations (PEOs) are third-party companies that provide outsourced payroll and human resources (HR) support.

Business owners and executives might hire PEOs if they’re short on time or have too many employees to keep track of by themselves. Indeed, it’s a more accessible and cost-effective option than hiring in-house professionals, but there are downsides. You must have a solid budget and an open mind when working with an external organization.

Let’s take a closer look at what a PEO is, what its strengths and weaknesses are and who it’s best for.

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What is a PEO?

As mentioned above, professional employer organizations are essentially contractors, and they cover your payroll and human resource needs. For example, a PEO can file your taxes, issue paychecks and answer employee benefits questions.

Think of a PEO as an a la carte, prepackaged human resources department. You can purchase their services as needed and stick with them until you put an internal HR team together. They’re ready to go with staff, software and expertise, so you can confidently hand over your payroll and HR operations — all for convenience and peace of mind.

PEO example

There are many PEOs out there. Some target specifically small businesses, yet others provide services to any size entity. A few of the top PEOs include Papaya Global, Paychex and TriNet, which we cover in our list of favorite PEOs.

However, our number one choice is ADP TotalSource. It serves businesses with five to 250 employees, and some of its main offerings include:

• Payroll and tax services.
• Workers’ comp and claims management.
• HR expertise.
• Benefits plans.
• Hiring support and employee retention.

These kinds of services are fairly standard for PEOs with some variance based on specialty or unique capabilities, but it’s also important to peruse user reviews to get a sense of how satisfied a service’s customers are and what level of quality you can expect.

What are the benefits of a PEO?

The overarching appeal of professional employer organizations (PEOs) is their money- and time-saving value. For instance, small-business owners usually employ a PEO in lieu of hiring elaborate administrative teams.

But there are other perks too:

• Improved employee morale: Staffers suffer when there is inadequate administrative support. A PEO can ensure a high standard of help is always available, improving morale.
• Access to experts: PEOs have teams of experts in HR, benefits and compliance. This expertise enables small businesses to make sound decisions.
• Flexibility: PEOs offer tailored solutions with various plans and services. This approach can fit any budget or need.
• Scalability: PEOs can help small businesses scale up or down as needed. You don’t need to hire more people to support a growing workforce. Conversely, letting go of PEO support when money’s tight is an option if you need it and aren’t locked in a contract.

For many businesses, PEOs pay for themselves. After all, they’re typically cheaper than hiring in-house professionals from scratch. Plus, their specialized knowledge helps you avoid costly issues like a missed tax deadline or compliance problems.

What are the downsides of a PEO?

Nothing’s perfect in life, and PEOs are no different.

First, you’ll need enough staff members to justify contracting a PEO. A dozen or more employees is a good rule of thumb, but this can vary. Any fewer and it’s likely easier to keep things informal and in-house — most likely in a bare-bones arrangement.

You’ll also need a proper budget. Undoubtedly, a PEO is out of the question if you’re scraping by or are waiting to see if revenue picks up. PEOs save money only when compared to hiring in-house professionals. They’re still a pricey proposition, though.

There are other downsides to consider:

• Loss of control: PEOs take over many of the HR functions that small-business owners typically handle themselves, such as payroll, benefits administration and other HR tasks. This can feel like a loss of autonomy for some folks.
• Lack of flexibility: PEOs typically offer more general services, which may only fit some businesses well. If a company has highly specialized HR needs, such as international payroll operations, finding a PEO that can accommodate all its particular needs may be difficult.
• Reduced privacy: When a business outsources its HR functions to a PEO, it’s sharing confidential employee information with that company. This disclosure can feel concerning to privacy-conscious people.
• Reduced control over employee relations: When a PEO manages a business’s HR functions, you’ll have less control over employee relations issues. This loss of oversight is troubling if you want strong authority over hiring, firing and discipline.

PEOs can be a good option for some small businesses, but they are not without their issues. You’ll need flexibility, an open mind and a comfortable budget to overcome these downsides. And it’s okay if you’re not quite at the right stage for a PEO — there are plenty of excellent payroll software out there to help you in the meantime.

Why would a company use a PEO?

Usually, smaller businesses still trying to find their footing employ a PEO. This situation includes entities with uncertain futures, newly launched ventures and those not yet able to afford large in-house administrative teams.

Here are some situations that make a PEO a good idea:

• Healthy budget and cash flow: PEOs can save money over in-house teams, but they are still pricey. If you have money to spend, these external organizations can provide excellent value and time-savings.
• Growing workforce: More employees means a greater need for administrative workers. A PEO can quickly solve this support gap if you’d rather not take on more human resources staff.
• Highly regulated industry: If your business falls under strict governmental oversight, then a PEO can keep things in check. For example, an at-home nursing business can focus on obligatory HIPAA training instead of attending human resources conventions.
• Uncertain outlook: If your business is turbulent, a PEO can vanish or return much easier than in-house employees. You won’t have to lay off administrative staff, for one consideration.
• Complex tax obligations: Most people don’t like doing taxes. If this describes you, a PEO can take these pesky duties off your plate. This relief is precious if you have a complicated tax situation, like employees in many states.

Overall, a PEO is geared toward growth. Small businesses use these organizations to keep their focus on their core business rather than bothering with administrative tasks.

Real-life examples

A young startup company is a good example of a business well-suited for a PEO. Startups often don’t have the resources to hire a full-time HR department. They’re also unsure of their future, and avoiding layoffs is ideal. This theme of uncertainty makes a PEO a quick, straightforward solution to handle administrative tasks.

Another example of a small business that might use a PEO is a business with seasonal staffing fluctuations. As you shrink operations, you can easily downsize PEO services and vice versa. On the other hand, you would have to conduct difficult layoffs if you had an in-house team.

When shouldn’t a company use a PEO?

A business’s financial situation and workforce size are two top factors when considering a PEO. You must have enough money and staff to justify a PEO. On the other hand, if you’re a mature business that’s flush with cash, hiring an in-house team may better suit you.

A PEO is not right for you if your business:

• Employs a very small number of people: PEOs typically require a minimum number of employees to be cost-effective.
• Has a specific set of HR needs that a PEO cannot meet: PEOs typically offer a standard set of HR services and may not be able to meet the specific needs of a company with unique HR requirements.
• Is unwilling to give up some control over its HR functions: When a company uses a PEO, it is outsourcing its HR function to the PEO. As a result, the company will no longer have complete control over its HR policies and procedures.
• Keeps a tight budget: PEOs typically charge a monthly fee based on the number of employees the company has. These fees can be expensive, so businesses must ensure the benefits outweigh the costs.
• Is risk-averse: Using a PEO means trusting them with two sensitive and critical departments — payroll and human resources. If the PEO underperforms or fumbles along the way, your business will suffer. You must feel comfortable with this risk.

If you already have an in-house administrative team, a PEO may cause friction. Your team may worry they’ll get laid off or have less authority over personnel matters. Luckily, most PEOs offer customized services. This tailored approach means you can retain in-house staff and use third-party help with extra tasks as a way to share responsibilities.

Key takeaways

Professional employee organizations provide human resources and payroll support on a contracted basis. This third-party arrangement makes it easy, quick, and cost-effective for businesses to employ.

Yet, only some entities are suitable candidates. You’ll need a healthy budget and a growing workforce to justify the expense. Plus, you must be open-minded to listen to a PEO’s recommendations and decisions.