What are the differences between freelancers and contractors?
Posted by John Yerou
on May 23rd, 2014 18:55pm in
Last Updated on August 12th, 2020 06:59am.
In the aftermath of the credit crisis, freelancing has grown at an unfaltering rate in the UK. Since 2009, the number of self-employed workers has grown by 6.3%.
In comparison, the overall labour market has only grown by 2%. So where has this additional growth come from?
There are two major contributory factors:
- many who lost their jobs during the economic turmoil saw self-employment as no greater risk than a permanent role;
- information technology has eradicated the communication barrier of working from home.
The outcome is that now over 1,000,000 people in the UK are ‘freelancing’ or contracting. That might seem a lot, but we’re only really playing catch up.
Beyond our shores, especially on the sub-continent, you’ll find freelancers in every walk of life. But what they class as freelancing, we split into two definitive sectors:
- ad hoc freelancers, often operating as sole trader businesses;
- professional contractors, who use limited companies or umbrella companies.
Does classification make that much difference, given that both are independent professionals? I’d suggest it does matter, and in more ways than you’d think…
The Question: Does the term ‘freelancer’ undermine earning capacity?
It’s a poignant ask. Before we can answer, we need to understand the differences between contracting and freelancing.
There’s no set differentiation between the two, but there is a huge void in take home pay. And it’s a gulf that only looks like widening if we don’t effect change.
Those unfamiliar with the industry tend to tar all independents with the freelance brush. That’s despite the sector covering a wide variety of self-employed professionals.
But the truth is, when put to an acid test, their roles differ greatly. The way each group uses payment structures are also poles apart.
This is no more apparent than within the contracting community itself. So let’s take a look…
Why do firms hire freelancers and contractors anyway?
In the UK, we tend to think that contractors are companies who work for the local council. Or if we use our imagination, a gang of builders contracting for larger construction firms.
The term sub-contractor further muddies the waters. We automatically think of a ‘subbie’ as a skill-specific member of one of the aforementioned gangs. Yet professional contracting also extends to an individual level.
A company identifies a temporary task, but has no idea how long it will take. They have no one skilled on their payroll, but know the task is bespoke, a one-off. Should that company feel forced into employing someone full time to do it?
Combining flexibility with professionalism
Outsourcing becomes the more likely option. It fits best with time or budget constraints, skills availability or any number of reasons. This is especially true when an organisation is experiencing transition.
The answer is to hire someone who can perform their unique task, without being beholden to them. The company has a choice. It can either hire on an ad hoc basis, when need dictates. Producing infographics, photo shoots or specialised content, for example.
Or, for more devoted tasks, they might employ a specialist on a fixed-term (although temporary) contract. Rebranding, IT or managing transition would all suit a more permanent, invested temp.
The ad hoc role, often invoiced per task or per hour and over shorter durations, would suit a freelancer.
The fixed-term contract is often for 3-, 6- or 12 months at a time. A contractor would fulfill this position.
In reality, either type of hire could complete the job to a satisfactory degree. So what are the differences between the two and why do they matter so much?
Working Hours and Billing:
A contractor’s hours often mirror those of the business they’re contracted to. More often than not, these are full time hours.
At the end of the billing period, usually a week, the contractor submits their timesheet. This can go to the client direct. But more often, a contractor gets their assignment through an agency. In that case, agency invoices the client. The client then pays the agency, who in turn pay the contractor.
By their nature, a freelancer works per project or against budgeted hours for a given task. This can involve the freelancer bidding on a job in the first instance, which can be time consuming in its own rite.
Once ‘won’, the freelancer will work within the parameters outlined during the bid/acceptance process. Upon completion of the number of hours or task outright, the freelancer will raise and submit their invoice. Again, this can be direct or through an agency.
The value of a contractor’s contract tends to be much greater than the individual projects freelancers work on. This is nowhere more apparent than in the rates that IT or Oil & Gas contractors command for their services.
Given the skills needed for those roles, employers need professionals trained in those areas. As such, clients prefer to approach prospective contractors through a specialist agency.
As well as handling their payments, agencies can vouch for their registered ’employees’. Their contractors will have certificates and an extensive work history on record, too.
The same isn’t true of a typical freelance project. They can be less challenging and the pay and timescale reflects those qualities.
Clients are also more likely to hire freelancers based on a one-off application or bid. This could be down to the wording of the proposal within the freelancer’s bid itself. But most freelancers display their portfolio and site rating on their profiles as testament to their skill set.
Freelancers everywhere, but not for long
It’s the latter demographic that’s seen the biggest shift since the economic crises. Today, there are hundreds of digital freelance agencies online.
Clients can hire people for almost any job with the only commitment being the current project.
Quite often, the best freelancers aren’t on any given site for long. Unless, of course, they prefer the distance working thus engenders.
But many build a rapport with a client or show aptitude above the norm and work direct if the long-term opportunity’s there.
Even then, there’s little mention of a firm contract. The only agreement is up until the end of any projects the two parties have negotiated.
Trading Mechanisms and Payment Structures
Contractors and freelancers often handle their businesses in different ways, too. The most apparent ways are in the way they trade and the way they’re paid.
This remains true, whether they’re contracting/freelancing through agencies or direct with the client.
Tax Planning and Accounting
Using structured tax-planning, limited company contractors can retain more of their income. As a limited company owner, they can claim much more tax relief than a sole trader.
In contrast, most freelancers prefer the self-employed—or sole trader—route. This is because they’ve often no guaranteed annual income.
Accountants, necessary to optimise the limited company trading structure, don’t work for free. Budget-conscious freelancers may have a business plan in place, but it’s somewhat restrictive.
The majority of their future projects are not yet ‘won’. And when they materialise, they’re often priced at a market-reflective rate. The result is that many freelancers do their own taxes via self-assessment.
Not all freelancers go the sole trader route, though. Those whose clients can’t commit but do offer the prospect of long term work do set up their own limited companies.
This is a bold and savvy tax-planning measure by the freelancer. It’s not undertaken because of any client request, but could pave the way for greater things.
Many businesses prefer only to work with limited companies or other formal trading structures. This may or may not include Umbrella Company employees, dependent upon the client’s viewpoint.
One reason is because the onus of a sole trader’s tax liability falls on the client’s shoulders, too. In some cases, clients assume even more responsibility for a trader’s tax than the trader themselves.
Most clients neither want nor have time to manage that responsibility. They’d much rather work with a limited company entity who accepts their own NICs and income tax liability.
As well as perceived professional status, limited company directors are separated from company debt.
Freelancers who are sole traders are liable for debt they run up as themselves or their business.
Why is the term freelancing so wantonly (ab)used, then?
Freelancers do work on contracts of sorts. Each job proposal won forms a short-term contract between client and freelancer. This may be where confusion creeps into common terminology.
There exists dedicated contractor recruitment agencies. They tend to focus on the higher-paying IT and Oil & Gas sectors in particular.
It’s unlikely that a typical freelancer would approach such an agency. Likewise, contractors wouldn’t use the digital agencies frequented by freelancers, either.
This is the crux of the question of the day.
Most working ‘in’ the industry know the difference between a freelancer and a contractor. The majority of self-employed people know which, if either, of the brackets they fall into.
It’s those new to self-employment who may get confused by it all at the outset. But after bidding on a few jobs, they’ll soon get to know into which peg they fit.
I want to become an independent professional; which route should I take?
Contracting remains strong in the UK. In fact, it grows stronger almost every quarter. With economic recovery remaining tentative, the need for a short-term skilled workforce remains high.
For brick and mortar contractors, Oil, Gas, Medics and IT Systems contractors, the future is rosy.
The opposite is true for freelancing. Globalisation of outsourcing is having a detrimental effect on labour rates. Business has gone digital, giving clients access to developing nations.
True, the quality may not be there. But when did that stop China growing to the economic behemoth it is today?
It’s essential for businesses to have an online presence. If they don’t own a website, then they must have a social media presence.
Maintaining an online point of contact is critical in today’s consumer-driven market. Yet many SMEs don’t have the need (or budget) for a full-time web designer, copywriter and social media manager.
The growth of the global digital agency has given businesses access to millions of eager part-timers.
Clients can hire freelancers from anywhere in the world and at astonishingly low rates of pay. And make no mistake, each and every agency categorises those bidding on jobs as “freelancers”.
Many of the candidates are, for want of a better term, cheap labour. What we’d consider a low wage in the West isn’t so in developing nations.
Even on UK-based agencies clients post jobs and freelancers accept them well under minimum wage. I’ve seen workers from India (on oDesk [now Upwork]) offer their services for as little as US$0.22/hour. Compete with that!
There’s a distinct battleline mapped out for Western freelancers. Do they hold out for what their services are worth or capitulate and compete on low-paid projects?
Taking a stand is one thing. When you’ve no ‘next project’, keeping a roof over your head takes prominence over principles.
What does the future hold?
As more businesses outsource mundane tasks cheaply, it’s not only freelancers with a fight on their hands. The UK job market as a whole could suffer; but that may be a long time coming.
For all the differences we’ve scrutinised, there’s one we’ve glossed over. Contractors (in general) get paid much more than freelancers.
Until freelancers grasp the limited company concept, they’ll remain the contractor’s poor relation. Change nothing, nothing changes. Don’t limit your scope because you’re not a limited entity.
Author: John Yerou
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.