Contract vs Direct Hire vs Contract-to-Hire: Which Option Is Right for Your Small Business

The decision between contract vs direct hire can be a significant factor in shaping the future of your company. Each brings distinct advantages and considerations. Whether you value stability, autonomy, or variety, understanding these employment arrangements can help you make an informed decision.

Contract Worker: A person hired, either through your company or through an agency, to complete specific tasks or projects in a set timeframe but is not an official employee of your company.
Direct Hire: A person hired directly by your company as a permanent full-time employee.
Contract-to-Hire: A person hired, typically through a third-party recruitment agency, with the option to move to a full employee at some point in their contract.

Below we have compared each type of worker, the pros and cons of hiring each, and the financial considerations for your small business.

Direct Hire vs Contract: Compared

	Direct Hire	Contract / Contract-to-Hire
Best For	Businesses needing to fill a long-term role with a permanent, full-time employee	Businesses that have a short-term need, such as a one-time project or seasonal position
Cost	Recruiting, onboarding, training, and salary	Agency Fees (20%-50%)
Taxes Withheld	✓	Responsible for calculation and payment of their own taxes
Full Onboarding	✓	Optional
1099 Reporting	✕	✓
W2 Filing	✓	✕
Third-party Recruiting	✕	✓
Receive benefits - healthcare, paid time off, 401k	✓	✕

What Is a Contract Worker?

Contract workers, also known as freelancers or independent contractors, are individuals who work on a project-to-project basis for various companies or clients. They are not considered regular employees; instead, they are hired on a 1099 basis (meaning they are responsible for their own taxes). Additionally, they typically do not receive benefits like health insurance, paid time off, or retirement plans. This arrangement gives both parties flexibility in terms of work hours, location, and duration of the working relationship.

Contract positions offer variety for the worker, allowing them to gain experience in different industries and work on diverse projects. This can be especially appealing for those seeking a non-traditional career path or exploring various job opportunities without a long-term commitment.

For businesses that have a short project or a position that is not long-term (such as a worker filling in during an employee’s extended absence or seasonal worker) a contract worker would work best. A contract worker comes in to fill an immediate need and then leaves once the work is completed. Some industries that are best suited for contract workers include industrial, healthcare, and administrative.

Contract workers can either be hired directly by your company or through a temporary agency. When hiring directly, be sure to thoroughly vet the candidate by reviewing their resumes, checking references, and conducting interviews. Additionally, when negotiating terms with a contract worker, consider offering competitive compensation and provide clear expectations for deliverables and deadlines.

A temporary agency will handle all screening, hiring, and management of the contract worker. All you have to do is choose which candidate you think fits best with your job requirements and culture. In addition, the temp agency will collect payment from you to pay the contract worker directly. They also handle all tax-related costs and employee benefits.

Check out the following articles for more information on hiring and paying independent contractors:


PROS	CONS
No liability to collect and pay taxes	Contract is over when the work is done
Addresses short-term needs without long-term commitment	Lack of loyalty and commitment
Bring a specialized skill set	Additional HR and administrative complexities
Lower overhead expenses	Higher average hourly rate

When using a temporary agency, they will find and screen potential candidates, and you will simply pay a fee to the temporary agency (typically 10%-50% of the salary or hourly rate). Learn more about how to hire temporary employees using a temp agency in our guide.

If you decide to hire your contract worker directly, the associated costs will include all hiring and onboarding costs, as well as salary. Plan to pay top dollar for an independent contractor, as they typically charge a higher hourly rate to compensate for their self-employment taxes and expenses.

What Is a Direct Hire?

Direct hire refers to the process of hiring a candidate directly as a permanent, full-time W2 employee (your company pays all taxes on behalf of the employee). This means that the candidate is brought on board without going through a temporary or staffing agency. One of the key benefits of a direct hire is that it allows companies to attract and secure top talent for long-term positions.

Direct hire arrangements enable stronger relationships to be built with other employees from the beginning, fostering a sense of loyalty and commitment. Also, by bypassing recruiting firms, you save on the costs associated with hiring someone to recruit for you, take ownership of your hiring decisions, and establish direct communication with candidates throughout the hiring process.

Direct hire positions provide stability and benefits to the worker that may not be available with contract roles. These positions often offer more structured career paths, opportunities for advancement, and a sense of belonging. For individuals seeking job security and long-term professional development, direct hire positions can provide a strong foundation for building a successful career.

Hiring direct works best for companies that are looking to fill permanent, long-term positions. For positions that have direct access to confidential information, such as human resources and accounting, a direct hire is better suited. A contract worker should not have access to confidential documents.

When it comes to hiring directly, you should prioritize the screening process to ensure the right fit. This involves clearly defining job requirements, accurately portraying your company culture, and vetting candidates for their skills and experience. Be upfront about expectations, growth opportunities, and potential challenges. Additionally, offer a competitive compensation package and benefits that align with industry standards.

Check out the following articles on hiring and paying employees:


PROS	CONS
Permanent, full-time employment	Slower hiring process
Cost savings (no agency fees)	Higher annual salary
Builds strong, long-term relationships	Limits access to a larger pool of candidates
Direct engagement with the candidate	Increases risk of bias

All costs associated with a direct hire will be absorbed by your company. This includes the cost to find an employee, the applicant screening process, onboarding, training, and salaries. Additionally, if you offer a referral bonus, you may incur a fee to another employee for the successful onboarding of a new candidate.

We recommend you use salary comparison tools when determining the amount to pay your new employee. These will allow you to compare industry rates so that you can offer a competitive salary that not only helps attract top talent but also increases your employee retention rate.

What Is Contract-to-Hire?

Contract-to-hire is a unique employment arrangement that offers both employers and job seekers the opportunity to “try before they buy.” It allows companies to assess a candidate’s performance and fit within the company before making a long-term commitment. This hybrid approach benefits both parties by facilitating informed decision-making based on actual performance and mutual compatibility rather than relying solely on interviews or resumes.

From the employee’s perspective, contract-to-hire provides an invaluable chance to gain real-world experience and showcase their abilities directly to the employer. They often lead to better job placements because they allow candidates to gauge whether a company aligns with their career goals, work culture, and personal values. This increases overall job satisfaction and decreases turnover rates.

A contract-to-hire is best for companies that want to “test-drive” a candidate before they bring them directly into their company as a permanent employee. This works well for managerial positions as you can evaluate their performance and how well they get along with their team before bringing them on permanently. This also works well for clerical workers to determine if their skillset matches your needs.

Most contract-to-hire workers are found through staffing agencies. It is important to first clearly define the role and responsibilities of the position. This ensures that the staffing agency understands exactly what you’re looking for in a candidate and can help find the best match for your needs.

One key benefit of using a staffing agency for contract-to-hire workers is their access to a wide pool of top talent. These agencies have established networks and resources that allow them to source highly qualified candidates who are actively seeking contract-to-hire opportunities. Additionally, working with a reputable staffing agency can provide peace of mind in terms of compliance with labor laws, employment regulations, and payroll management.

While we recommend using a staffing agency for cost-effectiveness and legal compliance, you can find and hire your own contract-to-hire worker. To do this, follow the same steps as hiring a contract worker. The only difference is that at some point, you will bring the contract-to-hire candidate on as a permanent full-time employee.


PROS	CONS
Vetted by a recruiting agency	Worker may decide to leave before becoming a permanent hire
Skills can be assessed before making a long-term commitment	Can reduce employee morale
Can accommodate growth within your company	Lapse in employee benefits

If you hire the contract-to-hire worker yourself, the costs involved will include all recruiting, onboarding, and payroll costs. Once they are moved to a permanent position, you will incur additional costs, such as benefits, training, and paid time off.

When using a staffing agency, the agency will provide you with already screened workers. You will simply pay a fee to the staffing agency (typically 10%-30% of the salary or hourly rate). While the candidate is on contract status, you will pay the staffing agency their hourly rate or salary (plus their fees) and they will handle paying the contract worker. Once you are ready to hire, you will pay the staffing agency a flat percentage of their expected annual salary.

Learn more about how staffing agencies work in our guide.

Factors to Consider When Choosing Contract vs Direct Hire

When choosing between a direct hire and contract worker, there are several important factors to consider.

Company Needs: Carefully evaluate your staffing needs. Direct hires are typically better suited for permanent positions with steady workloads, while contract workers can be ideal for short-term projects or specific skills that aren’t needed full time.
Initial Cost: Direct hires often come with higher initial costs due to benefits and training, while contract workers may offer more flexibility in terms of payment structure.
Training: Direct hires generally require more supervision and training, whereas contract workers tend to have more autonomy but may also need clearer project guidelines.
Culture Implications: Direct hires offer stability as they are fully integrated into the company culture, whereas contract workers generally work on a short-term basis, usually outside of the overall company culture.
Timeframe: Determine how quickly you need someone in the role. Direct hires generally take longer to recruit and onboard, whereas a contract worker can be brought in quickly to fill a specific need.
Working Hours: If you need the candidate to work specific hours, you may want to consider a direct hire. With a direct hire, you can dictate their schedule. With a contract worker, you are prohibited by the IRS from requiring specific work hours. If you do control the work hours of a contract worker you run the risk of misclassification. The IRS may classify them as a W2 employee, leading to the risk of non-compliance.

Bottom Line

The decision between contract and direct hire ultimately depends on the specific needs of your company. Evaluating organizational needs, budget constraints, talent availability, and project requirements will help you make an informed decision when choosing direct hire vs contract.