Contractors vs. Employees: The Real Tradeoffs for Startups

We’ve hired both. Made mistakes with both. Here’s what actually matters when deciding.

The True Cost Comparison

People compare salary to hourly rate. That’s wrong.

Employee True Cost

Base salary: $120,000

  • Superannuation (11%): $13,200
  • Payroll tax (~5%): $6,000
  • Insurance, equipment: $3,000
  • Paid leave (4 weeks): ~$9,200
  • Sick leave (2 weeks): ~$4,600
  • Training, onboarding: $5,000
  • Benefits, perks: $5,000

True cost: ~$166,000/year Effective hourly rate: ~$85/hour (assuming 1,950 working hours)

Contractor True Cost

Hourly rate: $100/hour Hours worked: 1,800/year (typical full-time engagement) Management overhead: 10% of your time

True cost: ~$180,000/year Plus: No leave coverage, no long-term commitment guarantee

The Math

At $100/hour, contractors and employees cost roughly the same for equivalent output.

Contractors at $80/hour or below are genuinely cheaper. Contractors at $120/hour+ are genuinely more expensive.

But cost isn’t the only factor.

When to Hire Contractors

Specialized Skills You Don’t Need Long-Term

Need a mobile app but your core product is web? Hire a contractor.

Building AI features for the first time? Consider working with AI consultants Sydney rather than hiring full-time before you understand what you need.

Variable Workload

Product launches need more hands. Maintenance periods need fewer.

Contractors scale with need. Employees are fixed cost.

Fast Start

Contractors can often start immediately. Hiring employees takes months.

When speed matters more than long-term cost, contractors win.

Testing Before Committing

Not sure you need this role full-time? Contract first. Convert to employee if it works.

We’ve hired three employees this way. Lower risk for both sides.

When to Hire Employees

Core Product Work

If they’re building your main product, they should be invested in its success.

Contractors leave when the contract ends. Employees build institutional knowledge.

Security and Trust

Contractors shouldn’t have access to everything. Employees can.

For sensitive work, employees are simpler and safer.

Culture and Team

Teams need people who stay. Who mentor juniors. Who care about more than their current project.

Contractors optimize for their next gig. That’s rational but not team-building.

Long-Term Cost

If you need this person for 2+ years, employment is almost always cheaper.

Contractor premium is for flexibility. If you don’t need flexibility, don’t pay for it.

The Management Difference

Managing Contractors

Clear scope. Defined deliverables. Documented requirements.

Contractors do what you ask. Not more. That’s fair—it’s what you’re paying for.

Your job: Know exactly what you want. Communicate it clearly.

Managing Employees

Direction. Coaching. Career development. Culture.

Employees figure things out. Take initiative. Cover gaps.

Your job: Set goals. Remove obstacles. Invest in their growth.

Different skills. Neither is easier.

Sham Contracting Risks

If someone works like an employee but is called a contractor, that’s illegal.

Signs of sham contracting:

  • Fixed hours
  • Single client (you)
  • Using your equipment
  • No ability to subcontract
  • Ongoing indefinite arrangement

ATO is aggressive about this. Get it wrong and you owe back superannuation, payroll tax, and penalties.

Safe Contractor Arrangements

  • Defined project scope
  • They control how work is done
  • They have other clients (or could)
  • Fixed-term or project-based engagement
  • They use their own equipment

When in doubt, consult an employment lawyer. The cost is worth avoiding the risk.

The Hybrid Model

What works for us:

Employees: Core product development, leadership, customer-facing roles

Contractors: Specialized projects, overflow work, experimental features

Fractional: Finance, legal, HR—part-time experienced people

We’re 60% employee, 30% contractor, 10% fractional.

Decision Framework

Ask these questions:

  1. Is this ongoing or project-based? Ongoing → Employee. Project → Contractor.

  2. Is this core to our competitive advantage? Yes → Employee. No → Either.

  3. Do we know exactly what we need? Yes → Either. No → Employee (they’ll figure it out).

  4. How fast do we need to start? This week → Contractor. Can wait → Either.

  5. What’s our runway? Short → Contractors (easier to cut). Long → Employees (cheaper over time).

The Conversion Question

Starting someone as contractor, converting to employee: Common and fine.

Starting someone as employee, converting to contractor: Legally risky and usually wrong.

If the role is permanent, hire permanently. Don’t game the system.

The Real Answer

Most startups should have mostly employees for core work, with contractors for spikes and specialties.

The companies that are “all contractors” usually either:

  • Haven’t done the math on true cost
  • Are taking legal risk on sham contracting
  • Have genuinely variable, project-based work

For normal SaaS startups: Hire employees. Bring in contractors when you have specific needs beyond your team’s capacity.