Employer of record vs. professional employer organisation: What’s the difference?

20 January 2022
When it comes to running critical parts of your business — like making sure your employees are paid on time and your payroll is compliant with local laws and regulations — there’s no room for error.

To meet cross-border hiring demands, many companies turn to professional employer organisations (PEOs) or employers of record (EORs). While both PEOs and EORs are external HR partners, there are differences in how each supports a company and its employees. It’s important to understand the distinction. In this article we’ll explain some of the benefits and limitations of each solution.

What is a professional employer organisation, or PEO?

A professional employer organisation is an external services provider that helps manage many human resources functions. With a PEO, companies can outsource administrative tasks such as payroll, benefits, training and more.

Essentially, a PEO establishes a co-employment relationship with its clients and its clients’ employees. Under a PEO model, all of a client’s employees in the jurisdiction in question are reported under the PEO’s tax identification number (for example, under the EIN in the US). This enables the PEO to aggregate workers across employers and negotiate employee benefits, workers’ compensation and other insurance as a large group.

Contractually, there are two employment agreements in a PEO arrangement. The first is between the PEO and the client’s employees, and the second is between the client and the client’s employees; this situation creates the so-called “co-employment” of the worker. In addition, the PEO and the client enter into a services agreement that defines roles and responsibilities.

Generally, the PEO is responsible for ensuring compliance with local employment laws, administering payroll and benefits, and providing general HR support.

The client’s responsibilities under the services agreement typically include managing the day-to-day roles of the employees, including providing direction and control over the work to be done, indicting where and when the work is to be performed, and setting compensation rates.

What is an employer of record, or EOR?

Employer of record companies provide similar services to those provided by PEOs, including payroll, benefits, and employment administration. Unlike PEOs, however, EORs do not form a co-employment relationship with the employees. Instead, the EOR becomes the employer, with a single employment agreement managed by the EOR. The EOR also enters into a services agreement with the client.

It’s important to note that, in contrast to a PEO, an EOR does not require all of a client’s employees in the jurisdiction in question to enter into the agreement. This can result in greater flexibility. For example, some companies use an EOR to manage projects that might be well-suited for independent contractors, but where local law dictates that employment is required.

EOR for international expansion and carve-out deals

Critically, EORs can help businesses operate in countries or jurisdictions where they don’t have an established legal entity — something PEOs can’t do. As a result, multinationals are increasingly using EORs to expand internationally. Basically, an EOR can enable a company to hire local workers in a new market quickly and with minimal risk.

This is also true when expanding into another country through an acquisition. An EOR arrangement can be particularly useful in cross-border M&A carve-out deals in which the buyer doesn’t acquire the legal entity. These deals are almost always time sensitive. The buyer may be able to use an EOR to transfer the acquired employees, often temporarily while the buyer establishes a local legal entity.

EOR providers, then, offer versality that traditional PEOs may not be able to match. In addition, EOR providers often have detailed knowledge about the local employment laws in their countries of operation. Their expertise enables their clients to comply with local regulations wherever they operate. And because failure to comply with local laws may result in fines and reputational damage, EORs are often a part of a company’s risk- and brand-management strategies.

Other hiring options and additional considerations

It’s important to understand that, just like PEOs, EORs have limitations. The longer a business uses an employer of record — and the more employees it hires through an EOR — the greater the risk of triggering a local permanent establishment and related obligations. Companies that use an EOR in a particular country should periodically review their local business activities with permanent establishment laws in mind. Some countries, such as Germany, even have specific limitations on how long an EOR may be used before a legal entity must be established.

That last point is critical. If you’re an organisation considering a PEO or EOR, you should understand that they are two somewhat similar options for hiring employees when expanding internationally and in certain other situations. There are other options, notably those of hiring through one’s own legal entity or through a non-resident employer (NRE) arrangement. You should understand all the options within the context of your own short- and long-term goals, your planned and/or existing activities in the target country, the number of local employees, local employer obligations, and more.

Most organisations hire a global services provider to fully understand their cross-border hiring options. You should vet any potential third-party service provider to ensure it has the local expertise, technology, controls and values needed to determine and deliver the best hiring solution for your unique situation.