We have a team member at one of our portfolio companies dealing with a family situation, which is completely understandable and completely human. But because she's a 1099, when she told us she wanted to take the summer off for a family road trip, our response had to be "okay." Not "let's plan coverage," not "here's the policy." Just okay.
Another contractor left with active clients mid-project. No transition plan we could mandate, no enforcement mechanism. We just absorbed it and scrambled while trying to build a pipeline, onboard new people, set Q2 revenue goals, and create any kind of operational predictability - all on a foundation of people we legally cannot manage.
This is the 1099 Trap, and it shows up in almost every service business I work with, especially ones that are bootstrapped.
Here's how it starts. A founder needs help, so they find somebody on Upwork, on Fiverr, somebody in their network, and say "come be a contractor for me, I'll pay hourly or per project and we'll figure it out." Typically it's per project, the work only grows when revenue grows, and there's no scalability baked into the company. Less paperwork, less liability, lower costs initially, and at the beginning that's absolutely the right call.
But at some point as you scale, those costs grow because your revenue grows, and at some point you're paying these contractors more money than you should be paying an employee. Every dollar you make costs the business the same whether you're at one million, two million, three million, or more. Some founders take that as a nice-to-have or even a point of pride that they pay their people well, but it's not a great way to scale the business, protect the business, or ensure you can serve people down the line.
Here's the thing - these agencies grow, these companies grow, they get to a point where they're not small anymore and they're trying to run a real company. But the cost structure hasn't changed. The margins that should be expanding as revenue grows are staying flat because labor scales dollar-for-dollar with revenue. The reality is that contractors at that size are almost the reason you cannot scale, and once you fix your labor, you can.
Unless you need specialized talent for a one-off project, the contractor model past a certain revenue threshold is just holding you back.
Working Theories
The decision is simpler than most founders make it.
1. Look at what you're paying your contractors. If you can pay someone of similar skill set the same rate but as a W-2 employee, you probably should. The loaded cost is higher, but the unlock is management authority, enforced schedules, and accountability that doesn't evaporate when someone gets a better offer or a vacation itch.
2. If your contractors do recurring work, hold client relationships, and are critical to revenue delivery - they should be employees.
3. Start with your most critical roles, the ones where a sudden departure would hurt clients. Convert those first and the rest can follow.
Moving to W-2 isn't a payroll decision. It's an operational unlock.
