We once thought about setting up an Umbrella Company. So James decided to find out exactly what’s involved. In this episode, James shares his journey into the eye-opening world of umbrellas and reveals what he learnt along the way. We guarantee you’ll learn something new: the killer marketing costs, the “timesheet submission fees” and providing liquidity to agents. It turns out there’s a lot more to running an umbrella than meets the eye, and it’s easy to see where your fees go in this low-margin business.
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Preparation for IR35 goes back a few years at inniAccounts, to the extent that in around 2018 we tabled the idea of becoming an umbrella to support those people who occasionally would find themselves inside IR35.
The idea wasn’t as daft as it sounds. Umbrellas typically charge £100 a month for a largely automated payroll process. We thought ‘we can do payroll so it’s a logical connection. Margin looks good too’. Speaking to someone who had set up and was running an umbrella for 1000 contractors, just 5% of the cost was going on a full time team of four high quality administrators.
Plus, the software to handle timesheets, compliance, payslips through to BACs is cheap to buy. I mean super cheap – we’re talking £1.50/ month/contractor licence fee.
So why then, with a market that has very low entry costs, and great margins didn’t we do it?
There was a niggle. Why are umbrellas charging £15-£25 a week, not the £2 to £3 our research had shown it to be worth? There had to be a hidden dynamic and in order to be absolutely sure there was no surprise we took a deeper look.
The world of preferred suppliers
First off, you have to be on a preferred supplier list if you’re an umbrella supplying to an agency. We didn’t have a cats chance in hell of making it. Even then we had to be a member of the FCSA, an active pro-umbrella professional body. You will probably know that in the wake of the loan charge scandal, the FCSA has positioned itself as badge of compliance, in support of an audit and compliance.
Investigating this membership criteria more, we discovered that £18,000 is the starting price for accredited membership to the FCSA and a compliance review. There’s also a costly rats nest of legal fees and protection required to set up an organisation that employs people.
Our estimates at the time were that around 50-100 of our clients would be using the umbrella service. With those membership overheads in the mix, it no longer made sense for the service to run with our clients alone.
Switching is rife
Cue market research with contractors using umbrellas to see if they would use a service run by us, irrespective of whether they were a client, and what they expected and needed from a service.
One of the most striking pieces of feedback was that most contractors had used more than one umbrella. That’s because it’s very easy to chop and change, either because they are forced to switch because the preferred supplier list changed, or the incentive to shift was worth a shiny new iPad on sign up. 12-18 months is the typical duration of a relationship.
We concluded that loyalty is not a word that figures strongly in this market. Every year you have to replace your entire client base to stay still, not grow. A tiring and expensive prospect for any business. Our initial estimates were £200 to acquire a client but looking back I can’t see there would have been any return on that investment at all.
You only need a bad quarter – the result of a tech glitch, a star salesperson leaving, or a competitor outbids you on pay per click on Google – and your annual recurring revenue would drop 25%. That’s a big deal, one that’s difficult to manage.
Recruiters take a sizeable cut from umbrellas under the guise of ‘fees’
It prompted me to dig out some research we commissioned a few years before on finding ways to reach contractors. The premise was, would recruiters be a route to market for us, a way to get our brand in front of contractors? In short, the answer was no.
Why? Large commodity accountancies for contractors have the market stitched up. They share 50% of client monthly fees back to recruiters. Also, rather naïvely, we hadn’t appreciated that partners in accounting firms are a strategic revenue line for agents. Revisiting this research, we realised that it also applies to umbrella companies.
Umbrella companies hand over £10-£15 per week to recruiters. You’ll know it as ‘a platform access fee’, a ‘timesheet submission fee’.
Suddenly our high margin umbrella business idea wasn’t looking so rosy. 20% was going into marketing and 40-50% back into the pocket of the agent. That takes cash. A lot of it. You can see how it undermines the case for payback for a privately owned SME like ours.
Recruiters use umbrellas as a bank
So, what’s really going on? When I was a panellist on the topic of IR35 a little while ago, I debated the case with a co-panellist from an umbrella that the model needed to be fixed term or agency PAYE. It was bonkers that a contractor has to pay to get paid.
He agreed but went on to say that umbrella companies provide a vital service to the recruitment industry because they provide credit to keep them afloat. Start-up recruitment agencies simply wouldn’t get the money from the bank, and umbrellas plug the gap.
What I had uncovered was that umbrellas provide liquidity to recruitment agencies. To survive the umbrella game. Agents are often on 30, 60 or 90 day client payment terms and as an agency must comply to regulations that state a worker has to be paid on time, regardless of whether the end client has paid, or even if the timesheet has been signed off, it means the cash has to be paid out to workers before it’s received by the agent.
Let’s face it money isn’t free – overdrafts, invoice factoring isn’t cheap. So, if we were setting up an umbrella, we would have to take on debt to provide the cash to a recruitment agency. Suddenly things get personal. The bank won’t give the sums we are talking about to me unless I put my house up as a guarantee.
We went on to quantify the amounts we are talking about. It’s not pretty. If we got into a situation of bad debt the impact is high – one agency, 20 people to pay at £600 a day, amounts to £250,000 over a month.
Scale is the only answer to survive
You therefore need scale to survive and that means hot shot salespeople. We admit as founders, that sales is not in our DNA. Instead, our model works on amazing customer service to drive loyalty and referrals and therefore growth. And as we discovered, without aggressive sales, you can’t compete against the established umbrellas.
There are also other residual risks in the mix, for instance, I’d have to be your employer making me personally responsible for any employment issues. Not really a position I want to get into.
Needless to say, we hit a low point in our plan to go into umbrellas and our IR35 outlook felt bleak.
PSCs ban lifted the lid on umbrellas in a way we hadn’t expected
And then PSC bans came along. Who foresaw that? I didn’t expect HMRC’s expectation that 1 in 3 of contractors would be affected by IR35 to be true. Umbrella only policies played into the hands of umbrellas. It was a booming market and we just couldn’t see a way to take a slice.
There was nothing else for it but to ask our clients what they wanted. Interestingly, setting up an umbrella was low on the list, instead they wanted lobbying firepower.
It was this overwhelming request that instigated the birth of offpayroll.org.uk where people could anonymously share their IR35 experience in terms of clients and recruiters.
But unexpectedly, we started to see the inside track on umbrellas emerge from the woodwork. Small umbrella players were being priced out of the market, played against one another on fees and cash. One agent was forcing contractors to use an umbrella, which is absolutely not allowed. Digging around we discovered there was a correlation between the two and the agent and umbrella involved was owned by the same company offshore.
Agencies were also restricting umbrella lists that didn’t include those that manage things like pension contributions.
We also uncovered the extent to which a large, well known, umbrella was pocketing holiday pay, rather than passing it on at the end of an assignment, paid in lieu or accrued and paid days of holiday. The eagle eyed among the contributors to offpayroll.org.uk had spotted it and managed to get out of court settlements.
Then there was the assignment rate and the complexity that is an umbrella payslip. Which must cover the apprenticeship levy, NI, umbrella margin, accrue holiday pay etc. It leaves a bad taste in the mouth every month, that can’t be fixed without a structural change in the market place.
Covid-19 presented a huge risk to umbrellas
It was when umbrellas found themselves at the wrong end of the Covid-19 assistance that things really started to unravel. Paying statutory sick pay is always going to be a massive overhead that had to come from the umbrella margin. Expectations that a quarter to a third of people would be off sick will have been a jolt to umbrellas. Rebates from the government saved them on that occasion, but the Job Retention Scheme wasn’t so kind because it didn’t cover apprenticeship levy and holiday pay accrued. That still comes down to the employer – not the end client or the contractor.
Now, when contractors move umbrellas so often, there’s no loyalty or relationship to call upon to save your umbrella. If you fail to pay you will lose contractors, and if you do pay you risk bankruptcy. As you can imagine it was a relief that we hadn’t set up an umbrella.
Reputation matters but won’t overcome contractors resentment
It doesn’t matter how good you are – ethical, transparent – you will still have challenges in terms of the marketplace dynamics, the dislike contractors have for being forced to use umbrellas generally, and the distaste for how much it costs them every month not to have employment rights. Clients on the other-hand will resent using umbrellas, and you have to keep recruiters liquid.
Fundamentally contractors are not your primary client when you’re an umbrella. You can have the happiest contractors on your books but unless you are keeping recruiters and the rest of the supply chain happy, you’re stuffed. You can’t act wholly in the best interest of contractors.
When you wrap it all up, it was glaringly obvious what a departure from our company values it would be to set up an umbrella.
We don’t need to be an umbrella to succeed
It’s this ideological challenge that makes me think umbrellas are not sustainable in their current form. I predict agencies that trade on their reputation will look at alternatives to avoid the risk of rogue operators tarnishing the sector. Agency PAYE could see a resurgence and more close working in partnership with the end client and the contractor. In fact, there is already an example and it was able to furlough without quibble. A big tick for change and an example of how regulation could play a role in stabilising a market.
As it turns out, the last year has proven that we don’t need to run an umbrella to grow. Clients stayed with us and didn’t move to umbrellas because they have been able to show clearly they are outside IR35. And new ones came to us for that reason, and in some cases due to poor service from their existing accountancy as well.
Above all it tells me specialism, sticking to what you do best, and putting the contractor wholly at the centre of the model will always pay off.