Editor’s Note: This is the second of two articles adapted from “Employment Contracts,” Chapter 14 of The High Achiever’s Guide to Wealth. Pick up your own copy here to read more on this topic and many others.
In America, it is not standard for workers in most industries to sign binding employment contracts. But as more Americans pursue freelance work or independent contracting, they will need to comfortably navigate contracts and other formal work agreements.
The COVID-19 pandemic seems to have accelerated an existing trend toward freelance work. In 2018, an estimated 20% of U.S. jobs consisted of independent contract and freelance positions. A survey from Upwork, a freelance job platform, set this figure as high as 36% in September 2020. Whether out of necessity or choice, many workers seem to be embracing self-directed positions. By its nature, freelance work means negotiating conditions with each client or employer. Freelancers who thrive thus build their skills in understanding, and sometimes creating, agreements that set the ground rules for a successful business arrangement. Such agreements define the scope of work, payment terms and other details. If your work is governed by a legally binding contract, evaluating the contract carefully before you sign is also a means of self-defense.
Even if your freelance arrangement is something less formal, attentively reviewing the terms before you start work can save you major headaches later. Some freelancers use a “letter of agreement” (usually an email of agreement in practice). This is an informal written summary of the terms the freelancer and the client discussed. Others use a “statement of work” or “scope of work” agreement, which is more detailed than a letter of agreement but less formal than a full contract. Depending on the nature of your business, you may want to hire an attorney to help you create a formal contract template, which you can customize for each client. Or you may find one of these less-formal options sufficient for your needs.
Considerations For Independent Contractors
Independent contractors may sometimes take longer-term positions in which they work with a single client at a time. In these cases, the client may look more like an employer, though the contractor retains more independence than a traditional employee. For these workers, the first point of order is getting clear on the question of whether they are truly an independent contractor or if they should be treated as an employee. This question is not up to employer, or even worker, preference.
The terms “independent contractor” and “employee” describe distinct ways of doing work on an employer or client’s behalf. Sometimes the distinction will be self-evident, but not always. Since 1978, the Internal Revenue Service has issued guidance to help employers make sure they are classifying their workers correctly. If you are a contractor, your contract should align with these legal requirements.
The overarching principle is that an employer has a right to control when and how employees do their work, while contractors have the right to control their own working conditions. For instance, in most cases, if you must be at a company’s office between 8 a.m. and 5 p.m. every day, you are an employee. Contractors generally agree to produce a certain result by a certain deadline, but can determine when and where they do the work.
Based on IRS guidance, contractors retain both behavioral control and financial control of their work. Clients can pay contractors by task or by the hour. Contractors may have some control over whether they prefer to charge by the hour or by the project; norms vary between fields. Companies also typically cannot demand that contractors sign noncompete agreements (which I will discuss in more detail later) or forbid them from working for other companies without risking turning the contractors into employees. In turn, contractors seldom have access to benefits such as company-paid health insurance or retirement plans. As self-employed workers, they also must handle their own taxes. For more on the distinction between employees and independent contractors, see “Employee Or Independent Contractor?” by my colleague Melinda Kibler.
What Should Be In Your Contract?
Whether you are reviewing a formal contract, creating a scope of work agreement, or considering any other method of agreeing to work with a client, there are some topics you want to be sure you address in writing. I will use “contract” throughout this section, but know that many of the same considerations apply to any type of written work agreement.
“Read the entire contract” may seem like basic advice, but it truly is important. Many of us are guilty of clicking “accept” on the terms and conditions of a website or app without worrying about the details. That is not ideal either, but when it comes to your career, the stakes are too high not to read and understand the entire document. If the document is a legally binding one, you should also be aware that you may face penalties for violating the terms (beyond burning a bridge with a client). If there is anything in the contract that you find unclear or that deviates from your expectations, the time to bring it up is before you sign.
As the last section specified, a freelance contract generally will not include terms like working hours or benefit details that might appear in an employee contract. Instead, it should outline any agreed-upon deadlines for the work, as well as a description of the work the freelancer has agreed to produce. Specific provisions can help to avoid disagreement later about what the original scope of work included. The agreement should also include when and how the client will compensate the freelancer, including an upfront fee if the parties agreed on one. If you are doing work for a startup, the company may offer you part of your payment in some form of equity; see my prior article, “How To Manage Equity Compensation,” for more on the advantages and complexity of this form of compensation.
Your contract should also lay out how you will deal with any proposed extra work that might arise. Are you open to adding extra work for a fee? Is there certain additional work you will not do? For example, if a company hires a writer to produce a manuscript, she may want to make clear that the project includes no subsequent edits under any circumstances. Or she may offer two rounds of editing in the project’s original scope, with any more requiring an extra fee. However you want to approach “scope creep,” your contract should outline what work is and is not included in your agreement. This is much more important for a contractor than for a traditional employee, whose job will likely grow and change over time.
As I mentioned in the previous section, IRS rules mean that most clients will avoid demanding that contractors agree to noncompete clauses. Noncompete agreements prevent employees from working for direct competitors or setting up a business in direct competition with the employer. Forcing a worker to agree to a noncompete clause means a business may need to reclassify that person as an employee. However, other restrictions may appear in the contract, depending on the type of work. These could include a nonpoaching clause (an agreement not to lure away the business’s staff); a nondisclosure agreement (an agreement not to share proprietary data or other sensitive information); or a nondealing clause (an agreement not to accept work from the business’s customers for a finite amount of time). If you are unclear about or uncomfortable with any of these restrictions, you may want to consult an attorney when reviewing the contract.
Many freelancers are creative workers, such as writers or graphic designers. This means intellectual property rights are likely to be an important part of any contract or agreement. Depending on what you are hired to do, your contract may include a “work made for hire” provision. This arrangement specifies that the work you are agreeing to perform will belong to the client. In many circumstances, this is normal and will be reflected in your compensation.
In other situations, you may want to retain some rights or have rights revert to you after some time. You may want to retain the rights to display your work as part of a portfolio without having to consult or compensate your client, for example. If you plan to license your work and the client seems open to the arrangement, you will likely want to involve an attorney who has experience with intellectual property to help create or review your contract, as the law can be complex. Many freelancers specify that they retain intellectual rights to their work until the client pays them. This ensures an unethical client does not start using the work without compensating its creator. The crucial point is that you and your client should be on the same page about who will own the creative work before you get started. A contract should confirm your understanding.
You and your client may agree to part ways before your contract ends for a variety of reasons, not all of them foreseeable. It’s worth touching on termination, even in a relatively short-term contract. Like an employee contract, a freelance contract may dictate that each party must give a certain amount of notice before ending the arrangement. You may also want to include a provision for inactivity, in case you cannot reach your contact at a company for an extended period. You should agree on a fair payment system for time spent or the amount of work completed if a project is cut short. For instance, you can outline how you plan to invoice on a pro rata basis for partial completion.
Regardless of whether you deal with freelance contracts regularly or only every now and then, it is important to approach a business relationship with a new client thoughtfully and methodically. A good client puts significant time and effort into creating a contract, or they will appreciate the effort you put into creating it. A clear and thorough document protects both parties and ensures you both get the most out of your business relationship.