rom the edge of Alaska's tundra to Miami's South Beach scene, ISOs and merchant level salespeople (MLSs) pound the pavement (or slush) daily. They also congregate at virtual water coolers such as the GS Online MLS Forum. It's where the feet on the street exchange tips and tricks, ask questions, vent frustrations, gossip a bit, and learn about recent happenings and emerging industry trends - in nearly real time.

Recently, passionate discussion on the MLS Forum has centered on whether ISOs are hiring more MLSs as employees instead of working with them as independent contractors. Inspired by this dialogue, we decided to explore this issue in depth.

Is the basic ISO business model changing? Are the distinctions between employee and contractor status important? What are the pros and cons of each type of relationship for ISOs and MLSs? And if the model is changing, how will that affect the way we do business?

There are important distinctions between employees and contractors. For example, income received as an employee is reported at year's end on a W-2 form, and employers withhold taxes, submitting the funds on behalf of employees to the appropriate governmental agencies. Independent contractor income is reported on a 1099 form, and contractors are responsible for making their own estimated quarterly tax payments.

Brent Longnecker, President of Longnecker and Associates, an HR consulting firm, said the reasons for hiring employees or engaging contractors haven't changed.

"It usually comes down to the same issues," he said. "A 1099 salesperson can - and most often is - representing other companies as well. Most ISOs or acquirers want their salespeople's undivided attention, and the way to ensure that is to have a W-2 sales staff.

"But your fixed costs will go up with a W-2 staff, so most people back into the decision. They look at what they want their distribution to be and then what they can afford to spend to reach that goal."

Cost considerations

Employees "cost a lot more," said Bob Carr, President and Chief Executive Officer of Heartland Payment Systems. "Heartland will pay out $5 million more in insurance, taxes and other benefits costs [in a year] than it would to get the same level of performance from 1099 MLSs."

The upfront, fixed costs - taxes, unemployment insurance, health benefits, etc. - for employees can be steep. But some argue that in the long run, a sales team comprised of employees can save a company money.

"Clearly the acquisition cost for a merchant with the ISO model is very expensive," said Jared Isaacman, CEO of United Bank Card Inc. "There are free terminals, heavy conversion bonuses and so forth. It now costs a processor or super ISO considerable upfront money to obtain a merchant.

Isaacman noted that some large ISOs are adopting a direct model: Their Web sites are central marketing points for new merchant customers and a means to sign merchants directly. This circumvents ISOs and MLSs. However, many ISOs want to support MLSs and find that hiring employees can save money, too. When an ISO or acquirer fills its sales team with employees, there tends to be less merchant churn. Additionally, the ISO may not have to pay employees residuals.

ISOs with independent contractor sales teams can hold down fixed costs. But, their related costs are variable and thus harder to predict. Also, firing or laying off a nonperforming employee can be more difficult than replacing a contractor.

Mike Henderson, the National Sales Manager for Aliant Financial Services, a registered ISO/MSP with JPMorgan Chase & Co. experimented with hiring employees but has returned to using a team comprised exclusively of independent contractors.

"There is little financial investment in bringing in a 1099 agent versus a W-2 employee," Henderson said. "The advantages to the ISO for 1099 would be ... a financial decision more than any other factor.

"On the flip side, you can set a much longer vestment time frame for a W-2 employee, or the ISO can choose to not ever vest them," he said. "So, they have to perform in order to receive residuals. And the ISO at some point keeps 100% of the profits on their accounts. I see a trend coming where a lot of companies are paying just a flat fee for an account and keeping all the residuals."

Talent retention

One of the most frequently cited arguments against hiring employees as sales agents is that sales superstars will gravitate toward situations in which they have maximum independence and no limits imposed on their earnings. This is more easily achieved by attaining 1099 status. So, the argument goes, an employed staff will attract only mediocre salespeople.

Henderson said this was one of the reasons his employee program went downhill. "We paid a salary, bonuses and commission but did not intensely monitor the daily activity," he said. "So we had a lot of people that gave false reports and milked a salary until we finally said enough is enough.

"We were not without fault in our program. We set the quotas based on deal count, not volume. So salespeople, for some reason, tended to migrate to the 3K to 7K accounts. We have gone back to an all-1099 sales force, which gave us the opportunity to increase the bonus program. So we are now able to compensate our productive agents even better."

Carr's experience has been different. "Our people are not salaried, but they are W-2ed," he said. "There is a world of difference between salaries and straight commission. We pay on a straight commission. Our salespeople have a monthly goal, and if they do not hit it consistently, they will not be able to make a living and will probably leave the company.

"Heartland has more sales superstars than anyone in the industry - by far," he added. "We have more than 80 salespeople who are millionaires." He noted that in 2005 he was paid less than his top 14 salespeople; in 2006, he was paid less than the top eight.

"What other company in our industry can even begin to compare to any of those figures?" he asked. "I challenge any company to show one millionaire working for them who is not the owner or one salesperson who makes more income than the CEO or owner. We have these salespeople in every corner of the country."

There are a number of reasons high-performing salespeople might be interested in becoming employees. Those with health issues or families may be willing to sacrifice a portable portfolio for insurance and benefits. Bank loans and mortgages are sometimes easier to get with W-2 status - even with a lower income. And some agents say they get their employers' attention more readily as employees.

"There are salespeople who want to be commission only; they want to run their own show," Longnecker said. "Then there are hybrids, people who would like a more secure base but also want an upside. And then there are those who don't want a commission at all. They are more comfortable in-house, for example, and on salary.

"The best bet, from the manager's standpoint, is to find the people whose personalities are best suited to the program your company offers." However, he added that many of the real go-getters don't have the disposition to be anything but independent: "If you find them, take them on as 1099s. But give them all the tools they need to do the job; it can be a win-win situation for everyone involved."

Quality control

Control is a big plus for many acquirers and ISOs staffing their sales teams with employees. MLSs with W-2 status represent only their employers' products and can't cherry-pick which merchant accounts go to which companies. In addition, they must conform to set policy and price guidelines. And their employers have more control over customer-service issues.

"We could not figure out how to maintain our brand integrity with 1099 people, so the biggest positive to us in having a W-2 staff is maintaining brand integrity," Carr said.

Rogue agents and ethics violations, in addition to card Association- and government- compliance requirements, are also considerations.

"From a risk point of view, I'm 100% for the employee force, as you can keep your thumb on them and regulate compliance much more closely," Henderson said. "As restrictions increase, it will be imperative to move to an employee force or allow some sort of waiver of liability to the ISOs for first-offending agents for compliance issues."

It can be tricky to maintain the necessary level of control over independent contractors without running afoul of the IRS.

"We pay all of our MLSs by W-2," Carr said. "We require that our MLSs work exclusively for us. We require that our MLSs sell according to our policy and price guidelines. We want to provide health insurance, 401K and stock-option benefits to our MLSs to provide them with a long-term career opportunity. We pay by W-2 because our business model requires it, based upon IRS rules."

Longnecker warned that blurring the boundaries between independent contractors and employees has gotten companies in trouble with the IRS. "It's extremely tempting to cut corners, to try to encourage loyalty from your 1099s without following the guidelines," he said. "But it is extremely important that everything be done correctly from both an ethics and a compliance standpoint."

Lack of control is often cited by MLSs as the biggest drawback to having employee status. Also, representing only one line of products can be limiting. MLSs who handle products and services from multiple providers can mix and match to find the best solution for their merchants.

Additionally, if employers fail to keep up with the market in terms of pricing or technology, their employees' sales efforts - and incomes - may be seriously depressed. In contrast, independent contractors can more easily employ the most promising (and profitable) solutions.

Furthermore, the lack of portfolio portability can be a serious drawback for MLSs working as employees. Agents devote great effort to signing deals; the golden ring is the accumulated residuals built from those efforts.

Prudent flexibility

Although many acquirers and ISOs use a combination of employees and independent contractors, very few have both types on their sales teams. However, many say that may come.

As more acquirers generate leads through Web sites or marketing campaigns, the appeal of having an in-house sales force is gaining traction over passing leads to independent contractors who have the option of placing leads with a competitor.

"I can see a mix at most ISOs with both a direct force and 1099 agents," Henderson said. But having both can leave managers walking a very fine line with the IRS and their MLSs.

"People are looking for flexibility in their jobs now more than ever," Longnecker said. "But in a competitive market, companies are looking for loyalty from their sales staff. It really comes down to finding the perfect mix that works for both the company and their individual employees."

Longnecker noted that using both types of workers must be managed very carefully. "I'd recommend very clear boundaries, perhaps geographically," he said. "You don't want your sales staff to become a distraction to each other, and you don't want them to become enemies."

Employees may end up resenting the freedom independent contractors enjoy, while contractors may feel that employees receive preferential treatment: more leads, more access to the support system of the office, better access to marketing materials and training, and more weight given to their ideas.

Providing all MLSs the support and tools they need is vital. It is only natural for independent contractors to gravitate toward companies that support them well. And employees are less likely to run out of steam if they feel they have a clear path to success.

But the distinction between the two must always be clear; otherwise, the IRS may intercede. "The company may get into trouble if they fail to follow the guidelines," Longnecker said. "And the 1099 sales agent may, too."

Volatile industries, such as oil and gas or technology, tend to prefer using independent contractors. Heavily regulated industries, like banking, lean toward hiring employees. But for sales, most industries use a mix of the two, and that isn't likely to change, Longnecker said.

There are compelling reasons for acquirers or ISOs to go with employees and equally compelling reasons to use independent contractors. And while some salespeople prefer employee status, others can't imagine losing their independent contractor status.

"In the end, it boils down to preference," Longnecker said. "The most successful companies and the most successful salespeople are those that determine the situation that works best for them and stick with it."