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Negotiating contract rates based on salaries: 3 key tips to getting the best rate

Negotiating fair and market-based contract rates with clients that are based only on the equivalent permanent employee salary could mean you end up under charging for your services. Whilst permanent salaries can be used as a starting point the two are not directly comparable.

You may find clients use the cost of what they see as equivalent employees as part of their negotiating position. But the comparison is entirely invalid because:

  • You are now are business-to-business services provider, not an employee
  • You supply your specialist skills to clients on specific projects, rather than as role-based
  • Your contract has defined duration and outcome
  • Employees get benefits, both tangible and intangible, like employment rights - you do not

So, here are three key aspects to when negotiating your starting rate and trying to comparing it to the equivalent salary in a permanent position:

1. Always remove permanent salaries from the negotiating table from the outset

The starting point of any negotiation over rates with a client is to begin above the current market rate for the assignment on offer and skills required, allowing some scope for negotiation and compromise.

Ideally, the client asks for a price and the contractor counters with something higher, then the negotiations begin in earnest.

In some scenarios, a client may try to bring into the discussions what they would pay their permanent employees, and introduce figures such as employer’s National Insurance Contributions (NICs) in an attempt to compare employee costs with contractor costs.

But a contractor is perfectly entitled to dismiss these figures as the red herring that they are. Contractors should expect to be paid more than permanent salaried employees, particularly if demand for their specific skills and experience is high.

The cost of a permanent employee, even if this employee performs a similar role and has comparable skills and experience, is simply not relevant to the negotiation.

Agreeing to a rate whereby the client pays the contractor the same as an employee would cost is actually a tremendously good deal for the client, and not for you at all.

2. Permanent salary calculations can be useful as a baseline, but nothing more

Where permanent salary and tax calculations can be useful is for benchmarking the minimum, baseline rate with a new client. Understanding the full costs to the client of a full time permanent employee can provide a benchmark.

The cost of a permanent employee, even if this employee performs a similar role and has comparable skills and experience, is simply not relevant to the negotiation

Contractors can use the interactive salary and tax calculators on this website to work out how much a permanent employee’s basic gross salary and employer’s NICs will cost a client.

If the position would normally attract additional benefits, such as health insurance and a car allowance, an estimate of these costs can be added to the sum. If you had life cover with your last firm then you will need to set this up yourself which can be paid by your limited company using a relevant life plan insurance product.

Contractors can calculate the minimum equivalent daily rate by dividing the cost of the permanent employee by the average number of workings days in a year, typically 220.

But the equivalent day rate is a minimum rate to be used for guidance only, and not what contractors should actually aim for during negotiations! Contractors should always negotiate using the current market rates for their specific skill.

3. Avoid contracting for past employers immediately after leaving

The most common scenario when a client tries to use permanent employee salaries and tax calculations as a bargaining tool is when a contractor returns to a former employer to fulfil a contracting assignment.

The former employer, who may well also have been the contractor’s line manager, will try to trade on that prior relationship and the salary the contractor previously received.

Another key reason why contractors should avoid contracts with former employers immediately after leaving is because of the risks of being found inside IR35, which can lead to them paying significantly higher income tax and NICs. You can contract for a former employer and avoid IR35, but you must be careful.

So, do your homework, find out your market rate, and make sure you are getting a deal that is at least as good as permies get when taking into account all those hidden extras like benefits and rights. Remember, whatever rate you go in on, you will be negotiated down from there. So go in high.

Updated: 27 September 2016

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