Built to Sell: HR

People are the metaphorical lifeblood of any company.  Perhaps it’s no coincidence then that the etymology of corporation is from the Latin word for body; like a real body, a company is only as healthy as its blood.  Consider these examples:

  • Young children need less blood in total but more blood per pound than full-grown adults (Company Lifecycle).
  • With too much or too little blood, either in total or in certain parts, the body can experience decreased efficiency or death (Staffing Levels and Mix).
  • While different bodies naturally have different types of blood, some types can’t be mixed without one body rejecting it, resulting in destructive internal warfare (Company Culture and Employee Fit).

A company’s HR strategy is therefore one of its most important assets, and its HR policies and procedures represent the first-line of both offense and defense in the market for survival and success. As we discussed in our prior post, HR considerations often cross into the legal sphere, so it’s important to attend to legal implications and considerations as well as business factors when making decisions.

Building a company that is compliant with respect to HR is an important part of this, but so is assembling a strong team that meets your company’s needs at various times in your lifecycle.

What are your needs?

Who do you want on your team?

When you’re first starting out, don’t feel like you need to hire for every position you might need at some point in your company. Before hiring, you should take a realistic assessment of where you need help. Cash flow concerns often dictate decisions early on in a company’s history, but don’t let yourself be swayed by trying to save a few dollars. Could you hire a contractor to finish developing software? It might cost $2,000 to do this, but if it gets your product to customers sooner, you might end up better off.

Keep in mind that your needs will probably change over time. Start-ups and small businesses that are attempting to run lean may rely on the brute determination of the owners to get everything done. In setting up and running our own companies, we’ve often wore multiple hats at a time. As your business picks up, you may decide that in order for you to focus on creating enterprise value you are going to begin delegating administrative or non-strategic tasks. Depending on how you hire, you may have flexibility to easily ramp-up or slow down these labor costs as your business’ maturity level and needs change.

How should you hire?

All hiring is not created equal, and there are pros and cons (always!) to each method. Here are the various ways that you can bring on additional labor:

  • Company co-owner
  • Employee
  • Contractor (“freelancer”)
  • Alternative arrangement

Company owner

Bringing someone into your company as another owner can be a big risk, but it can also pay off in early financial savings. The decision to add another member/partner/owner should be made carefully, as it’s the most difficult of the labor additions to undo. Before bringing on additional owners, you should be sure that your interests are protected if any issues arise. Depending on how your company is structured, you may need to pay yourself and any other active owners a salary for work performed, so this option has varying levels of financial savings depending on your company structure. If you’re building your company to sell, remember that unless you’ve structured your company so that you retain the ability to make and effect decisions regarding the sale or financing of your business, adding additional owners can complicate and slow down the process. Additionally, if your goal is to build your business to sell, adding other owners essentially sells your future gains at a huge discount to meet current needs. This may sound rather bleak, and as though it’s never a good idea to bring on other owners, but this is certainly not the case; you might bring on other owners because they’ll create real value for your business or because their skill set would provide beneficial synergies with yours.

Employee

Hiring your first employee significantly shifts tax, compliance, and reporting requirements for your company. As soon as you hire an employee, the company is responsible for federal, state, and possibly local payroll and unemployment taxes, as well as workers’ compensation. Once you already have one employee in a location, however, the administrative cost of adding additional employees is relatively minimal.

Healthcare and benefits can be quite a substantial expense, especially for small businesses who don’t benefit from the economies of scale of most insurance plans. While you may not be legally required to provide healthcare for employees, not doing so can make it difficult to hire good labor. If this is non-negotiable (which it often is when you’re cash-constrained), try to come up with other ways to appeal to potential employees: offer unlimited vacation policies, remote work policies, or other flexible arrangements that they might not get at other companies.

Given the reporting and compliance requirements every time you hire or fire a new employee, you may want to consider trialling the resource as a contractor. It’s much harder to fire an employee than it is to simply not re-engage a contractor.

Contractor

Using a contractor is generally the easiest, quickest way to add additional labor. Contractors or freelancers work for themselves (or an agency) on a contract basis. If you hire a contractor to complete a specific project, and they do a poor job, you simply choose not to hire them again and move on to someone else. Unless you breach the terms of the contract, a contractor couldn’t sue you for termination in the same way that an employee could. With contractors, the reporting requirements are generally much less involved: payments made to contractors usually are simply reported annually to the IRS on Form 1099 (it’s a more complicated process if the payments are made to a foreign contractors doing work in US).

Hiring contractors through an online platform like Upwork or Guru allows you to gain access to a broad base of potential personnel. Although these platforms charge a markup, they handle some of the paperwork (e.g., Forms 1099) and generally offer greater protection than if you directly contracted with the worker.

Be careful not to play games with personnel classification here: don’t try to call an employee a contractor just to avoid payroll taxes. There are different “tests” or factors that agencies use to determine whether a worker should really be classified as an employee, rather than a contractor. The penalties for misclassification can be quite high, so careful assessment is important.

Alternative arrangement

Companies need to perform certain functions to survive and thrive.  Consider these capabilities below:

  • Understand and forecast complex technical or business landscapes
  • Generate, qualify, and convert sales leads and opportunities
  • Access key individuals, companies, or regulators
  • Raise debt or equity capital to align with strategy and market forces
  • Execute legal transactions and manage legal and regulatory risks

In many larger or more mature companies, these capabilities are provided by internal employees such as the Chief Risk Officer (CRO), General Counsel (GC), or Chief Financial Officer (CFO).  However, for many smaller or younger companies, hiring or contracting for these capabilities just doesn’t work. Instead, obtaining these capabilities through alternative arrangements such as equity grants for advisors, commission-based relationships, joint ventures, or outsourced executive and leadership relationships is often the best route.

Streamline the process

The initial hiring and onboarding process can be the most time consuming part of the personnel lifecycle, so when your time is limited you want to make sure you have a streamlined process to follow. By having a set list of tasks to complete, you’re able to save your mental bandwidth for value generating activities, not trying to remember whether you asked the new hire for all of the right information. In the future, a potential acquirer or investor is going to ask for your records anyway, so it’s much easier to have them prepared in advance, rather than scrambling as part of due diligence.

Regulatory compliance

When you hire an employee, certain documents must be completed and information provided by specific deadlines. Compliance is key, as buyers don’t want to acquire a company that has racked up fines (or potential fines, if they haven’t been assessed yet).

Federal

The number one document for new employees is Form I-9, which is used for employment and identity verification. You might think that just because you don’t have to submit the form to anyone, that you’re off the hook, but this is far from true. Audits of I-9 documentation have increased by nearly 350% over a single year. The good news is that it’s pretty simple to get this right, especially when you only have a few employees. The key is knowing ahead of time that once the employee has been hired, he or she must complete the first section on or by the first day of employment. As the employer, you have to complete the second section, which includes physical review of the employee’s identification documents, within 3 business days of the employee’s first day of work.

You must also obtain a completed copy of the employee’s Form W-4 before the employee’s first payroll is run. Given that Form W-4 instructs the employer on how much to withhold, it would be difficult to run payroll without this info! Employees are allowed to change their withholding information at any time; once the employee provides you with a complete updated Form W-4, you must update the payroll withholding within 30 days of receipt. If an employee is exempt from withholding, he or she must provide a new W-4 each year (they expire February 15th of the following year), or else you as the employer must withhold at a set rate.

When you hire contractors, you should request  Form W-9 prior to making payment to the contractor. You’ll need information from this form to prepare Forms 1099, and it’s much easier to get contractors to provide information when their money is on the line! We know from personal experience the joys of chasing down a contractor to get this information after they’ve completed a project.

State

Depending on the state in which you hire employees, your requirements can vary drastically. In general, at a minimum, most states require the following:

  • Employer registration for withholding taxes
  • Employer registration for unemployment insurance
  • State equivalent of Form W-4
  • Registration of new hires

Once you’ve registered for taxes in a jurisdiction, you don’t have to register again when you hire more employees in that jurisdiction (but you likely will need to report any new hires).

Outsourcing

Payroll is a great area to outsource, because it can require frequent payments and submissions that are easy to miss if you’re focused on product development or servicing clients. Providers such as Intuit Payroll, Gusto, or Sage provide all offer full-service payroll support. These generally require some initial inputs from you, but once you’ve set up your employees it can be a pretty self-sustaining situation.

If you choose not to outsource payroll services, you need to ensure that all of your payroll tax filings and payments are up-to-date. If you fall behind, the interest and penalties can begin to snowball if you’re only paying a portion of the total amount owed. Acquirers know the hidden costs of improperly managed payroll, and if you want to sell your company without a discount for that, you need to monitor your company’s compliance.

Internal compliance

A handshake agreement may work for getting the neighborhood kid to mow your lawn, but when it comes to HR, stick to written contracts.

Internal compliance generally crosses into other areas like information security, IT, and legal. Following internal compliance checklists helps to make your life easier by noting exactly what tasks have been done for each person. Our other posts in this series will discuss some of the compliance steps that fall under InfoSec, IT, and legal.

What does an internal compliance checklist look like? It can include the following types of steps:

  • Assessment of worker status (exempt vs. non-exempt, part time vs. full time, contractor vs. employee, etc.)
  • Communication with personnel regarding company policies and procedures
  • Signed agreements
    • Contractor/employment/admission agreement
    • Confidentiality agreement
    • Non-compete agreement (note that depending on your industry/the type of work being performed, this may not realistically be legally enforceable)
    • Employee handbook
    • Information security policy
  • Background check (it is very important that you gain consent from personnel prior to running a background check. We like using FRCA-compliant providers like GoodHire, as they reduce your risk.)
  • Access to appropriate systems

Offboarding

As important as hiring employees is, the offboarding process when an employee or other resource leaves can be even more fraught with peril. Especially when you’re parting with a resource on unhappy terms, you need to ensure that you properly offboard the person to protect your company and its resources. Information security and IT are major concerns in a non-mutual separation, and we discuss them more in the related posts of the Built to Sell series.

For “Built to Sell” purposes, be sure to document each resources date of departure, as well as reason for departure (termination, mutual separation, completion of project, etc.). As part of the offboarding process, you should remind the separating resource of any obligations that he or she has beyond the separation, such as a non-disclosure or non-compete agreement.

Know Your Team

When you’re building your company to sell, the qualifications of your team can be very important, especially if the acquirer is interested in bringing on all or a portion of your personnel. It can be useful to document the qualifications of the members of your company. You may already have this information and be using it for marketing purposes (and if you’re not, consider adding it to your team page!). Does anyone have any licenses or certifications that set your company apart from competitors? Are there any published works from team members?

Transparency vs. Keeping Quiet

When you’re in discussion for a potential acquisition, you need to decide how upfront you want to be with your employees and other resources. There are pros and cons to each approach, but you know your company and your resources better than anyone, so you are best poised to make the decision.

Being Transparent

Your employees and contractors may appreciate it if you tell them about the deal up-front. Depending upon the type of acquisition, your personnel may or may not be significantly affected (if, for example, you’re pursuing an equity deal, the acquirer may simple continue the same operations under their ownership). On the other hand, the acquirer may only be interested in your intellectual property and would pursue an asset deal that would result in your company dissolving and all personnel being terminated. In this case, they might appreciate advance warning so that they can search for a job in the meantime. A word of caution: consider how an early exit of personnel might impact closing the deal.

Keeping it Under Wraps

When a deal is moving slowly or is uncertain, it may be better to wait to inform anyone outside of the negotiations of the possibility of an acquisition. If employees hear that there’s a possible deal, and it falls through, they may lose faith in your company and jump ship.

If the deal is predicated upon continued employment by your employees, informing them of the deal can throw a wrench into negotiations. Once someone knows that they’re a linchpin, they may begin to negotiate for better terms for themself, even if it puts the deal at risk.

Takeaways

You don’t need to build a complete team right from the start, but when you do begin to expand your team, be sure to follow standardized procedures to ensure that you’re handling all of the HR tasks the right way. As you begin to consider selling your company, make a decision as to what level of transparency you want to give your personnel with respect to a deal.