April 3, 2020 Preparation to Limit Employment Liabilities in a Sale

Employees can be a manufacturer’s greatest asset in a sale, but without special attention, they could be a seller’s greatest liability.

By Brent Ashley, Lisa Hedrick and Sarah Mikowski

To lure in the right kinds of buyers, from a business perspective, sellers must address skills gaps and clearly establish how the business attracts and retains qualified employees. From a legal perspective, demonstrating compliance with employment laws can make or break a deal.

Buyers are particularly focused on employment issues because they have the potential to impose significant liabilities on the new owner—liabilities that can attach to the new owner of the business even in an asset sale. When a buyer has concerns about employment law compliance, it is common for the buyer to ask the sellers to assume responsibility for any associated liability post-closing. A potential buyer, however, may also consider the impact that this non-compliance has had on the company’s value. If bringing the company into compliance after the closing will increase the business’ costs significantly, it would not be unusual for a buyer to ask for a reduction in the purchase price.

Thoughtful preparation with regard to a prospective buyer’s employment concerns will help preserve deal value and limit post-closing liability.

Employee Classification

One of the first items a potential buyer may request is a list of all employees and independent contractors with compensation and other detailed employment information. From this list, the buyer is likely to focus on whether employees are exempt or non-exempt from overtime laws under the Fair Labor Standards Act (FLSA); whether contractors are properly classified as independent contractors; and where employees are located for sales and employment tax purposes. Misclassification in any of these areas can result in liability for the company and, thus, for the buyer post-closing. If employees are classified as exempt under the FLSA, for example, a buyer will want to understand the applicable exemption and how that determination was made. The fact that an employee is salaried is not sufficient for her to be exempt from the overtime requirements of the FLSA.

Compiling employment data early streamlines the due diligence process and sheds light on potential areas of concern. If concerns are identified, working with advisors to correct any misclassification or to explain certain classifications will be crucial to maximizing value.

Employee Benefits

Another area of focus for potential buyers may be compliance with employee benefit laws including the Employee Retirement Income Security Act of 1974 (also known as “ERISA”) and the Affordable Care Act. In many instances, identification of a misstep with respect to employee benefit laws can be corrected. Having a qualified advisor conduct an internal audit of the paperwork and filings with respect to employee benefits gives the seller time to address any issues prior to a sale process. Among the concerns that may surface from the audit: failure to offer all qualified employees participation in benefit plans; failure to make required employer contributions to benefit plans; and failure to have the appropriate plan descriptions and other summaries available.

Many companies also have bonus or equity-based plans that require payment in connection with a sale transaction. Buyers will pay close attention to ensure these plans comply with applicable laws related to deferred compensation and—in some cases—may require termination of the plans in connection with closing.

Employee Contracts

Most buyers will want to check the box with respect to employee handbooks and policies, but they also may be interested in reviewing other contractual arrangements that you have with employees. For example, buyers may want evidence that your business has signed confidentiality and invention assignment agreements with all employees who participate in the development or design of products, technology or other intellectual property. Buyers also may inquire about non-compete and other restrictive covenant agreements that are in place for key sales employees and key executives. If these types of agreements are not yet in place, it may be possible to put them in place prior to a sale transaction, giving the buyer more comfort with respect to intellectual property and key employees.

Preparation is Key

A common theme of successful deals is seller preparation. By engaging knowledgeable advisors to review compliance with key employment laws prior to beginning a sale transaction, a seller can take control of any “clean up” that may be required. Early identification of any issues allows the seller to take appropriate action and ultimately to control the narrative with potential buyers.

Lisa Hedrick, Brent Ashley, and Sarah Mikowski are attorneys at Hirschler Law in Richmond, Virginia. Hedrick is a partner with the firm and focuses her practice on mergers and acquisitions involving privately-held middle market companies across the U.S. She can be reached at lhedrick@hirschlerlaw.com. Ashley’s practice focuses on mergers and acquisitions, private equity and corporate counseling of private companies. He can be reached at bashley@hirschlerlaw.com. Mikowski provides corporate and business-related legal services to closely-held companies and individuals, including counsel in corporate law, and trust and estate matters. She can be reached at smikowski@hirschlerlaw.com.

Brent Ashley

Lisa Hedrick

Sarah Mikowski

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