There is a well-known business maxim: Start with the end in mind. For most owners of staffing firms, the end is a successful exit. With this touchstone in mind, it becomes easier to distinguish between the important legal and compliance issues (what will impede a successful exit) from the unimportant (i.e., don’t sweat the small stuff).
As a former attorney in private practice, general counsel, and now CEO of the IT and engineering staffing and solutions industry’s national trade association with robust insurance and M&A programs, I have had a unique window into the legal and compliance issues that can impact or even derail an eventual exit.
Mitigate risks. In staffing, as in all business, risk is unavoidable. Accordingly, staffing executives should focus relentlessly on mitigating those risks that harbor dire or even existential consequences.
Client contracts. Staffing firms rarely have equal bargaining power relative to their clients. While many firms focus exclusively on business terms, it is important to attempt to negotiate key legal terms as well. For example, make every effort to narrow indemnification obligations (where the staffing firm commits to paying claims of others brought against the client) and seek limitations of liability in client contracts. While clients will not always agree with proposed changes, making the effort to limit overbroad indemnification obligations can significantly reduce a firm’s risk.
Employee classification and tax issues. After a Letter of Intent is signed but before a sale transaction is consummated, the buyer’s counsel will evaluate whether the seller has been compliant with its legal and tax obligations. Among the areas assessed is whether employees and independent contractors were properly classified. Has the company been improperly treating employees who are performing non-exempt duties (i.e., eligible for overtime) as exempt? Misclassification of employees under federal and state overtime laws can represent latent liability that can impact a sales transaction.
Similarly, while many IT staffing firms must engage independent contractors (typically on a corp-to-corp basis) or forego significant business opportunities, efforts should be made to minimize the risk of reclassification, including putting in place appropriate agreements.
Of course, management should also ensure they have fulfilled their federal and state tax obligations.
Restrictive covenants. While some states have been limiting the types of restrictive covenants that are enforceable, a firm contemplating a sale should ensure it has in place noncompetition, non-solicitation and confidentiality agreements as permitted by applicable state law.
Insurance a must. For risks that cannot otherwise be fully mitigated, secure insurance.
The insurance industry categorizes claims along a matrix of frequency and severity. Ironically, most professional staffing firms don’t carry the types of coverage that will respond to either the frequent or severe risks they are likely to encounter. While staffing firms routinely carry professional liability (also known as Errors & Omissions) and crime policies because they are required by their clients, such claims are extraordinarily rare in practice.
By contrast, staffing firms are exposed to all types of employment claims. Despite the prevalence and potential severity of the risk (think class action or collective action lawsuits), only about onethird of IT and engineering staffing firms elect to buy Employment Practices Liability Insurance (EPLI) that would cover such claims. In addition to covering losses attributable to a range of employment claims, EPLI policies can help cover the potentially devasting legal defense costs.
For many staffing firms, contending with legal and compliance obligations is viewed as both a necessary evil and a confusing morass. By keeping the end in mind — a successful exit — owners and executives can appropriately focus on the legal and compliance issues that matter.
Firms that don’t have an in-house attorney should consider investing in outside counsel with knowledge of the industry in negotiating agreements and conducting legal audits ahead of going to market.
