M&A and the Price of Misclassifying Independent Contractors

Mergers and acquisitions (M&As) trends are growing on a global scale, and the benefits are many. M&As create cost efficiencies through economies of scale and also lead to tax gains. They often increase revenues and can reduce cost of capital. And while the benefits of M&A are significant to businesses, there is often an overlooked factor that can potentially collapse the upsides to these benefits.

As M&As continue to trend upward, so does the contingent worker population. According to the Bureau of Labor Statistics (BLS), the total number of flexible workers exceeded 2.6 million in late 2013 with projected growth to continue full steam in the coming years. Contingent labor growth is a direct result of the changing overall workforce landscape, and companies are making considerable investments in their contingent workforces to reduce costs and remain nimble.

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To that extent it’s important to recognize that during a merger between companies, independent contractor (IC) liability is often overlooked. This “hidden exposure” can be devastating to any company as state and federal agencies are increasing their efforts to uncover unknown ICs and penalize the companies responsible for misclassifying these workers. Individual states are also establishing harsh consequences as IC misclassification continues to be a growing problem, and ICs themselves are becoming empowered with information on how to secure their rights as an independent business.

Ultimately the acquiring company inherits the ICs as well as the risk associated with those IC engagements. Because the level of IC validation (if any) with the selling company is unknown, it’s critical to include discovery of the IC population as a part of the overall M&A due diligence process. Because there are so many moving parts during an acquisition, this piece of the due diligence process can easily fall through the cracks, giving rise to the possibility of engaging with workers who were misclassified from the onset with the selling company. Therefore, missing this step could result in an audit of all workers and creating a scenario for damaging penalties and fines.

A well-defined discovery and analysis process to uncover ICs requires an in-depth assessment of the worker population. Particularly in an acquisition context, it is imperative that the acquiring company require the selling company to provide access to all IC relationships including LLCs, partnerships and C and S corporations as well as what was paid to each over the course of months or years worked.

While it’s most advantageous to conduct a pre-closing review, a post-closing due diligence could be the next best consideration. This is especially important if it was discovered that there is a population of workers who are paid through accounts payable. In fact, coupling pre-closing with a post-closing process provides a deeper dive, as a result of increased visibility into the entire worker population.

The litany of items needing to be reviewed is lengthy and it can become difficult for a company’s legal, finance or even HR departments to manage the aspects of this important worker population. Discovery efforts should be conducted in a thoughtful fashion and include a solid communications, education, and delivery process. More and more, businesses are turning to compliance companies that are independent contractor engagement specialists (ICES) to ensure contract workers are properly classified. By engaging with an IC compliance expert both prior to closing an acquisition transaction as well as post-transaction, companies involved with M&A can mitigate their risk and avoid the costs and damages that accompany misclassification violations.

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