In my most recent blog, I described two vital areas that every company should closely consider, both as a general matter and in preparation for sale of the company: ensuring that each company team member signs a PIAA, and having a clean and clear cap (capitalization) table. In addition to these, many other important compliance issues are often overlooked by early stage companies, usually due to lean staffing and lack of information rather than bad intent.
The company risks getting into trouble with a variety of regulatory authorities because of these compliance gaps. However, even if the company escapes that scrutiny, the gaps inevitably come to the surface during the due diligence that buyers conduct as part of the acquisition process. When potential buyers discovery compliance gaps, the best case scenario is a delay in the process while the company does some clean-up. Worst case, the buyer lowers the purchase price or walks away from the deal. Clearly the company will benefit from not allowing these gaps to develop in the first place.
The types of gaps that can occur are extensive, and vary on the type of business – service versus product, physical product versus software, B2B or consumer-oriented, regulated industry or non-regulated, etc. However, the following are some of the most common areas where I see compliance gaps:
- Employee versus contractor. The rules regarding whether an individual is a contractor or an employee are complex and vary depending on the state within the US and the situation at issue (income tax, state labor classification, employee benefits, etc.). In many respects it is easier and more beneficial for the company to classify its workforce as contractors because tax burdens are reduced, and there is no need to provide health insurance or other benefits, etc. However, many companies are headed for trouble because they classify individuals as contractors when in substance they are employees.
- State qualifications. Companies are required to register in every state in which they conduct business. There is no single definition of what constitutes “doing business.” Based on that ambiguity and lack of awareness, many companies fail to register in every state in which they do business, which has serious negative consequences.
- State sales tax. Based on the 2018 US Supreme Court opinion in Wayfair, states may now require companies with no physical presence in their state to collect sales tax on sales into that state and remit those taxes to the state. Virtually all fifty states have amended their sales tax laws in light of Wayfair and now impose these requirements on out-of-state sellers. Each state has exemptions for companies with a low volume of sales into their state; those exemptions are typically based on dollar amount of sales into that state or number of transactions. However, many companies with sales that exceed the thresholds and are accordingly obligated to collect and remit sales tax on sales into various states are not doing so, which inevitably leads to problems.
- Privacy and GDPR. Privacy compliance has become an increasingly fragmented and complex area, including various state laws (the California Consumer Privacy Protection Act being the most striking example) and a number of industry-specific privacy requirements. In addition, if the company has customers, suppliers, resellers, strategic partners, or contractors in any European country, it is likely subject to the EU General Data Protection Regulation, which involves a complex set of new requirements.
- Other Cross-border Issues. Given the ease of global shipment of products and instant transferability of “soft goods” such as software and technology, many companies have some aspect of their business outside the US. This can be suppliers, customers, employees, or contractors that are non-US. However, these cross-border transactions raise compliance issues that all too often are not properly considered. These can include tax issues and export/import requirements in the US and in the other country or countries. The specific issue will depend on the nature of the goods or service that the company is transferring, the direction of the transfer (inbound versus outbound), and the country involved.
The above list is far from comprehensive. However, it highlights the fact that any company interested in being acquired will be well-served if it increases its attention and devotes more resources to all legal compliance matters.
Stay tuned for future blogs, where I’ll dive in to the acquisition process itself!