INTERVIEW: Client Spotlight with Ralph Ramirez

I was very excited to get to interview Ralph Ramirez. Ralph is an exceptionally talented client and owner of Townecraft Homewares.

In this insightful video you get to hear how he approached this multi million dollar business acquisition, some true “pro tips” if you’re considering purchasing a business, and the critical importance of “evolving a culture” (not just “creating a culture”) that allows you to further the success of the business you’re purchasing.

Why Businesses Fail: Failure to Invest in Human Resources

Introduction

Many businesses fail for many different reasons but mostly because they fail to properly consider the crucial challenges at the very outset. The following is part I of VII of my assessment of critical business failures.

Startups fail to spend money on viable human resources.

It is an unfortunate truth that many business owners try to cut costs wherever possible. However, as the saying goes, sometimes spending money is the only way to make money and break past the financial plateaus that most businesses face. So, the question is, where should you spend money? The answer is simple: you spend money on viable human resources. If you want to grow, you need to at least consider investing in the right human capital. You invest in human capital because you want to become more efficient at the number of repetitive tasks your business employs so that you can focus on developing the human relationships that feed your business.

I would argue that one of the smartest decisions you’ll ever make as a business owner, if done right, is letting go of control. I’m referring to no longer micro-managing every aspect of your business, no longer wearing every single hat and instead engaging in high leverage activities such as delegating tasks to others.  By others I mean employees, independent contractors, or outside service providers.

The key however is effective delegation. i.e. giving your employees the tools and motivations and a clear picture of the desired result. In other words, giving your employees the education, resources and know how to achieve a result — not micromanaging their personal process.

People that can perform the services that otherwise take away from your time engaging in more important tasks — the personal aspects of your business such as business development, networking, and client management– are the wisest investment you can make for yourself and for your business. You can systematize repetitive tasks. You can outsource tasks that are more complex to the right professional service provider (think accounting, contract management, project management, bookkeeping, etc.). You cannot systematize human relationships. Human relationships follow a different principle: slow is fast and fast is slow.

To this end, I have created for my own business: templates, answers to questions most frequently asked by clients, answers to questions most frequently asked by new hires, template terms and conditions for each client engagement, educational guides, and preferred protocols for anyone who is performing services on behalf of my company for my clients. 

In doing so, (1) I provide people who work for me with the tools and resources to accomplish the given task, (2) I identify minimal parameters for executing the methods for each task,  (3) I create efficiencies with the things they do for my company without micromanaging, (3) I set forth a clear upfront mutual understanding and commitment to specific expectations and results, and (4) I set forth a quality statement of what the results will look like. I create efficiencies where efficiencies make sense.

Need some guidance? Let’s chat!

The Independent Contractor Test

The IRS test often is termed the “right-to-control test” because each factor is designed to evaluate who controls how work is performed. Under IRS rules and common-law doctrine, independent contractors control the manner and means by which contracted services, products, or results are achieved. The more control a company exercises over how, when, where, and by whom work is performed, the more likely the workers are employees, not independent contractors.

A worker does not have to meet all 20 criteria to qualify as an employee or independent contractor, and no single factor is decisive in determining a worker’s status. The individual circumstances of each case determine the weight IRS assigns different factors.

NOTE: Employers uncertain about how to classify a worker can request an IRS determination by filing Form SS-8, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” However, some tax specialists caution that IRS usually classifies workers as employees whenever their status is not clear-cut. In addition, employers that request an IRS determination lose certain protections against liability for misclassification. Consult with your CPA.

The 20 factors used to evaluate right to control and the validity of independent contractor classifications include:

  1. Level of instruction. If the company directs
    when, where, and how work is done, this control indicates a possible employment relationship.
  2. Amount of training. Requesting workers to undergo company-provided training suggests an employment relationship since the company is directing the methods by which work is accomplished.
  3. Degree of business integration. Workers whose services are integrated into business operations or significantly affect business success are likely to be considered employees.
  4. Extent of personal services. Companies that insist on a particular person performing the work assert a degree of control that suggests an employment relationship. In contrast, independent contractors typically are free to assign work to anyone.
  5. Control of assistants. If a company hires, supervises, and pays a worker’s assistants, this control indicates a possible employment relationship. If the worker retains control over hiring, supervising, and paying helpers, this arrangement suggests an independent contractor relationship.
  6. Continuity of relationship. A continuous relationship between a company and a worker indicates a possible employment relationship. However, an independent contractor arrangement can involve an ongoing relationship for multiple, sequential projects.
  7. Flexibility of schedule. People whose hours or days of work are dictated by a company are apt to qualify as its employees
  8. Demands for full-time work. Full-time work gives a company control over most of a person’s time, which supports a finding of an employment relationship.
  9. Need for on-site services. Requiring someone to work on company premises— particularly if the work can be performed elsewhere indicates
    a possible employment relationship.
  10. Sequence of work. If a company requires work to be performed in specific order or sequence, this control suggests an employment relationship.
  11. Requirements for reports. If a worker regularly must provide written or oral reports on the status of a project, this arrangement
    indicates a possible employment relationship.
  12. Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of employment relationships, unless the payments simply are a convenient way of distributing a lump-sum fee. Payment on commission or project completion is more characteristic of independent contractor relationships.
  13. Payment of business or travel expenses. Independent contractors typically bear the cost of travel or business expenses, and most contractors set their fees high enough to cover these costs. Direct reimbursement of travel and other business costs by a company suggests an employment relationship.
  14. Provision of tools and materials. Workers who perform most of their work using company-provided equipment, tools, and materials are more likely to be considered employees. Work largely done using independently obtained supplies or tools supports an independent contractor finding.
  15. Investment in facilities. Independent contractors typically invest in and maintain their own work facilities. In contrast, most employees rely on their employer to provide work facilities.
  16. Realization of profit or loss. Workers who receive predetermined earnings and have little chance to realize significant profit or loss through their work generally are employees.
  17. Work for multiple companies. People who simultaneously provide services for several unrelated companies are likely to qualify as independent contractors.
  18. Availability to public. If a worker regularly makes services available to the general public, this supports an independent contractor determination.
  19. Control over discharge. A company’s unilateral right to discharge a worker suggests an employment relationship. In contrast, a company’s ability to terminate independent contractor relationships generally depends on contract terms.
  20. Right of termination. Most employees unilaterally can terminate their work for a company without liability. Independent contractors cannot terminate services without liability, except as allowed under their contracts.

The Economic Realities Test

Similar to the common law test, the economic reality test focuses on the degree of control exercised by the employer as an essential factor in determining whether an employer-employee relationship exists. While no single factor is controlling or decisive in determining whether an employment relationship exists, the facts and circumstances that courts and federal enforcement officials examine in deciding whether an individual is an employee or an independent contractor are:

  • the degree to which the employer controls or directs the manner in
    which work is performed,
  • whether the worker’s opportunity for profit or loss depends on his or
    her managerial skills,
  • whether the worker’s duties are performed for the employer on an
    ongoing or permanent basis,
  • whether the service performed by the worker is an integral part of the
    employer’s business,
  • the extent of the worker’s investment in equipment or materials needed to perform the job, and
  • the degree to which the worker is engaged primarily for the benefit of
    the employer.

The IRS considers a worker to be your employee if you have the right to control not only what work will be done, but also how the worker will do it. If you treat a worker as an independent contractor, but the IRS decides you have sufficient control over the worker to create an employment relationship, the IRS can hit you with a costly bill for the employment taxes you should have been withholding and paying.

The Common Law Test:

IRS examiners use the 20-factor common law test to measure how much control you have over the worker. These factors are reflected on IRS Form SS-8, (this form can be downloaded at www.irs.gov) “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.”

You can fill out the SS-8, including the facts of your relationship with the worker, and submit it to the IRS to get a determination of whether the worker is your employee or not.

However, many companies simply use the SS-8 as a self-audit to avoid a misclassification trap; they don’t actually submit the form to the IRS.

Of course, many workers — the IRS estimates as many as 85% of all Form SS-8 filers — submit the form to the IRS because they want to contest their treatment as independent contractors.

But the issue of who has the right to control is often not clear-cut, and the Tax Code doesn’t define “employee.” So, the IRS developed the “20-Factor Test” to arrive at an answer. The IRS later refined this test—it added four new, critical factors and added more weight to some and de-emphasized others in the original 20. You don’t need to have all the factors in your favor to be able to treat a worker as an independent, but you are more likely to pass the common law test if the more important factors point to independence.

According to the manual the IRS uses to train its worker classification auditors, the three most important factors are:

Instructions to workers: Your worker is probably an employee if you require him or her to follow instructions on when, where, and how work is to be done. This is a very important factor. However, if you tell your electrician you want blue switch plate covers instead of white, you are not exercising control to a degree that would make the person an employee.

Job training: If your company provides or arranges for training of any kind for the worker, this is a sign you expect work to be performed in a certain way; therefore, the worker is your employee.
Training can be as informal as requiring the worker to attend meetings or work along with someone who’s more experienced.

Worker’s ability to make a profit or suffer a loss: An employee may be rewarded, disciplined, demoted, or fired depending on job performance, but only an independent contractor can realize a profit or incur a financial loss from his or her work. In other words, an employee will always get paid; an independent contractor, however, has a financial stake in his enterprise.

IRS also gives high priority to the following factors:

Intent of your company and of the worker: To build a solid case, you and the worker should sign a written agreement stating the worker is an
independent contractor who will be paid by the job or project, provide his or her own tools, etc.

Pay basis: If you pay a worker on an hourly, weekly, or monthly basis, the IRS will consider it a sign the worker is your employee. An independent is generally paid by the job, project, assignment, etc., or receives a commission or similar fee.

Benefits: Providing benefits other than pay are a strong indicator of employee status. Incorporated status: Workers who are incorporated are generally considered to be working for themselves, not as your employee.

Importance of the worker’s services: If a worker provides services that are integral to the success of your business, the worker is likely your employee.

Personal performance of services: An independent contractor should have the freedom to hire assistants or subcontract work to other workers or firms at his or her expense (this is where profit or loss could enter the picture). If you require the worker to perform the work personally, that’s a
sign of control and therefore indicative of employee status.

Providing assistants: There’s likely an employer-employee relationship if your company hires, supervises, and pays assistants for the worker.

Ongoing relationship: The worker doesn’t have to work for you continuously to be considered an employee; it may be enough if the worker gets assignments at frequently recurring, even if irregular, intervals.

Setting the order or the sequence of the work: If you determine what gets done when, it indicates you control how the work is performed. Allow an independent to decide his or her schedule, both day-to-day and for the longer term.

The Reasonable Basis Test:

While the common law test looks at the nature of the working relationship, the reasonable basis test is based on how the courts and the IRS have classified similar workers in your company or your
industry in the past.

The reasonable basis test is considered a “safe harbor.” That is, if you can show you had a reasonable basis for treating a worker as an independent contractor, the IRS is prohibited from
reclassifying the worker as your employee either prospectively or retroactively. You have a reasonable basis for treating a worker as an independent if one or more of the following conditions exist:

A court ruling in favor of treating workers in similar circumstances as non-employees; A ruling by the IRS (usually a Revenue Ruling) stating that similar workers are not employees subject to employment taxes;

An IRS Technical Advice Memorandum or Private Letter Ruling issued to your company, indicating that the particular worker isn’t an employee;

A past IRS payroll audit that didn’t find workers in similar positions at your company to be employees; or

A longstanding, widely recognized practice in your industry of treating similar workers as independent
contractors.

When hiring anyone, consultation with an attorney or a CPA or both is highly recommended. This article is intended for educational purposes only.

Employees: Friend or Foe?


Protecting the company’s customers, confidential and proprietary information

It should be no surprise that “business governance” is not just about the relationship between the business owners. It also includes the employment relationships including the relationship between the company and its consultants.  Employment relationships are typically documented in the following types of agreements: basic employment agreement, executive level employment agreements, indemnification agreements, independent manager agreements, non-compete agreements, non-solicitation agreements, and employee handbooks.

Remember that from a tax perspective failing to properly treat an individual as an employee (and instead treating them as an independent contractor) can have dire consequences. The I.R.S. follows a 20-part test (see appendix “a”), for determining whether one should be considered an employee or a contractor. If they’re deemed an employee you may be subject to numerous state and federal tax filings, penalties, and other fees from agencies such as the I.R.S., Department of Labor, and Worker’s Compensation Board.

For instance, I had a client who hired someone as an independent contractor. That contractor was driving a company vehicle when he got into a car accident that totaled the vehicle as well as injuring the contractor. The injured contractor filed a claim with the worker’s comp. Board which triggered an audit of my client’s company. The worker’s comp board fined my client $18,000 for not having workers compensation insurance (required if you have employees), and as I write this we’re battling with the Worker’s Compensation Board over whether the injured worked is indeed a contractor or whether he should be deemed an employee and therefore covered under Worker’s Compensation Insurance. Because my client’s company does not have Worker’s compensation insurance, if the individual is deemed an employee, my client, not just his company, might be personally responsible for paying the fines and other fees associated with this legal battle.

Some factors courts will consider in determining if an individual is a true independent contractor vs. an employee are: (1) does the individual have control over their own schedule (2) are they getting paid a flat fee or an hourly fee (3) the level of autonomy in how the individual performs the work. It sounds like a simple test but it requires very careful analysis.

 However, documenting the employment relationship isn’t just about the potential tax and financial consequences. It’s also most certainly about protecting the company from the employee. For instance, one could argue that a company’s intellectual/proprietary property walks out the door every day when its employees leave the building. The information that is entrusted to a company’s employees is its lifeblood. All too often, however, start-up companies do not do enough to protect their own intellectual property or customer goodwill after their employees leave the company, or even leave the building.

Unfortunately, some companies take a superficial approach to this critical issue. Many emerging companies use a standardized offer letter and intellectual property agreement, focused on non-disclosure of information, assignment of inventions, and, in some instances, non-competition and non-solicitation restrictions. As a starting point, this may suffice, but planning and vigilance are necessary to ensure that companies are in an optimal position to enforce such agreements down the road.

Companies should give careful thought to tailoring restrictive agreements to particular employees or job classes, rather than using a boilerplate agreement provided to many categories of employees, as a more focused, narrowly tailored agreement is more likely to be enforced in court. In short, one size does not fit all.

Companies should also consider defining what they consider to be “competitive” activity rather than simply barring employees from joining any employer that “competes” with the company. Being more specific, especially in the context of restrictive covenants, will only benefit you as an employer.

Companies should also give careful thought to defining what they consider to be confidential, proprietary information, beyond the typical (and important) boilerplate about “inventions and developments, customer lists, business plans, etc.” For the same reasons as above, specific is terrific.

Companies should be mindful of using a “one-size fits all” strategy when they have locations, employees, or independent contractors in different states. Non-compete agreements for California employees will not be enforced to the same extent as non-compete agreements for New York employees. State law can vary significantly with respect to these matters. As a result, companies must consider using agreements tailored to the specific laws of the states in which they have employees. This tends to concern many of my clients because they view the non-compete agreement as their only recourse in the event an employee steals confidential information, solicits customers, or does anything else to that effect post-employment.

But there are numerous other remedies available. If a high-level employee leaves your company and then starts a competing business using stolen or proprietary company information, you could still have claims for unjust enrichment, unfair trade practices, conversion (stealing), in addition to a breach of contract claim.

Companies should also be careful about the process by which these agreements are signed. For instance, when a company fails to have a new hire sign a non-compete agreement at the time the employee is hired, then there is a significant argument that the non-compete agreement is not enforceable because of lack of consideration. This can be true even where an employee signs the non-compete agreement just a week after being hired! When imposing a restrictive agreement such as a non-compete agreement, upon the employee, you want to make sure that there is sufficient consideration paid to the employee so that such an agreement is deemed enforceable.

Ultimately, when attempting to enforce a restrictive agreement in court, the company will be arguing that its confidential information is at risk based on the former employee’s actions; agreements should be drafted to maximize the likelihood that this argument will be accepted.

So, other than the points noted above, what are some things a company can do to ensure enforcement of restrictive covenants and protecting valuable proprietary or confidential information? Here are a few steps you as a business owner can take:

  • Regular dissemination of a confidentiality policy,
  • Regular dissemination of updates to employee handbooks.
  • Education and training of employees on intellectual property issues,
  • Restricting access (via passwords, locks, etc.) To sensitive information to those employees who need such access,
  • Labeling confidential documents (both hard copy and electronic),
  • Create an exit process (a termination process) such as the consistent use of a termination checklist that reminds workers of their obligations under existing policies and agreement.
  • Create an exit process that ensures the company immediately collects company property such as laptops, storage media (discs, drives) and hard copies of documents. If the company has any suspicions about the outgoing employee’s conduct and/or intentions, immediate consideration should be given to actually investigating the employee’s computer-related activities prior to his or her departure.
  • In many instances, retention of a third-party data recovery expert may be advisable both because of the technical challenges involved in investigating electronic activity and because of the need to preserve evidence of that activity,
  • Consider implementing an ip protection process such as communicating to your former employee and his or her new employer about the existence and continued applicability of the employee’s restrictive covenants and the company’s expectations about compliance with those promises.

Taking all of these steps will significantly improve a company’s chances of protecting its intellectual/proprietary property especially following a valued employee’s departure.

Establishing an employment protocol

Generally, most employees are employees-at-will meaning they can be fired for any reason or no reason at all so long as those reasons aren’t discriminatory.  However, problems arise when the employer’s reasons for firing an employee are not properly documented and the employee later returns as a disgruntled employee using one of the big law firms as the method of squeezing out a few (or much more than a few) dollars from you the employer under the fair labor standards act (FLSA) and other similar statutory bodies of law.

I have a client who purchased a business and then months after purchasing the business fired an older (70 year old) independent contractor. The former contractor brought an age discrimination claim against my client’s company under New Jersey law (which even permits age discrimination claims from independent contractors). In hindsight my client should have offered a severance agreement, paying the independent contractor in exchange for what is basically a “do not sue the company” agreement. My client’s arbitration fees will be at least $20,000.00 based on the American Arbitration Association fee schedule.

The solution to creating strong employment contracts is not as difficult as most business owners think and it is always worth it. Yes, it requires some organization and some systematization in your employee monitoring, hiring and firing processes, but the results mean less chance of being exposed to a baseless or frivolous lawsuit that will cost you tens of thousands of dollars and the risk of a possible judgment. We get into some of these processes in greater depth in the sections below.

Document your employee’s performance

Documenting your employee’s performance on a monthly or quarterly basis is a simple process. It means keeping a record of the positive and negative things that stand out in the employee’s performance, recommendations for improvement, and even making note of certain goals you want the employee to achieve with respect to his or her performance. There is no specific format. Rather, the key is being systematic about your process and making sure that your employees are aware that they are subject to performance reviews which can effect their (1) hours (2) compensation or (3) employment status – both positively or negatively.

Making your employees aware that they are subject to a performance review on a monthly or quarterly basis can also lead to more positive result in their performance. For instance, implementing an employee review process that otherwise effects their bonuses or other forms of compensation is an incentive for them to improve themselves and become a more valued employee for your organization. 

In addition, having a process where you keep track of employee performance helps you as the employer identify who your most valued employees are or whether they are objectively entitled to receive bonuses, increased compensation or promotions. More often than not, small business owners make decisions about their employees from an emotional or sympathetic viewpoint rather than one based strictly on a quantifiable and documented process. It’s not about emotions, it’s about business and creating a productive and rewarding culture for your employees within your business.

Document your employee’s time

When you’re dealing with worker’s compensation claims or overtime hours claims, the key to a successful defense is documenting your employee’s time to the minute. It’s not a difficult problem to solve. Use time cards, and make sure your employees sign their time cards at the end of each day.  And to any business owner “sharing employees” with another business they own, I especially caution you against doing that.

If your employees work remotely, have them log in at the end of each day in an easy to integrate time-tracking system or have them email your manager at the end of each day with a log as to where they were, during what time periods, and when they ended the day. Overtime claims are an incredibly easy claim to defend if you have the proper documentation. Unfortunately, many employers neglect simple documentation procedures which can save them tens of thousands of dollars in litigation costs.

Document and memorialize your employee’s termination 

Finally, when you are making the dreadful (or relieving decision) to terminate an employee, regardless of the level of their employment, you want to make sure you do and have the following:

1. Have a proper termination/exit interview with a proper managerial witness from your staff (if possible) outlining the reason for the termination or suspension

2. Have the employee sign a release and severance agreement

3. Provide a termination letter to the employee outlining in simple terms the basis for the termination and the next steps.

The above tasks may on some level sound mundane, however if they mean saving you 10, 20 or 100,000 dollars, then why not make it a part of your day to day practices?

Is Your Proprietary Information Safe?

One could argue that a company’s intellectual/proprietary property walks out the door every day when its employees leave the building. The information that is entrusted to a company’s employees is its lifeblood. All too often, however, start-up companies and small businesses often do not do enough to protect their intellectual property and customer goodwill after their employees leave the company, or even leave the building.

Unfortunately, some companies take a superficial approach to this critical issue. Many emerging companies use a standardized offer letter and intellectual property agreement, focused on non-disclosure of information, assignment of inventions, and, in some instances, non-competition and non-solicitation restrictions. As a starting point, this may suffice, but planning and vigilance are necessary to ensure that companies are in an optimal position to enforce such agreements down the road.

Companies should give careful thought to tailoring restrictive agreements to particular employees or job classes, rather than using a boilerplate agreement provided to many categories of employees, as a more focused, narrowly tailored agreement is more likely to be enforced in court. One size does not fit all.

Companies should also consider defining what they consider to be “competitive” activity rather than simply barring employees from joining any employer that “competes” with the company.

Companies should also give careful thought to defining what they consider to be confidential, proprietary information, beyond the typical (and important) boilerplate about “inventions and developments, customer lists, business plans, etc.”

One Size Does Not Fit All

Companies should be mindful of using a “one-size fits all” strategy when they have locations, employees, or independent contractors in different states. Non-compete agreements for California employees will not be enforced to the same extent as non-compete agreements for New York employees. State law can vary significantly with respect to these matters. As a result, companies must consider formulating agreements tailored to the specific laws of the states in which they have employees.

Companies should also be careful about the process by which these agreements are signed. For instance, when a company fails to have a new hire sign a non-compete agreement at the time the employee is hired, then there is a significant argument that the non-compete agreement is not enforceable because of lack of consideration. This can be true even where an employee signs the non-compete agreement just a week after being hired!

Ultimately, when attempting to enforce a restrictive agreement in court, the company will be arguing that its confidential information is at risk based on the former employee’s actions; agreements should be drafted to maximize the likelihood that this argument will be accepted.

So, what are some things a company can do to ensure enforcement of restrictive covenants and protecting valuable proprietary or confidential information? Here are a few steps you as a business owner can take:

  • Regular dissemination of a confidentiality policy,
  • Education and training of employees on intellectual property issues,
  • Restricting access (via passwords, locks, etc.) to sensitive information to those employees who need such access,
  • Labeling confidential documents (both hard copy and electronic),
  • Create an exit process (a termination process) such as the consistent use of a termination checklist that reminds workers of their obligations under existing policies and agreements.
  • Create an exit process that ensures the company immediately collects company property such as laptops, PDA’s, storage media (discs, drives) and hard copies of documents.

    If the company has any suspicions about the outgoing employee’s conduct and/or intentions, immediate consideration should be given to actually investigating the employee’s computer-related activities prior to his or her departure.

  • In many instances, retention of a third-party data recovery expert may be advisable both because of the technical challenges involved in investigating electronic activity and because of the need to preserve evidence of that activity,
  • Consider implementing an IP protection process such as communicating to your former employee and his or her new employer about the existence and continued applicability of the employee’s restrictive covenants and the company’s expectations about compliance with those promises.

Taking all of these steps will significantly improve a company’s chances of protecting its intellectual/proprietary property especially following a valued employee’s departure.

Need to Protect Your Company’s Intellectual Property?

Are you a business based anywhere in the Westchester County of New York, and surrounding counties, and need help with securing some of your company information? Feel free to contact Attorney Jeffrey Davis, a Westchester business attorney who has vast experience in the registering and protection of intellectual property and the drafting and review of relevant IP documents and contracts.