Using an employer of record to transfer employees in a cross-border M&A carve-out deal

Many of these M&A transactions are carve-outs, in which employees may be included in the deal. If the acquiring company already has a legal presence in the target country, transferring the employees can be relatively simple. 

But if the buyer does not have an existing legal entity in the target country, the deal can get complicated quickly. Due to time constraints, many companies consider using an employer of record, or EOR, to transfer acquired employees in a timely manner. An EOR is a third-party organisation that acts as the legal employer of the acquired employees on behalf of the buyer while also fulfilling the employees’ tax, benefits and other local compliance obligations as soon as the deal closes. The EOR arrangement may remain in place for months — or in some cases a year or more — while the acquiring company investigates permanent options, such as establishing a local subsidiary or branch.

“An employer of record is a good solution in an M&A carve-out where the buyer does not yet have a legal entity in place,” says Charlotte Hultman, Global Sector Head, Corporates at Vistra. “It lets the new company set up operations right away while providing stability for the acquired employees.”

The rush to close a deal

M&A deals are complex and have strict deadlines. A legal means of transferring acquired employees must be in place in order for a deal to close, but often the buyer doesn’t have enough time to establish a legal entity in the target country.

Setting up an entity can take weeks or months, depending on the location. Across the globe, Know Your Customer (KYC) laws have lengthened the time it takes to open a bank account, a prerequisite for establishing an entity. In other parts of the world, multiple government agencies must approve a business application. In Brazil, India, China or Singapore, a wait of six months is not unusual.

“In a merger, both parties want to close the deal, but they can’t wait six months,” says Onno Bouwmeister, Global Sector Head, Private Equity at Vistra. “The buyer can set up an EOR, and at the same time, start the process for creating a legal entity where the employees will eventually be transferred.”

Sometimes buyer and seller negotiate a transition services agreement (TSA) in which the seller agrees to manage HR, payroll, benefits and other mandates for a set period after the closing. This is unusual, however, as sellers typically wish to move all assets, including employees, on closing. Even when a TSA can bridge a temporary gap, setting up the new legal entity often takes longer than buyers anticipate.

“It’s not uncommon for a TSA to last 90 days, and I’ve seen clients go back to the seller and say, ‘We need more time; can we keep you on longer?’” says Saul Howerton, Vice President, Advisory at Vistra. 

Again, sellers are not always receptive to such agreements. “They usually want to end their liabilities as soon as possible,” says Bouwmeister.

In contrast, an EOR is expressly designed to manage its clients’ employment and benefits obligations where they don’t have a local legal entity. While some countries have time limits for EOR-type structures — in Germany, for example, it’s 18 months — they typically last much longer than a TSA. In some countries, if an office has a low employee headcount and doesn’t sign sales contracts, an EOR may be an appropriate solution for years. In most situations, however, an EOR is appropriate as a temporary solution.

Another tactic acquiring companies sometimes try is hiring acquired employees as independent contractors, but that process carries significant compliance and reputational risks.

“You may try to call them contractors, but as soon as you put ink to paper, you’re probably not compliant. If it went to the courts, they would probably say you’re an employer,” Howerton says.

Questions about the status of Uber and Lyft drivers have thrown the employee-versus-independent-contractor debate into the international spotlight and increased the scrutiny of contractor agreements by tax authorities in many countries.

Companies caught classifying workers incorrectly as contractors rather than employees may owe back payments and penalties for not having contributed to social security, holiday pay and other legal entitlements. Even if local authorities don’t find out about worker misclassification, the arrangement may create ill will among workers, who in turn may notify the authorities themselves.

In some mergers, it is the seller who is using independent contractors inappropriately. “I’ve seen deals fall apart because of that,” says JP Gooch, VP of Vistra EOR Operations.

The bottom line is that hiring workers as independent contractors is a red flag in virtually all M&A transactions, and in many cases it’s unlawful. Both buyers and sellers in a deal involving transferred employees can avoid trouble by making an EOR a provision of the deal from the start.

Testing the waters

Building a bridge to a legal entity is not the only reason buyers use an EOR. Some aren’t sure whether the newly acquired office will be successful for their company. An EOR allows them to give it a try without making a bigger commitment.

“A company sometimes waits for six months before deciding whether they want to stay in the new market or not, and an EOR gives them that flexibility. If they decide on a legal entity, they will have to liquidate the company, which can be quite costly,” Hultman says.

Preparing for the future

An EOR is often the quickest solution for taking on employees in a cross-border M&A carve-out deal, but buyers must carefully consider the unique circumstances of each operation. If the office includes a large number of employees, or even a single contract-signing deal maker, creating a subsidiary may be the only option. Furthermore, not every country accepts EORs. Mexico, for example, recently passed legislation limiting the outsourcing of jobs to non-core activities.

Buyers should also think ahead to the post-EOR period, when the foreign office may not work as it did for the previous owner. For example, if a 12-person branch is carved out of a 500-employee company, insurance providers may not work with the smaller group, or may charge much higher rates. Some workers may feel uncomfortable at an organisation with a minimal in-country footprint, especially if the transition is rocky.

The sooner a company begins to plan for the post-merger future, the better the outcome will be. 

“The employment and ‘people’ side of a cross-border M&A deal is often overlooked,” Howerton says. “I would encourage companies to get advice from qualified legal and tax partners as soon as a foreign office is being considered so that everyone understands what’s needed to support it.”