What does the passage of AB 5 mean for your California business? The short answer is, it depends.
In its April 30, 2018 Dynamex decision, the California Supreme Court replaced the various factor tests (for determining whether an individual was an employee or independent contractor) with what is known as the ABC test. The California legislature recently passed AB 5, which to a large degree codified Dynamex.
A person should be classified as an employee rather than an independent contractor if providing labor or services for pay unless all three of the following are true:
A. The person is free from the control and direction of the hiring entity in connection with the performance of the work, both per the terms of the contract itself, and in fact.
B. The work performed is outside the usual course of business of the hiring entity.
C. The person is customarily engaged in the type of work performed as an independent trade, occupation or business.
Note that this is an all or nothing test- all three must be true, or the individual is an employee under the law. There are several exceptions to this general rule, each with its own requirements. In several instances where the new ABC test is exempted, the old rule under Borello is applied. Borello uses a ‘control of work’ test, which is loosely mirrored in “A” of the ABC test. Borello applies to most licensed professionals, while there are specific provisions for a wide variety of roles, from HR administrators to fine artists, and from cosmetologists to contractors licensed by the CSLB.
The characterization of a person as an employee affects the employer's obligation to carry workers compensation insurance, withhold and remit payroll taxes, and provide other worker protections required under the law. The potential cost of getting it wrong makes it worthwhile to take the time to talk with your business attorney before the law takes effect January 1, 2020.
 Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903
 S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341
Reading the 'fine print' on a multiple page contract can induce headaches in most people. That being said, as a business owner you will discover, if you have not already, that when things go sideways, the devil is indeed in the details.
Your expertise in the products or services provided by your business are your avenue to success. Arbitration clauses, indemnification provisions, and attorneys fees allocations are some of the things that only really matter when things go wrong. However, they are nearly always determined by what is agreed up front, when neither party to a contract wants to appear too nit-picky or to give the appearance of thinking things might later go wrong. Much like a prenup has to be drawn up in advance of the wedding when the parties have the leverage to negotiate, so attention to the boilerplate has to be given at the outset.
But there's a way to handle this that will ease the inherent tension that comes when working out the details of how to resolve a dispute long before any dispute can be visualized. Make your attorney the 'bad guy'- hand the proposed contract off to your counsel and they can do the work of reviewing it with your interests in mind, and by shoring up any weak provisions and ensuring fairness in the written agreement they can help ensure that you get what you intended from the agreement. Meanwhile you can continue to provide the excellent products or services that brought the other party to your door in the first place.
The three credit reporting agencies (Equifax, TransUnion and Experian) are making significant changes in response to a recent report from the Consumer Finance Protection Bureau (CFPB). These changes may impact the way a lender searches for information in order to accurately assess an individual applicant’s credit-worthiness.
The CFPB has focused on the credit reporting function due to historical difficulties with duplicative or mixed file reporting, dispute handling, and accuracy in reporting on public records data such as judgments and tax liens. Because inaccuracies can impact access to credit for consumers, and may also impact how much the consumer will pay for the credit they do obtain, the CFPB prioritized a review of the reporting/amalgamating process done by the credit reporting agencies.
Following the CFPB report, as of July 1, public records data will be excluded from consumer credit reports provided by the big 3 unless they meet certain criteria, including a minimum of personal identifying information, and courthouse visits of not less than every 90 days to update the records. It is expected that the vast majority of the existing records will not meet the new tests and will be deleted from existing reports.
What does this mean for lenders? Additional diligence may be required in cases where the existence of a lien or judgment would be critical to the credit decision. Of course, the value of such diligence must be weighed against the cost and time involved in obtaining it. The loan size, type, and other information known about the applicant will no doubt be factors to consider. A lender will be well advised to revisit its written policies and take steps to ensure consistency in this, as in all aspects of the provision of credit.
The Bipartisan Budget Act of 2015 includes some changes that may affect LLCs taxed as a partnership, and their members, beginning January 1, 2018. Existing LLC managers and members should take a few minutes to consider the impact on their company.
Key changes include: a) any adjustments resulting from an IRS audit will be made at the entity level rather than being passed through to members unless the LLC makes a push-out election; and b) the tax matters partner is being eliminated and replaced by a partnership representative, whose decisions are binding on the LLC and its members.
An LLC with 100 or fewer members and whose members do not include any partnerships, other LLCs, or trusts may elect out of the new rules each year on its return. It must notify all members, and must also provide the IRS with a list of all members and their tax identification numbers, including the shareholders of any S corporation that is a member (each S corporation shareholder counts toward the 100 member limit).
Practically speaking, LLCs should consult with their tax advisor regarding the LLC's eligibilty for, and the advisability of electing out. If electing out is appropriate, it is probably a good idea to establish some mechanism prohibiting a transfer of interest that would make the LLC ineligible in the future, such as one that would increase the number of counted members over 100, or would include a trust, for example.
In the event that the LLC can't or doesn't want to elect out, the LLC should decide in advance whether it will make the election to push out any adjustments (resulting from an audit) to members, whether the burden of any such adjustments should be borne by persons who were members in the year audited instead of the year the adjustment was made, and if not pushed-out, how the LLC payment will be funded.
The LLC should also consider the impact of the partnership representative's power to bind the LLC, including a discussion of indemnification of the partnership representative, and whether any other members should be permitted to participate in any negotiations with the IRS along with the partnership representative.
Like most of life, choices in the context of operating a business are not always as straightforward as one might like. Take, for instance, what happens as business starts to pick up. It's fantastic to see that more and more clients are lining up at your door, whether in a virtual sense or actual. The dilemma is that, unable to see the future, we can't know if that uptick in business is going to become an upward trending line on the sales volume graph, or a blip that is not sustained.
Things to consider at such crossroads include infrastructure such as warehouse space, larger offices, inventory strategies, and staffing.
Perhaps most challenging is the decision whether to add staff, and if so, how and when. Most employers actively try to avoid layoffs and reductions in staff, to avoid the financial impact, of course, but most also feel some sort of moral obligation to employees who perform their jobs well.
Some employers strive to avoid this issue by contracting with individuals as independent contractors rather than as employees. Whether they really qualify as independent contractors or not, the employer may feel that this designation gives the employer legal and moral 'cover.' Unfortunately, at least from a legal perspective, it does not.
Whether a person performing work for your company is an employee or an independent contractor is largely a question of law. You can (and should) have a written agreement with any independent contractors you contract with, but that won't protect you in the event that they really are classified as employees under the applicable law. If there are persons who are being paid as independent contractors to do work that is central to the operation of your business, they are likely to be reclassified as employees in the event of an audit or investigation. This is especially true if there are also employees performing the same types of tasks.
The potential risk of misclassification is pretty significant. Once one agency has identified a business for investigation, or one employee submits a claim (workers comp, wage and hour, etc), the various federal and state agencies will cross-report to each other, and this will result in multiple agencies investigating and possibly imposing fines or penalties.
The tests that will be utilized vary from agency to agency but the primary consideration is the “right of control” – or who directs the work. Other factors include the nature of the relationship (whether paid for a specific project or ongoing hourly or weekly pay); who supplies the instrumentalities/tools, place to work; whether the individual is engaged in their own business with other clients or works solely for your business; whether the person is supervised by someone at your company; and whether you have the right to terminate at will (if so, they are more likely to be found to be an employee).
California law is generally hostile to the independent contractor classification. There is a statutory presumption of employee status, and you as the employer would have the burden of proving otherwise. This is not to suggest that each arrangement to provide services is an employer/employee arrangement, just that you should proceed with caution, and perhaps the advice of your attorney, when it comes time to increase your production capacity.
During 2016, and heading into 2017, California employers have had to figure out to handle changes in the law such as the increase in minimum wage, the federal changes to the rules regarding exempt employees, and the Fair Pay Act, which requires equity in pay between employees of different genders who are in similar positions. As is often the case, there's more to each of these than meets the eye.
For instance, the recent amendment to the Fair Pay Act (Labor Code Section 1197.5) provides that an employee's prior salary cannot, by itself, justify any disparity in compensation, and expands the requirements of the Act to include employees' race or ethnicity, and not just gender.
As it relates to the new federal minimum for an exempt employee's salary, a California employer must consider both federal and state law to determine if they are in compliance. The Final Rule published by the U.S. Dept. of Labor, took effect December 1, 2016, requiring that to be exempt from overtime pay, the employee must be paid at least $913/week ($47,476 per year). Nondiscretionary bonus pay may be included in the calculation, up to 10% of the total compensation, and paid at least quarterly. Note that the employee's job must still meet the applicable 'duties test.'
California has wage orders for various occupations that vary; however, most require that exempt employees be paid at least twice the minimum wage. Currently that's no problem, because the federal minimum of $47,476 annually is greater than two times the minimum wage at 40 hours per week of $43,680 ($10.50 as of 1/1/17 x 2,080 hours/year). However, California's minimum wage is scheduled to increase periodically, and while the federal minimum is also set to adjust every three years based on a wage index, that index is a national measure, and it is very possible that the federal minimum will be overtaken by California minimums at some point.
The takeaway for each of these is that a employer may want to schedule periodic reviews of their compensation programs, which will not only help with compliance with laws, it will provide an opportunity to develop overall retention plans for key employees.
Sometimes a business owner finds that others want to use some aspect of their success, perhaps just the right to use a recognized name, or perhaps much more. In order to protect their intellectual property rights, the owner of the successful idea will need to establish parameters and restrictions on use. Because of the numerous and often expensive requirements for establishing a franchise, sometimes the agreement is called a license instead. Caution is advised at this juncture, because regardless of what that agreement is called, there may a different meaning assigned to it under the law.
What is the difference between licensing and franchising?
Licensing typically provides the right to use a name or a system such as software. Franchising involves the right to use the name, the business system, and the payment of initial and ongoing fees, and provides significantly more control of the recipient business to the franchisor than to a licensor.
The Federal Trade Commission (FTC) considers anyone who offers, sells or distributes goods, commodities or services to be involved in the sale of a franchise if they: a) have a trademark, name or other commercial symbol the recipient will use; b) provide significant assistance to the recipient in their method of operation; and c) charge a fee for their services (the “three leg test”).
A licensor may exhibit two of the three characteristics of a franchisor, but they may not control the business operations of the licensee. This is the key distinction between a license and a franchise, although others may also be important. A licensor will generally not provide the support or training that a franchisor would. In essence, the license simply allows the recipient to use licensed material or do something that would otherwise be in contravention of intellectual property law.
There are, of course, risks associated with granting someone the right to use one’s name, or mark. The owner of the business or idea who seeks to expand it may want to ensure that the parties who use their name represent a particular image to the public, and therefore may need the control that a franchise arrangement can provide. For instance, McDonald’s wants each store to provide the same products- same taste, same appearance, etc- regardless of whether that store is in Alabama or Alaska. Examples of non-profits using a franchise model include Catholic Charities, YMCA, Planned Parenthood and United Way. These non-profits benefit from the arrangement in that local control results in better funds generation and buy-in, and limits the liability of the franchisor for the actions of the franchisee, yet allows the franchisor to control many aspects of the franchisee’s operations, thereby protecting its reputation, and expanding the reach of the non-profit.
Franchising allows more control over the franchisee because the franchisor can control the quality of the operation and services delivered. A franchisor has the ability to stop a franchisee who is not representing the brand appropriately by its conduct. It is, however, more expensive and time-consuming to establish and maintain a franchise than a licensing agreement.
Why it matters
Franchising is governed and regulated by the FTC, in addition to state and local laws. The laws and regulations promulgated thereunder require a franchisor to create and file a franchise disclosure document (formerly known as a franchise circular), a comprehensive document including disclosure of financial information, pending litigation and other matters that would be important to a potential franchisee. Compliance with franchising laws is time-consuming and expensive. Failure to comply, even where innocent or inadvertent, may result in liability for damages, rescission, criminal penalties, civil fines, and the award of attorneys’ fees. If an agreement meets the FTC’s three leg test, it doesn’t matter what the parties call it, the FTC will call it a franchise. A licensing agreement falls outside the FTC’s purview, and is essentially a contractual arrangement, subject to the usual laws of contract.
A business plan isn't built from start to end. In fact, I recommend starting in the middle, moving to the end, circling back to fill in the missing pieces, and finishing at the beginning.
The last section you should write is the executive summary. Start with the goals and objectives- what is it you want to accomplish? Are you hoping to go public after some time, franchise the idea, or do you want to create for yourself a job doing something you love to do? Do you have a passion for service, or do you like having control of your own schedule?
Then comes the sometimes difficult task of researching market and financial data so that you can intelligently discuss the market for your product or service, what the competition is doing, why your pricepoint is appropriate and sustainable, and the basis for your financial projections- both how you have come up with projected sales, and what you are basing projected expenses on. Whether you are writing the business plan with an eye to obtaining funding, or simply to create a guiding document for the months to come, the process, while challenging, helps you make informed decisions about purchases, leasing space, hiring employees, and most important- whether to move forward with the business.
The resources for data will depend in part on the industry, your location, and whether you already have contacts from which you can harvest information. Often you will be able to get other business owners to talk with you, especially if they are not your direct competitors. An industry association is a good place to look as well. Accountants, consultants, and data collectors can provide data for a fee. There are some free sources for data listed at sba.gov. (https://www.sba.gov/blogs/conducting-market-research-here-are-5-official-sources-free-data-can-help)
There are also some great sources of ideas for your business plan, such as http://www.discoverbusiness.us/business-plans/#17. This page has an excellent breakdown of how to approach industry analysis, and more sources of free data.
The Business Plan
Some believe in luck, and others agree with Seneca, who said "Luck is what happens when preparation meets opportunity." If you want to build a successful business from scratch, you'll need a little of that luck - and a lot of preparation too.
Sometimes the business is born out of a hobby that grows beyond its natural bounds, and sometimes it is cut from whole cloth, freshly minted. Whether you are starting from absolute ground zero, or you have floated some test balloons and like the result, this is a good time to lay some groundwork.
Betting on the Come
We've spent quite a bit of time talking about buying what someone else has created. There are a lot of reasons why buying an existing business may be the best choice for you. There are also reasons why it may not.
Sometimes there just isn't an existing business that does what you want to do, or its culture, market position, price, or other characteristics make it an undesirable acquisition. There may not be financing available. Or maybe you just really want to build your dream from the ground up.
Whatever the impetus, there are some steps you can and should take to minimize your risk and to establish a good foundation for the fledgling business.
Take the time to write a business plan. Aside from being a tool for obtaining financing, or investors, it imposes on the creator the discipline of fleshing out the dream, describing it in concrete terms, and assigning number values to the grand scheme. This process will help you determine if you need to obtain any sort of licensing in order to operate the proposed business, will help you establish pricing, and allow for a more objective view of the competitive landscape in which you intend to operate.