Should You Use a PEO?

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For HireWe often discuss the challenges that entrepreneurs face that don’t have anything to do with why they got into business in the first place.  Important but not necessarily thrilling topics like deciding between cash and accrual accounting or which financial ratios are best to understand your business don’t often move the needle for most entrepreneurs.  If HR is another one of those non-desirables topics for you, it might be worth investigating if a Professional Employer Organization (PEO) makes sense for your business.

A Co-Employer

You might have seen HR software that helps with a lot of the necessary paperwork that comes with having employees.  A PEO takes that one step further, by essentially sharing liability with you as a co-employer.  PEOs are most frequently used by small to medium sized businesses with as few as ten employees to as many as 300.  A PEO can handle:

  • Onboarding
  • Benefits administration (health, investing, etc)
  • Payroll and employee tax compliance
  • Leaves of Absence/PTO
  • Standard employee paperwork, like
    • Workers’ compensation
    • Unemployment insurance claims
    • OSHA compliance
    • COBRA

PEOs have to constantly keep abreast of new state and federal regulations so that’s something else you won’t have to worry about.  By actually being the employer of record for your team they are able to use economies of scale to get good deals.

Some PEOs even help you with sourcing and hiring talent.  This frees you up to focus to just:

  • Create job descriptions and determine pay
  • Manage and develop your team

It is said that companies that use PEOs have 10-14% less employee turnover, though that stat does come from their national association, so take it for what you will.

Cost and Downsides

Less paperwork?  Sounds wonderful!  Where do I sign?  A few things to consider first.

Cost

There are hundreds of PEOs operating in the US at the moment and there’s no consistent pricing but some estimates offer:

  • 2% of salaried and 6% of hourly workers’ gross pay per month
  • $40-$160 per employee per month

Downsides

There’s not a lot of flexibility within PEOs for customization.  They choose the third parties they deal with (again, benefitting from their economies of scale) and if you don’t like the choices you have in health care or investing, you don’t have alternatives other than going to another PEO.

It’s also inconvenient to cancel working with a PEO during a calendar year as you will then trigger multiple W-2s and tax forms as you move away from them as the employer of record and start with another PEO (or revert to your company being the employer of record).

There’s also the cost of a PEO itself, but often people move to one precisely because it’s less expensive (and less concern) than having a full-time HR person.

What to Consider

There is obviously a lot to consider in essentially partnering with a company to handle HR functions, but there are four issues we think are most important:

  1. Ask for references, particularly in your industry.  You want to know what the experience of someone in your field has been like with this particular PEO.
  2. Find out if the PEO you are looking at has independently audited financial statements.  There’s a lot to keep track of when your business is managing employees in multiple businesses across multiple states.
  3. Speaking of states, make sure that the PEO meets all the requirements your state has in place for such organizations.
  4. If you want to get really fussy, there’s a self-identifying IRS certification that only a small percentage of PEOs attain.  People who voluntarily do more paperwork for the IRS?  These are not people afraid of paperwork!

Are you thinking of using a PEO as part of growing your business or getting it ready for a sale?  Want a second opinion as to whether it makes sense for you?  Give us a call!

Case Study #49: Dream Water, Dream Exit

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Dream WaterDavid Lekach knew when he started Dream Water that he wasn’t just building a product, he was building a category.  Thankfully, there was a preexisting product that had blazed a concept and delivery method that everyone understood: 5 Hour Energy’s little bottles were everywhere and people knew what they were used for.  Dream Water wasn’t going to give you more energy, in fact, it was going to help you go to bed, but it was in that same familiar 2 ounce bottle.

The story started with a friend who had developed a 1.0 iteration of what would become Dream Water and a small group of collaborators backed with funds from friends and family.  While the initial investment in Summer 2009 was just around $1,000,000, Dream Water would go on to raise a total of $6,000,000 as they ramped up sales and production: David and his family retained roughly 55% of the equity in the business.

Ingredients

Dream Water is lightly flavored water with three active ingredients:

  • 5-HTP, also known as oxitriptan
  • GABA, which causes calming and sedative effects in the nervous system
  • Melatonin, which increases in the body as it’s exposed to darkness

Product Placement

While it was perfectly natural to get an energy shot at a gas station or convenience store, David figured that if people had trouble sleeping, they would probably go to a pharmacy, so he partnered with a famous New York pharmacy called Duane Reade.  The launch was only three months in when Walgreens announced an acquisition of Duane Reade, and now the team was faced with not just a local or regional rollout, but a possible nationwide rollout.

Interestingly, David figured early on that it wasn’t just about getting Dream Water placed in the right section of the “sleep aids” aisle in a pharmacy, but also about getting in the impulse areas, a place where 5 Hour Energy was dominant.  As he worked with various retailers, he would simply ask to have one of his boxes in the place of the fifth or sixth flavor of Five Hour Energy.  Those retailers gave Dream Water a shot and the sales validated the strategy.

The Wal-Mart Effect

David’s strategy of convincing retailers to allow the product to show in impulse areas worked consistently, and as such he used the small wins he had at various regions of Wal-Mart to give him a shot at national rollout in the impulse areas.  But unfortunately, Dream Water got placed at the very bottom of the rack (instead of at eye level) and didn’t get much traction, and once you’ve been pulled out of the impulse rack after a quarterly review, it’s very tough to get back in.  This caused a big drop in sales and demoralized David for a while.  

But he didn’t feel sorry for himself for too long, because he got an unsolicited term sheet from his Canadian distributor.

Scale Matters

The distributor in Canada wanted to get his COGS down so that he could scale the business but he couldn’t do so without some better deal, possibly a licensing arrangement, with Dream Water.  But the distributor leapfrogged a licensing deal and offered an acquisition instead.  

It was late in the calendar year and David was really focused on growing the company and hadn’t even considered a sale, so he decided to have a very tight deadline in place when the Letter of Intent was signed on December 15th.  He told the distributor that he had 60 days to close the deal and he wanted $200,000 up front, in part to defray the accountants and lawyers he would need to hire help with diligence, but in part to move forward on a licensing deal if the sale couldn’t close.

February 15th arrived and the distributor called asking for more time.  David said that he was okay with the deal not happening and moving onto the licensing track.  The buyer did not want to go that way.  David demanded another $100,000 for a 30 day extension, and said he would charge that every 30 days.  This was not a deposit on a future sale, it was simply a “late fee” of sorts.  It’s an unusual tactic but the buyer accepted it and paid it, and paid it again when the next 30 days elapsed and the deal wasn’t done, and one more time at the beginning of May.  Part of the reason that the deal was taking longer was the fact that the distributor had brought in a much larger partner (a publicly-traded company, it turns out) to help fund the acquisition.

Publicly-Traded Buyer

On May 3rd the buyer was required by law, since it was a publicly-traded entity in Canada, to publicly disclose any acquisitions a month before closing.  With the end of the deal finally in sight, David again charged his $100,000 “fee,” in part now because the buyer sold, among other things, cannabis, and he didn’t know how that would affect his relationships with the US retailers, including family-friendly Wal-Mart.  The acquisition could now have an adverse downstream effect.  But, despite those concerns, the sale closed, at $34.5M CAD (which was around $27M USD at the time) and thankfully, all the retailers stayed on.

Lessons Learned

As always with these case studies, we have a few takeaways:

  • Keep your options open.  David wasn’t looking for a sale, but when an opportunity came, he was willing to develop it.
  • Be willing to walk away.  David said, and believed, that he was happy to move on with a licensing deal.  That attitude only strengthened his negotiating position.
  • Know what the buyer wants.  David knew after the original 60 days had passed that the buyer wasn’t interested in a licensing deal, but really wanted to buy the company, and hence he used that knowledge to his advantage.
  • Don’t be afraid to ask.  We don’t often see sellers simply levying non-offsetting fees on buyers because the deal is taking longer than usual.  But David saw that he was taking a significant amount of time away from Dream Water to work on the deal and he wanted to be compensated for that, as well as to de-risk himself somewhat if the deal ended up not happening.  The worst thing a buyer can do is tell you “no”.

Have you gotten an unsolicited offer for your business?  Don’t trust that you’ll be able to pull off the unusual feat that David did.  Instead call a broker.  We’ll help you navigate the situation.

The $15/Hour Minimum Wage Debate

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A provision to gradually increase the federal minimum wage to $15/hour was recently removed from a budget reconciliation bill in Congress.  While that pay increase doesn’t look like it will be coming at the federal level this year, the debate around the topic isn’t going away and has already led companies like Amazon and Target to announce their own moves to at least $15/hour for all new employees.  In the same vein, the State of California has announced a state minimum wage of $15/hour effective January 2022.  Whatever the starting pay is for your employees, you should know and understand the talking points of this debate.

Stats and Guesses

As part of the legislative process, the Congressional Budget Office (CBO) put out some projections on the effect of the move toward $15/hour:

  • The cost to the government would be $54 billion dollars over a ten-year period
  • 30 million Americans would get a pay raise
  • Of those 30 million, 900,000 would be lifted out of poverty
  • Possible job cuts as a result of this could be close to 1.4 million workers (.9%)
  • Labor costs/Purchasing power (depending on your perspective) would increase by $333 billion over the same ten-year period

While the CBO is a nonpartisan body, that doesn’t shield them from criticism, and these numbers received their fair share of disagreement from both sides of the aisle.  What is clear already is that more than 29 states have minimum wages that are higher than the federal minimum wage, which was last adjusted in 2009 to $7.25/hour.

Your Business

We’ve talked before about different ways to financially reward employees and why hiring for cultural fit is an important part of making sure that your team isn’t only money motivated.  While not every business has the resources to simply double starting pay, and while the vast majority of our clients don’t have a single team member on minimum wage, it’s important to realize that such a dramatic change will affect everyone and every business.  Questions you should be asking include:

  • Do any of my key vendors employ minimum wage workers?  Have they forecast how our prices would change if that minimum wage would change dramatically?  Do I have contingency plans in place in case they decide to cease operations?
  • Using answers from the first set of questions, how would you deal with increased costs?  Would you pass that on to the customer?  If so, what percentage?  How does your business change as a result?
  • How closely are the lowest-paid members of your team compensated in relation to the minimum wage?  What adjustments would you need to make to their salaries as a result?

Sometimes we can forget that changes we don’t think will affect us or our businesses will indeed affect us and our businesses, and in profound ways.  Rather than passively wait for changes to occur, the best business owners proactively attack challenges before they become problems.

Are you and your team happy with the compensation plan you have in place?  Have you thought about that plan in relation to a possible future sale?  Give us a call to talk about it.

Crowdfunding Basics

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CrowdfundingWhile we have been speaking about SBA and PPP options to get businesses through the challenging period of Covid-19, there is an additional type of funding that might interest some business owners who are looking to grow in the months and years ahead: crowdfunding.

While most people have become familiar with the principle of donation crowdfunding via websites like Kickstarter and Indiegogo, and debt crowdfunding via Lending Club and Prosper, many are unaware that the 2012 Jobs Act signed by President Obama got the ball rolling for equity crowdfunding.

Equity Crowdfunding

Equity crowdfunding is exactly what it sounds like: giving up equity in your company to people from the general public who are interested in funding you.  While the legislation was passed in 2012, it wasn’t until 2015 when the SEC adopted final rules for equity crowdfunding that platforms eager to help business owners could really get going.  

By making sure that crowdfunding backers were actually purchasing securities, the SEC de-risked both sides of the equation: business owners couldn’t just put up any project to get funded, and potential investors were given full risk disclosures so they couldn’t complain later on that they didn’t know what they were getting into.

Pros

Using equity crowdfunding, business owners can obtain funds they need for no credit or collateral.  They will sometimes get enthusiastic ambassadors for their company in the persons of the investors.  Studies also show that equity crowdfunding tends to skew local and regional, so that also means there’s often a community connection with these backers.

Investors have the chance to invest in small and medium sized businesses without having to earn the title of “accredited investor.”  They get to be involved, even if it’s in a small way, with a small business, and they have many different industries they can choose from.

This doesn’t mean there aren’t downsides to raising money this way.

Cons

For investors, the wait for a return on their investment can be longer than they are used to, particularly if they have mostly spent time in the stock market, where ups and downs can be more easily tracked and, sometimes, understood.  The securities are also illiquid, as there isn’t (yet) a secondary market for these shares.  Finally, investors can still get quite diluted, especially if the business decides to go on for angel or venture funds after a successful crowdfunding raise.

There are downsides for business owners too.  Firstly, a crowdfunding campaign is precisely that: a campaign.  You’ll need to put together media, collateral, and a clear message as to why you need these funds and what kind of return can be expected.  That takes time and money.  Of course, too, there’s the reality that you are giving up parts of your business, which, even if you’ve only made it a small percentage, will still come with certain legal compliance costs.

Platforms

The equity crowdfunding market is still pretty new so there is no Google or Amazon in the space yet.  Websites like WeFunder and Localstake offer minimum investments in projects as low as $100 and $250, respectively.  Localstake even has some sophistication in their equity crowdfunding, offering revenue shares, convertible debt, or preferred equity as options.

Other sites, like Crowdfunder and Fundable, are simply advertising platforms and don’t serve as a medium for transactions.  Investors make nonbinding pledges and transactions happen offline.  Fundable even offers help (paid, of course) with your pitch construction and prospectus.

Choice 

While we’ve spent most of this article discussing equity crowdfunding, the reality is that businesses are still free to use donation crowdfunding instead.  Those businesses can gauge customer interest in a new product by creating a crowdfunding page for it and if existing or potential new customers “vote” enough for it by prepaying, you can have the confidence to move forward, as you’ve essentially created a fully funded purchase order.  

Crowdfunding isn’t for everyone, either on the investor or business owner side, but there have been some good success stories so far.  This book chronicles twenty case studies if you’re looking to learn more about the field in general.

Are you unhappy with your banking relationship or are you looking for some alternative funding options?  Give us a call: we’d love to connect you with the right people.