Acqui-hire is different than acquisition in that the primary purpose of the transaction is to obtain the employees of another company, not the company’s technology, goods, or client base. Acqui-hire is beneficial for companies struggling to increase their talent pool through traditional hiring methods. An acqui-hire has many components a business owner must consider such as culture, financing, and office politics. Additionally, companies must consider the tax and legal implications of acqui-hire to be successful.
In an acqui-hire, the new employees are the most important asset, and many companies will pay a high price for each incoming employee. Some buyers will price the purchase “per head” and may pay up to a few hundred thousand dollars per employee. However, buyers should consider delaying payments to retain their new employees through performance-based earnouts, employee incentive pools, and equity clawbacks. The structure of these employee incentive packages determines the tax payments for the buyers and employees.
Acqui-hire transactions can be a combination of stocks and assets. The type of transaction will benefit the buyer and seller differently. The ideal balance to an acqui-hire structure includes payments that benefit the seller and incentivize the new employees to remain with the organization. Buyers will need to consider how the payments for the new employees will be categorized. Will the acqui-hires receive payments before or after the deal is complete?
Preferably, the seller’s employee compensation is classified as a capital gain, which has a lower tax rate than income compensation. Currently, the top income tax rate is 37%, while the highest capital gains rate is 20%. However, if the price is recognized as income, the buyer gets immediate deductibility. Negotiating payments is an art, not a science, and the buyer and seller must agree to a balance.
Payments to certain employees may be subject to “golden parachute” rules found in the Internal Revenue Code (IRC) section 280G. The portion of any payment equal to or greater than three times the employee’s average salary is subject to a 20% federal excise tax and cannot be deducted by the acquiring company. Congress enacted this provision in 1984 to discourage executives from accepting acquisition offers for personal gain that may not be in the best interest of their business or employees.
There are specific legal considerations that relate to an acqui-hire. In most cases, the buyer only wants the employees and may sign a release agreement to hire the seller’s employees after the deal. There may also be covenants required for those employees and the selling company’s intellectual property. In addition, there are legal procedures to consider for any employees who will not be continuing in the new company.
In California, Colorado, Oklahoma, North Dakota, Minnesota, and the District of Columbia, non-compete agreements are illegal. One exception is in the case of the sale of a business. Business owners should consult with legal counsel early in the process to draft enforceable non-compete agreements. There may also be a need for non-solicit, no-hire, and confidentiality agreements. These agreements are important to ensure the employees understand what they are allowed to share with the acquiring company. Employees who are not continuing with the buyer should also be required to sign non-compete forms to protect the organization from the loss of intellectual property or clients.
An acqui-hire may include retention contracts for the new employees to ensure they stay through the transition period. A 2020 study found 47% of key employees left within one year after an acqui-hire. Without these contracts, some employees may take their bonuses and leave at great expense to the acquiring company. Contracts can include incentive payments for employees who stay for certain periods of time or achieve certain milestones. These payments may be classified differently than standard income and therefore fall under different tax rules.
There are many factors to consider during the aqui-hire process. Business owners looking to use this strategy should consult with tax and legal counsel early in the process to ensure a smooth transaction. A successful acqui-hire is possible with adequate planning and benefits both the buyer and seller and their employees.