Choose the best exit strategy for your business

How to choose the best exit strategy for your business?

Every entrepreneur has one target in mind when starting their business, to grow and to be profitable in the long run. Many entrepreneurs start a business to multiply its and other stakeholders’ investment. It has been more common lately to see a company go thru an IPO or acquisition as an exit strategy. This blog will discuss how to choose the best exit strategy for your business.

As discussed in our blog, starting a successful business in an inflated economy, you have the opportunity to create innovative products or services to solve a problem that arises during hardship times. As an entrepreneur, you have the power to influence and change the current ecosystem by building a great startup. So why think about an exit?

How to choose the best exit strategy

Reasons why an exit strategy is needed

Many factors can contribute to an exit:

  • The business has been running at a loss for a while now
  • Legal reasons such as massive lawsuits
  • The demise of the owner (usually sole proprietorship)
  • Merger & Acquisition looks appealing
  • IPO to multiply investors’ money

What makes an exit a bad strategy?

A lousy exit usually involves poor strategy adaption. When a business owner decides to halt the business, choosing the right exit strategy is vital. Poor strategy management may cause financial losses and even steer the business brand away from its values. Business owners can choose the suitable method based on the business needs; every element of the strategy implementation is essential for a smooth exit process and optimizing business outcomes.

Most common exit strategies

There are a few exit strategies that we will discuss here. The most common ones are:

  1. Transferring the business to another family member or a neutral person
  2. Merger and Acquisition
  3. Business liquidation
  4. Bankruptcy filing
  5. Selling the company to a partner or an interested investor
  6. IPO (Initial Public Offering)

Exit Strategy 1: Transfer the business to a family member

Why choose this exit strategy?

As a business owner if you decide to retire, one of the most common ways to exit the business is by transferring to a family member. Business owners like this exit strategy as they are able to keep the business with family and pass it on from generation to generations to come.

Factors to consider when exiting this way.

It is prevalent to inherit a business from a family member. Usually, this type of business is more mature and established in the economy. The transferee should evaluate some factors before beginning the transfer. First of all, the soundness of the acquiring party. It is crucial to ensure the new owner has the mental and financial ability to take over the business and sustain its values and profitability. It can often become a challenge for both parties to have the same business practices mindset. Both parties should try to reach a common ground where the transfer can be done smoothly while ensuring the legal aspect of the transfer has been taken care of.

Exit strategy 2: Mergers & Acquisitions (M&A)

Why choose this exit strategy?

This M&A strategy is most common among startups and business owners. It can be a preferred strategy as the owner can set their terms, continue to hold control, and influence the price of the acquisition. 

Factors to consider when exiting this way.

There are two outcomes from this type of transaction: either businesses merge and maintain equal interest and holdings, or the acquiring party becomes the major stakeholder of the merged entities. When the latter happens, the appointed CEO will be from the acquiring side, and significant changes can be made to the structure and processes of the other company. This strategy requires internal and external expertise to complete each transaction area and weigh the outcome of such activity. Some of the crucial part that will decide whether to continue with the strategy is the projected profitability, the size of the debt, and any ongoing legal issues that might fail the purpose of the M&A transaction. More on this topic soon!

Exit strategy 3: Business Liquidation

Why choose this exit strategy?

Business owners are ready to liquidate their business and move to the next venture. This may sound very appealing to a business owner if the passion for the business is lost. If the entrepreneur does not have any family members or partners to sell the business to, then liquidating the business is the preferred stategy to exit.

Factors to consider with this exit strategy.

It may sound simple and easy, but it is critical to inspect and ensure you create a proper checklist for each business area. Liquidating a business translates to permanently shutting down the business, so it is essential to ensure the business values and brands stay positive in the market and that such a decision will be profitable. Business owners often seek external services to help analyze and compile the necessary data to adapt the exit strategy successfully.

Exit Strategy 4: Bankruptcy Filing

Why choose this exit strategy?

Almost all business owner tries to avoid this type of exit. Filing for bankruptcy often relates to the inability to sustain the business profitably while the level of unpaid debt is snowballing. To avoid being sued or the possibility of losing not only business but personal assets, many owners’ resorts to this avenue. It takes a thorough process to qualify for the filing.

Factors to consider with this exit strategy.

Business owners should weigh the outcome and the consequences so that it will appear beneficial for choosing this exit strategy. We recommend seeking professional services to advise and assist in consolidating the business for filing purposes. 

Exit Strategy 5: Selling the business to a partner or investor.

Why choose this exit strategy?

The exit strategy above is pervasive, especially among startups and small businesses. For example, many small entrepreneurs create business pages on social media such as Facebook to market their products and services. In time, the pages might have gathered a large number of followers, which might pique others’ interest in buying over the page with the acquired followers. It is easy for an interested investor to market their business with an established page with more significant followers by just changing the page’s name and other details while maintaining visitors’ traffic. 

Factors to consider with this exit strategy.

Suppose business owners wish to sell their business, especially the ones with established brands. In that case, they should carefully review the circumstances and potential loss of future profit by analyzing the company’s value at the time of the sale.

Sometimes, it will include a royalty income in the sale agreement. There are many angles to be looked into before effecting any deal to achieve the best outcome. 

Exit Strategy 6: Initial Public Offering (IPO)

Why choose this exit strategy?

An Initial Public Offering (IPO) is also a desirable exit strategy for entrepreneurs and investors. This exit strategy can substantially multiply the investment of private investors and business owners, making it very desirable.

Factors to consider with this exit strategy

Many factors can affect an IPO, such as market conditions can influence how profitable this exit strategy can be. Other reasons companies go for IPO include brand strength, liquidity, company success, and improved market valuation. We will write more on this strategy next week.

How can Startup Tandem help you?

As a business owner, you should partner up with a team that can help you choose the best exit strategy for your business and support you in the process that comes with it. All of these exit strategies need finance advisory and legal support.

The advisory team at Startup Tandem is available to help you prepare your company to achieve the desired exit. Startup Tandem advisory can help you value your company by using the discounted cash flow or LBO model and provide advice on any transaction to achieve the best exit possible for you and your investors.

Startup Tandem has developed a network of businesses and individuals that come together to help startups and small businesses. Reach out if you need referrals or if you need to discuss any of these exit strategies more in depth.

Avoid Expensive Employee Turnover

Avoid Expensive Employee Turnover

Avoid expensive employee turnover by improving your hiring practice

As a small business owner, you may not have a human resource department to guide you through the best recruitment, hiring, and retention practices. The process of recruiting for the same position comes with a significant cost attached to it. This blog will discuss steps to improve your hiring practices as a business owner. Avoid expensive employee turnover by improving your hiring process thru these steps below.

Avoid Expensive Employee Turnover
Avoid Expensive Employee Turnover

Human Capital is the Greatest Asset.

It does not matter what industry you are doing business in, retaining human capital is the most valuable asset in an organization. Employees are either interacting with customers directly or indirectly when creating products. Therefore, hiring the best candidate is the first step to avoiding the expensive costs that come with employee turnover.

Employee turnover can get expensive

During the replacement process of an employee, a business loses time and a tremendous amount of money. The Society for Human Resource Management (SHRM) reported that “on average, it costs a company six to nine months of an employee’s salary to replace [them]. Let’s consider an employee making $60,000 annually; replacement fees come to $30,000 – $45,000 in recruiting and training costs.”

You may have many reasons to let go of an employee or for them to quit. Still, hiring the right person aligned with your company’s culture and values is the most important thing you can do as an employer to avoid attrition.

Hire and build a diverse team

You should aim to attract a diverse talent of individuals. Companies that have diverse teams are proven to be more successful at making better decisions as everyone has different problem-solving skills and resources. If you build a diverse team, you will also be able to connect with different types of customers. Diversity is the way to go when building a successful organization!

Step 1: Culture, Culture, Culture (and Values)

Of course, you want to make your culture attractive to recruit the best of the best. But you also need to hire people who will be a great cultural fit for the company. Determine the motivation for each prospective employee and see if it aligns with the company’s values (E.g., Here at ABC company, we want people who want to grow and learn).

Step 2: Hire for personality, train for skill

The most successful companies understand that you can’t change personality (a soft or “power” skill). They are forgiving about not having “hard” skills because they realize most people can quickly learn these skills with the proper training. Southwest Airlines coined the term “hire for personality, train for skill” and has done just that for years (Baker, 2014). Trader Joe’s is known to hire for “personality, specifically extroversion” (Ager & Roberto, 2014). Both these companies see that retaining employees with a great culture and training is cheaper in the long run than hiring people who later leave or get terminated. Attracting the “right” people is paramount.

Step 3: Cross your T’s and Dot your I’s

Do good work at both the attracting and deciding phases. Do not skip any of these steps just because you like a candidate.

Interview Process:

  • Ask questions about competencies/knowledge, skills, and abilities (KSAs) needed to succeed in the specific position.
  • Ask questions about a prospective employee’s personality, vision, mission, values, and culture.
  • Ask, “Why this specific company?” This question will immediately let you know if they’ve done their research.
  • Ask, “why remote/hybrid/in office? 
  • Ask, “Why this specific industry?”
  • Ask both behavioral and situational questions. “Behavioral… focuses on a candidate’s past experiences, behaviors, knowledge, skills, and abilities by asking the candidate to provide specific examples of when they have demonstrated certain behaviors or skills to predict future behavior and performance. Situational questions give the interviewee a hypothetical scenario and focus on a candidate’s past experiences, behaviors, knowledge, skills, and abilities by asking the candidate to provide specific examples of how the candidate would respond given the situation described.” (SHRM, 2022).
  • Ask for completion of a valid personality test such as the Caliper.
  • Ask for consent to a background check (criminal, civil, degree confirmation, license confirmation, etc.)
  • Ask for three professional references and call all of them even if they provide a letter of recommendation. Some people will tell you things verbally they would never write in a letter.
  • Offer a limited window to sign an offer letter and employee agreements but offer support and be available/approachable for questions and negotiations. This creates a sense of urgency and lets you snag that desirable candidate. 

Step 4: Create a hiring matrix

This technique has come very usefully for the Startup Tandem team. This matrix should have the following factors:

  • Decision criteria can be such as ‘professionalism, skillset’ in certain area etc.
  • Weight assigned to each criterion ex: 25%,50%
  • Rating per criteria ex: 5,4,3
  • multiply weight and rating to get the score per criteria
  • Comments per interviewer

Stay Compliant

Be sure to file a new hire report in your state. This determines if the new employee owes money to the government (e.g. child support). If they do owe money, the court or government agencies will mail you information on how much to deduct from their paychecks so your employee can pay back their debt. In California, for example, if the employee will be paid over $600, the form needs to be filed within 20 days via Form W-4 (form will vary by state) or you will face late penalties.

As they change, follow all state and federal anti-discrimination laws every time you hire an employee. For example, “California law protects individuals from illegal discrimination by employers based on the following: Race, color. Ancestry, national origin. Religion, creed.” CA Civil Rights Dept.
Report all employees’ data annually to the Equal Employment Opportunity Commission (EEOC). This is not something you do upon hire, but rather by the annual deadline. You will find the reporting dates on our Startup Tandem HR Compliance Calendar. The last one was May 17, 2022, but they often get extended.

What to do next?

As a founder, CEO, and owner of your own company, you should allocate time to developing a correct hiring process that is aligned with the values of your company. developing these processes will avoid expensive turnover. There are compliance policies that you should keep in mind when hiring, which can become challenging to navigate. A partner like Startup Tandem can help you set up such processes and build a budget for retaining valuable human capital.

How Can Startup Tandem HR Help?

If you follow these simple steps, you can hire the right person who will strengthen your culture for years to come. Although it may take more time and energy than your current hiring process, this is an opportunity to cut those tremendous turnover costs. Ideally, you will lose very few employees over the years.

Startup Tandem provides human resources consulting services to help you navigate issues like this and:

  • Best Hiring Practices
  • Writing company policies and procedures
  • Creating an employee manual
  • Creating a termination checklist
  • Assessing employee’s leadership style
  • Assessing employees conflict management style
  • Improving team dynamic
  • Stay compliant with each state where you have employees
  • Setting up Retirement and health plans for employees

Startup Tandem HR consulting is led by a phycologist that can help you create the questions and tests to hire the rightest candidate for your company’s culture.

How can Startup Tandem CFO help?

Startup Tandem CFO can help you create a budget that includes expenses such as software to run a background check, personality, conflict management, and leadership tests. Your budget should also include training and retaining human capital. Following hiring the best people for your company comes retaining your employees. We should also help you track your actual versus your forecasted expenses in the budget to stay on top of your cash flow.

Now that we discussed how to avoid expensive employee turnover by improving your hiring process, you can learn how employees like to feel appreciated by their boss. Everyone has a different way of feeling appreciated by their boss. Our blog Unique Ways to Optimize Retention, Engagement, Productivity – Startup Tandem, will give you some insight on how to increase retention. More on this topic soon! Sign up for our newsletter to receive blogs directly to your email.

References

Ager, D. & Roberto, M. (2014). Trader Joe’s. HBS No. 9-714-419. Boston, MA: Harvard Business School Publishing.

Baker, W. (2014). Southwest Airlines’ Nonstop Culture: Flying High With Transparency and Empowerment. HBS No. W94C04. Boston, MA: Harvard Business School Publishing.

Lynchburg Regional SHRM. (2017). Essential Elements of Employee Retention. https://lrshrm.shrm.org/blog/2017/10/essential-elements-employee-retention

SHRM. (2022). Job Interview Questions. https://www.shrm.org/resourcesandtools/tools-and-samples/interview-questions/pages/default.aspx

How Do New Tax Reform Impact Private Equity and small business owners?

What to do with the new tax reform as a business owner?

Biden’s new proposed tax reform to increase tax on carried interest can negatively affect institutional investors and small businesses. This will affect small business owners, startups, and projects, in this blog we will discuss what to do as a small business owner. Before diving into this topic, we should understand how private equity works.

What is Private Equity?

Private equity is essential in helping private businesses obtain funding. These firms manage funds to help private companies such as startups expand their working capital, scale operations, make acquisitions, or fund new projects. 

In most cases, it is a common and preferred avenue to raise capital or for a business expansion compared to obtaining money thru debt. 

The funds they manage can come from Limited Partners, a combination of high-net-worth individuals and institutional organizations. 

Venture Capital 

Private equity firms can manage many types of funding; the most commonly used for startups is Venture Capital.

Venture capital is a fund used for a new business or a matter of expansion. Not all Venture Capital is made equal. Venture capital firms with millions of assets under management will only cut a check for a startup if this raises a series B or higher. These startups are in the growth or maturity stage of their business cycle. 

Usually, these investors intend to cash out their investments during an initial public offering or an IPO. 

How does Private Equity help startups?

Private equity is different from traditional financial instruments. These companies will provide capital to startups in exchange for the company’s stock. Unlike other financial institutions, obtaining money does not come with high interest and poor repayment plans. Therefore, they make the preferred choice to expand the cash runway for a startup. 

In some cases, Venture Capital firms or individual investors will offer their knowledge and expertise to help scale the business. This level of involvement is not usual in traditional financial institutions.

How will the proposed tax reform affect private equity?

The main issue discussed in the tax reform on private equity is the carried interest allocations. In 2018 the allocation increased from 1 year to 3 years, which means investors can only claim capital gain with a favorable tax rate on the carried interest of an investment after three years of holding period. Recently, the government has been looking at extending the allocation to 5 years with a higher tax rate. This issue will impact individual and institutional investors as they won’t be able to take advantage of the much more favorable tax rate on capital gains than the income tax rate. 

What does this mean to business owners and investors?

The new tax reform on private equity will directly impact new business and business expansion activities that rely heavily on private funding. Investors might shy away from private equity investment or be looking into liquidating their current holdings to escape the possibility of the allocation extension. 

Acquiring debt will be the next option, but the recent increase in the interest rates might make it difficult for a business. Especially if a business is an early-stage startup with no strong credit profile, history, or cash runway.

Merger and acquisition activities might also be affected due to higher interest that needs to be paid to transfer or acquire the other entity. 

Funding startups and small business has been one of the biggest use of funds. This new tax reform will affect investors on how they invest and small business in obtaining available funds needed to navigate the economy rising prices in logistics and raw materials to name a few.

What is a possible solution?

There are ways to minimize the Fed tax rate on carried interest allocation so that investors might still consider investing. One way is for new businesses to apply and qualify as small business stock (QSBS) under Section 1202. 

This step will allow individual and institutional investors to exclude 100% of their capital gain from the sale or exchange of QSBS if held for more than five years. You can acquire more information thru the Securities of Exchange Commission (SEC) website. 

How to qualify as a QSBC

To qualify for as a small business stock (QSBC) there are a few items to check of the list:

  1. The small business needs to meet and pass the ” qualified trade or business” test. Meaning only small businesses that offer services and products that do not rely on an employee’s skillset to earn revenue. Retail, wholesale, manufacturing, and technology companies meet this test. Firms like professional services in finance, accounting, engineering, hospitality, farming and mining do not pass this test.
  2. The business has to be a domestic C- Corporation
  3. The accumulated assets for the small business are less than $50 Million.

How to claim the tax benefit on a QSBC

For an investor to be able to avoid the tax on carried interest, this must:

  1. The investor needs to be a natural person, meaning not a company
  2. The investor must hold the stock for five years or more
  3. The stock is sold thru private placement like private equity
  4. This stock should be purchased with cash or assets or exchanged for service

How can Investors still benefit from investing in private equity despite the new tax reform?

Investors can waive the carried interest allocation when there is subsequent appreciation in the holding investment. To be able to do this, comes down to the profit-to-cost ratio, whereby waiving the allocation will not impact the total return of the investment.
Institutional investors may narrow their investment into operating partnership businesses or private companies so their income will be less affected by this event.

How are you affected as a consumer?

Consumers have no direct impact from this event; however, due to inflated interest rates and inflation, the spending power might be adversely affected, thus lowering the demand for goods and services. This reform will impact businesses’ sustainment and growth as demand is not meeting the supply. The increase has been seen in the Consumer-Packaged Goods industry, particularly companies whose products are in the cyclical sector. 

What can you do to mitigate the risk of losing investors?

At this time, it is vital to seek professional advice and services to maneuver the process in the right and profitable direction for those who are starting a business or planning for an expansion. You can adapt many strategic moves for smooth sailing for business owners and investors. 

Time and acquiring the right information are essential elements for a smart business movement.

How can Startup Tandem help? 

If Biden passes this new tax reform, funds will be limited to support the growth and initiatives that small businesses take to help the economy, and environment. Venture capital firms greatly fund the innovative startups with surge, angel investors and other PE firms. Without the support of these funds, the United States startup ecosystem will decline. If you have a startup, it is imperative as a startup owner to act fast.

Startup Tandem provides fractional CFO services for startups and small business owners. This service helps small business owners prepare smarter to proactively create forecasting, manage cash, budgets, and financial analysis of their current business financial health and assess to meet growth plans.

Head over to our next blog Financial Management Tips For Early-Stage Startups – Startup Tandem to help you get started with a strong foundation. We are here for anything you may need! Contact Us – Startup Tandem

Starting a successful business in an inflated economy

How to Start a Business in An Inflated Economy?

In this blog, we will discuss steps on how to start a successful business in an inflated economy. Businesses and entrepreneurs can and do succeed during hyperinflation. Starting a business is hard, let alone trying to set one up amid the highest inflation levels seen in the last 40 years. Incredibly, no one under the age of 50 has witnessed such times.

Inflation is a thing but not a permanent factor

The thing about starting a business during the high inflation period is the opportunities to create innovative solutions to problems we did not know existed until now. When prices go up, consumers are savvier in how they spend. Companies adapt and change their selling structures to give better deals and discounts and push more local products – reducing logistical costs.

Steps you should take to start a business

Let’s explore some basic steps to start a successful business in an inflated economy.

External Industry Analysis

Before starting your own business, it is critical to understand exactly what you’re getting into, particularly for first timers. As the First step, you need to do external industry analysis, and you should break this down into five segments, following Porter’s five forces1:

  1. Threat of New Entrants- If the industry presents a low or no threat for new companies, then the threat of new entrants is high. This may happen when initial capital requirements are low, and state and federal requirements are none or low. 
  2. Threat of Substitutes- This threat is high if there is a large volume of indirect competitors to your product or service. 
  3. Bargaining power of Supplier– The bargaining power of suppliers is low when all groups of suppliers do not have the same power. 
  4. Competitive Rivalry – This threat is high if there are a lot of direct competitors in the industry offering the same product or service.
  5. Bargaining Power of Buyers – This power is high when buyers can influence prices for the product or service offered. 

A whole range of things can happen in your industry but outside of your business, meaning that external factors can play a part in your company’s performance. The more you know and understand your industry, the better you will be positioned for success.

Internal Analysis

You should develop an internal analysis of your company’s strengths and weaknesses. It would help if you created an analysis of the company’s infrastructure that makes up the primary and secondary activities. You can do a SWOT analysis outlining internal strengths and weaknesses and external opportunities and threats. 

When deciding what industry to choose, you should look at how it gets affected by the economy. Cyclical Industries are affected by a recession. This is a bi-product of how much discretionary income a consumer spends on specific products or services. 

Non- Cyclical Industries

In times of economic downturn, it is essential items that are recession-proof. We all need access to food, water, gas, electricity, and medical care. So when starting, it may be wise to opt for a product or service that is highly needed. 

During the COVID lockdown, many restaurants folded, but the smaller, localized take-out and delivery stores created innovative solutions to adapt and bring your favorite foods to your door. Delivery services also boomed during these times. 

Hyperinflated economies can lead to opportunities to create innovative solutions to a problem with this type of economy. During COVID, the restaurant had to change its business model to adjust to the new way of living. Some restaurants created a new service offering farm-to-table-made baskets by creating synergies with farmers. Other restaurants closed their doors to reduce overhead costs and only served fresh, packed-to-go meals off the menu at standardized prices. 

Consumers’ spending habits also changed during COVID, increasing sales for e-commerce startups. Many startups reached $1 Million in gross sales thru their online website, creating a solid brand presence. 

When creating a business during a recession, the idea is to pay attention to behavior patterns and trends. Although COVID has been an event that was not easy to predict based on past recession trends, how the government reacted to it was a good indicator of what to expect from consumers. At least for some time. 

Create a business plan

Once you are clear on what innovative solution you want to focus on creating as a business, you need to finish completing a business plan. We say completing a business plan because all the steps mentioned above are part of your business plan. This business plan will come in handy when requiring capital infusion. 

A business plan should have the following sections: 

  1. Executive Summary
  2. Company Introduction
  3. External Industry Analysis
  4. Internal Industry Analysis
  5. Strategy analysis
  6. Strategy Formulation
  7. Strategy Execution 

Once you have created the necessary external and internal industry analysis research, you can start building your business model. 

Strategy analysis, formulation, and execution will come as you line up the next five years of your company. You should be able to determine where your company will be and the capital required to hit those milestones.

Go to our blog How To Build A Startup Financial Model – Startup Tandem to get more information on building a simple model for your startup.

Determine capital needs

One of the most challenging areas is determining the capital needs of a business that is not fully running yet. Many entrepreneurs create projections that are very ambitious on revenue growth. Determining the expenses that will take the company to hit that revenue growth should be a logical, industry-standard year-over-year growth approach. Once you have developed a strong and conservative proforma, you can determine the cash (capital) needed to launch and each growth stage.  

Government aid

Before setting up a business, check if you are eligible for a government grant to help get your business off the ground. It’s been a rough ride for many smaller businesses during the pandemic, but help may be available for you on a government, state, federal or local scale, as well as a bunch of private sector firms.

Research your eligibility before starting up.

How can Startup Tandem help?

Startup Tandem business model is to scale with your business. Services are customized accordingly to each business’s growth. Startup Tandem has a team of financial analysts, accountants, and fractional CFOs that can support you in creating your startup.

Startup Tandem is known for its network of professionals that can help you create a successful business. Success can be achieved by increasing revenue, getting legal advice, getting in front of venture capitalists or banks, being placed in retail, or helping you solve any other problem you may have.  Head over to the blog Will My Business Survive The Current Economy? (startuptandem.com) to read more about if your business can survive a recession.

Start today with an initial call to discuss your business needs. From there, we can develop a plan that fits your budget and growth stage. Monthly meetings can ensure you stay on track to achieve your business and financial goals.

References

1-CGMA Affiliates. June 10, 2013. Porter’s Five Forces of Competitive Position Analysis (cgma.org)

How to Avoid a Wrongful Termination Claim

Avoid a Wrongful Termination Lawsuit with a fractional HR

As a small business owner, you may not have a human resource department that can guide you thru the do and don’ts of terminating an employee. Letting go of an employee can be a scary process that can result in a wrongful termination lawsuit. Termination can happen for many reasons; perhaps the employee was just not a culture fit, or the employee was insubordinate or did not perform to the company’s standards. No matter the reason, you have done the most challenging part: deciding you need to part ways. In this blog we will discuss steps to avoid a wrongful termination lawsuit. Of course, treating the person you’re terminating with compassion is essential. But it is also important to set up a defensible termination to avoid a wrongful termination claim.

Step 1: Verbal and Written Warnings

How does one navigate this? We’re taking the guesswork out of the termination process by offering these tips to ensure a smooth transition for everyone.

  1. Verbal Warning (s) all along the way make communication clear but also respectful. No one wants to get something in writing, especially if it is unclear. A verbal warning makes the exchange more of a conversation, bi-directional, and open to discussion and clarification. In a remote organization, ensure this meeting is planned and held via video conference – with cameras on! Allow time to discuss what went wrong and what to do next time instead. Above all – be kind.
  2. Written Warning (s) all along the way make communication clearer between the employee and the company. Additionally, accurately written warnings cover you against a future wrongful termination claim. Make sure to be very factual and specific. Include dates, times, and quotes if you have them. You can cite policies/ procedures/ handbooks/ contracts the employee has signed. Each written Warning could even have a line for the employee to sign at the bottom.
  3. Review the personnel file to look at the overall picture. Ensure that the warnings were clear to the employee and sufficient. Include emails that show the employee has been warned. Additionally, make sure that the trend is such that the employee is warned of a rule and then breaks that rule again. It is not fair for an employee to have a warning, improve, and get fired.  

Step 2: The Termination Process

  1. When a termination decision is made, document it. This may include sending an email to human resources. This is helpful to show the timing, as the process of terminating the employee could take days or even weeks. Timing is essential, especially if the employee wants to retaliate somehow. Timing would show, for example, that a termination decision came before a workers’ compensation claim.
  2. A termination letter or a meeting will be the next step, depending on how receptive and accountable the employee has been in the previous actions. A termination letter is best sent as a word document on letterhead. Again, this letter could have a line for the employee to sign at the bottom. Avoid imprecise language, such as calling a performance-driven firing a “layoff.” That is a “termination.”
  3. When possible, include human resources as a witness for all steps. They can only help if present for meetings and involved with written warnings and the termination letter, as they can assess for compliance with labor laws, employment laws, and state codes.
  4. Be clear, short, and professional. Don’t keep engaging with the employee after termination by answering too many questions. Less is more when it comes to avoiding a future wrongful termination claim. 
  5. Make sure logistics are all taken care of on the day of termination. Figure out what belongs to whom and when they’ll get it. Make sure to check with your state laws as to when the employee can get their last check, as they vary. Take all access to servers and applications away after they save company property/information to the company server/applications. If they have a work ID/badge or physical work tools such as a laptop or cell phone, it should be made clear when and how those need to be returned.

Looking Ahead

  1. Tell your team the news. A call to a quick video conference meeting for an announcement is the best way to accomplish this. If this is impossible, the next choice would be to send a simple email (“Employee A is no longer with the company”). In the next one-on-one meetings with employees and HR or their direct report, get feedback about the employee who is now gone. Always check in with their thoughts/feelings and answer any questions they may have. 
  2. Prepare for the future. This includes assigning coverage of tasks and maybe even changing roles/responsibilities and strategies. In the next team meeting, address coverage, changing roles and responsibilities, and strategy again so everyone is on the same page regarding the company’s direction. Talk about the next steps to build trust and hope.

The Termination Letter

A) Name of Employee and employer contact information

B) Dates include the date the letter is written, issued, and most importantly – the termination date. Ideally, these are all on the same date.

C) Reason For Termination. Some examples include incompetence (the lack of productivity or poor work quality), insubordination and related issues such as dishonesty, disrespectful behavior and going against company policies), absences /tardiness, and criminal behavior, including theft (revealing trade secrets, plagiarism, etc.)

D) Explanation of Company Property to be retrieved. In this remote work era, this may include deleting files from a personal computer and placing work done on company time to an appropriate work application such as Dropbox. 

E) Severance, Benefits, and Other Compensation Information. This includes information on when benefits will expire and how to continue coverage (COBRA), severance amount of applicable, unpaid reimbursements, etc.

F) Legal Agreements. This typically will focus on what is company property, including trade secrets and work completed on company time.

G) Details About Their Final Paycheck. This includes information on when the check will arrive, how (direct deposit or paper check), the dates worked, and the check issued. 

How Startup Tandem HR can help?

If you follow these ten simple steps, you can ensure a rightful termination. Remember, this is an opportunity for a fresh start. Startup Tandem provides human resources consulting services to help you navigate issues like this.

You can also add insurance such as Employment Practices Liability Insurance to protect your business in a case of a lawsuit.

Additionally, there are best practices to take next time you hire an employee to minimize your need to go thru this process. Our next blog will share a few steps you should take to hire employees aligned with your company culture and values. Hiring best practices is the first step to avoiding termination.

Following with hiring the best people for your company comes retaining your employees. Everyone has a different way to feel appreciated by their boss. Our blog Unique Ways to Optimize Retention, Engagement, Productivity – Startup Tandem will give you some insight on how to increase retention. More on this topic soon! Sign up for our newsletter to receive blogs directly to your email.

References

McDonald Jr., James. (2018, April 4). How to Ensure Rightful Terminations in California. https://www.shrm.org/resourcesandtools/legal-and-compliance/state-and-local-updates/pages/how-to-ensure-rightful-terminations-in-california-part-1.aspx