Acquihiring: costs and benefits of hiring workers by corporate acquisition

Startups in the Silicon Valley fostered the practice of acquihiring, a type of corporate acquisition where the primary objective of the buyer is to hire some or all of the team workers rather than to acquire assets or projects. Both companies and individuals in Brazil may start to benefit from this trend; but attention is required, as potential disadvantages exist alongside clear advantages.

The ability of companies’ founders to have a rewarding exit strategy from their business is increasingly perceived as a measure of success of entrepreneurs. Selling one’s equity to a large, renowned corporation is a career achievement for startup founders and serves as a work accreditation in the marketplace. This creates the social conditions for acquihiring, a combination of the words acquisition and hiring.

In acquihiring, timing is of the essence. This type of transaction is usually designed for businesses in an early stage of development. Since in these acquisitions businesses’ assets and projects do not have a significant value, buyers will be less interested in paying a part of the purchase price for them. Conversely, initial investors such as angel investors, friends and family, and venture capital funds will ask for a higher exit premium in the context of acquisitions of more mature startups.

Talent targeted by the acquisition may include shareholders, employees or non-employee workers of the startup. A potential buyer or employer must compare the cost of paying a hiring bonus to target individuals with the costs of acquiring equity interest in the startup. Whereas the bonus would be paid directly to one or more target individuals, acquihiring involves also the payment to other shareholders or investors who do not drive the motivation to acquire.

Hiring bonuses are usually treated by Brazilian tax authorities as service compensation (the legal basis for this treatment is disputable), subject to income tax at a rate of up to 27.5%, as well as social security contribution, other taxes on payroll, and contribution to the Severance Indemnity Fund (FGTS) which in total may reach up to 39.8% for non-financial companies (in case of employees) or 20% (in case of non-employee workers). .

In acquihiring, on the other hand, this burdensome taxation would be replaced solely by income tax levied at rates ranging from 15% to 22.5% on the shareholders’ capital gain (if any) upon the sale of the equity. The 15% rate applies to gains of up to R$ 5 million (approximately US$ 965,000).

The buying company may also benefit from an additional tax advantage: acquihiring provides favorable conditions for tax amortization (deduction) of goodwill paid in the acquisition, reducing corporate income taxes, provided that the buying company is profitable in the ensuing years, is taxed under the real profit regime, and complies with certain other legal conditions.

Acquihiring tends to allow the buying company to directly purchase the target company and then merge it (one of the conditions for the tax benefit), avoiding the need to create an intermediary ‘vehicle-company’ to make the acquisition and then be merged into the target company. This allows goodwill to be amortized for tax purposes with lower risks, as the use of vehicle-companies has often been challenged by tax authorities and invalidated by courts.

Another aspect to be considered is the cost of termination of the relationship with the target workers. In case the target individuals are employees of the target company, acquihiring also avoids the host of severance-related payments that are mandatory under Brazil`s labor laws. These include Christmas bonus, vacations (the relevant payment being increased by one third), prior notice, and a termination fine. Severance also triggers payments related to social security contribution and other taxes on payroll, in addition to income tax of up to 27.5%. If, on the other hand, the target individuals are non-employees, acquihiring avoids income tax of up to 27.5% and social security contribution that would be levied on severance payments.

The relevance of contingencies is also key in the decision to pursue acquihiring. Acquiring a business, even in earlier stages, requires a reasonable diligence. Startups operating more informally may accumulate labor, tax and other contingencies, and the risks of a buyer being considered a successor of sellers in these liabilities should not be neglected. Hiring employees directly minimizes the risks of succession.

Upon the purchase of a business featuring a key individual shareholder or the hiring of a key employee it is a desirable (and common) practice to introduce a non-compete obligation in case the person in question decides to leave earlier than planned. Acquihiring is more flexible as to the content and extension of such non-compete obligations.

Labor courts in Brazil generally hold the view that non-compete clauses are a limitation to the right of employees to free work, and accordingly tend to take a restrictive approach to them. Courts typically decide that employees must receive a compensation as consideration for non-compete commitments, and that these must be limited both geographically and time-wise. Whenever an individual agrees to a non-compete obligation in the context of an acquisition, however, the purchase price is generally regarded as sufficient consideration for the non-compete obligation and courts tend not to interfere with the terms and conditions set forth by the parties.

Whether or not individuals will integrate harmoniously into an acquiring organization is a key consideration for any decision on acquihiring. Integration will be driven by factors such as synergies and complementarity of activities, as well as the need for creation of a teamwork environment with the existing workforce.

Attention to pay levels is also necessary. Workers having the same professional qualification and performing the same activities, as a general rule, must receive equivalent remuneration – which can increase remuneration paid to employees of the acquiring entity. If, conversely, the acquired business is kept segregated from the other activities of the acquiring organization, equal pay rules will not come into play. Other arrangements may be put in place, including consulting agreements, appointment to managerial positions which do not fall under the scope of labor laws, and/or attribution of minority equity stakes, which may be less expensive from the tax and social security standpoints.