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Startup Survival: How can I reduce payroll without laying off my team?

Augie Rakow & Greg Grant

NEXT/Employment Chair,

Shulman Rogers

At NEXT we help companies use legal strategies to extend their cash runway.  Here in Startup Survival, we like to share our observations, learnings, and new ideas.

Fast-growing companies usually hire ahead of need. This was especially true as the end of the long bull-run screeched to a halt last month.  

But in the last few weeks, even the strongest are taking uncommon measures to reduce their personnel costs and extend their cash runway. Many fast-growing companies onboarded new employees on Monday, only to announce layoffs and worse by Friday. 

Your situation may not be quite that dramatic. But maybe it is. You are certainly facing big choices.

This article shares 8 payroll strategies you can use as layoff alternatives. 

How can I reduce payroll expense without layoffs?  What are my options?

We describe 8 legal strategies below.  Before we dive into each one, here’s a quick rule of thumb … Layoffs reduce payroll and benefits, but can also force unexpected cash payouts such as accrued/unused leave and possibly severance, and then you also incur re-recruitment costs if business resumes.  Furloughs and pay cuts avoid severance and re-recruitment (and paying out leave “banks” in some states), but you typically have to maintain benefits.

Let’s dive in.

  1. Reduce work hours. 

If you employ a large workforce of hourly non-exempt employees, you can always schedule fewer work hours.  Keep in mind that for exempt employees, reducing hours doesn’t necessarily reduce their compensation.  In both cases, employers must continue to comply with federal and state wage and hour laws. You also need to review your benefits terms to make sure reducing hours won’t jeopardize any benefits plans and trigger COBRA. Finally, reduced hours mean reduced hours – not same work less pay. Remember employees must be paid for all hours actually worked. That’s work reduction in a nutshell.

  1. Reduce compensation. 

Employers can generally renegotiate an employee’s compensation terms.  That is generally an employer’s right. But it can be tricky to reduce compensation without triggering other negative consequences. Think through this checklist to avoid some of the most common traps, then consult with your employment lawyer before initiating pay cuts: 

  • Employees can’t agree to “defer” their wages or salaries.  Even if they want to for the sake of the company.  
  • Also, don’t promise to “make it up later”. Even though you may aspire to.
  • Respect wage and salary minimums.  Non-exempt employees need to be paid for all hours worked at a rate no less than minimum wage, and paid time and half for overtime.  If exempt employees drop below the minimum salary level, they will convert to non-exempt and be entitled to non-exempt benefits (incl. overtime) and protections. 
  • For non-exempt and exempt employees you’ll need to comply with your state’s advance-notice requirements (i.e., one full pay periods’ notice or more), so, plan ahead, give proper notice, and schedule the reduction for a certain period of time.
  • Ask yourself if your plan would disproportionately impact protected classes. Look at the data, not just your intentions.  If impacts are disproportionate, documented legitimate business reasons must support your plan.
  • If employees have vesting acceleration provisions, check for “Good Reason” provisions as compensation reduction can accelerate vesting. 

Nobody wants a pay cut. But like any sacrifice, if the burden is thoughtfully planned and equitably shared across the company, the decision can remind people that they can do more together, and refocus culture on the company’s mission. 

  1. Freeze non-critical transfers, promotions and hires.

Freezes can reduce short-term labor expense and ease pressure for larger layoffs.  Morale will naturally suffer in a longer freeze. So be ready to offer additional equity or other upside to your top employees. Your law firm can help devise incentives that steer clear of deferred compensation traps. Deferred compensation is tricky and counter-intuitive so consult an expert.

4. Furlough is a new concept for many new CEOs. 

Furloughed employees stop working for a period with the intent to reactivate later (typically within 6 months).  Furloughs can reduce short-term labor expense, and avoid having to re-hire your entire workforce. 

The ‘No-Work Rule’.   You must expressly prohibit all furloughed employees from performing any work for the company, or you will open the company up to “off-the-clock” wage claims and associated damages and penalties.  Under the no-work rule, non-exempt employees are paid for any hours they actually perform work, while exempt employees are generally entitled to pay for any week they work. So schedule your exempt employee furloughs in weekly increments.

Furloughs can trigger other obligations, too.  Details matter here, and they vary by state, so consult your employment lawyer about states where your employees are located.  But here are some of bigger traps that apply to most companies:

  • Furloughs of 6+ months can trigger federal WARN Act notice requirements.  WARN entitles employees to 60 days’ advance notification, or pay in lieu of such notice. These rules are intricate and contain new exceptions for coronavirus in certain states, so consult an expert.
  • Furloughed employees may be entitled to be paid their accrued leave.  Get this answer in advance, as it’s a cash out-of-pocket obligation, with damages and penalties if not complied with.
  • Furloughed employees will likely qualify for unemployment insurance benefits. 
  • Furloughs may trigger COBRA. 
  • Furloughs can trigger stock vesting acceleration. 

Keep in mind that some employees facing immediately short-term financial distress may prefer to be terminated and receive accrued vacation and/or severance pay.

  1. Sick leave, vacation & PTO

Most companies don’t think of sick leave, vacation and PTO when they consider expense-management strategies.  However, vacation policies that require pre-approval may offer you the ability defer such leave if that is best for your company.  As with all such decisions, you must use a non-discriminatory basis, that is solely to promote the best interests of the company during these challenging times. 

An employee’s use of paid sick leave, whether related to COVID-19 or not, is not subject to an employer’s discretion.  However, in certain instances, employees may now choose whether to use their accrued paid vacation or PTO in conjunction with other paid sick leave.  Just remember, that needs to be the employee’s choice.  If all of this seems complicated, it is because it is.  In fact, anyone considering these options must review all applicable federal, state and local laws and regulations, and are strongly encouraged to seek professional assistance in advance, as navigating this 3-D minefield of federal, state and local compliance is not for the meek.

  1. Voluntary terminations. 

In a voluntary termination program, the employer gives employees the opportunity to voluntarily agree to be terminated in exchange for severance.  Severance usually comes in the form of cash, health benefit payment reimbursements, or accelerated equity vesting. 

Employees facing short-term financial distress may be more likely to take this option than usual.

  1. Federal loans under the SBA’s Paycheck Protection Program.

In recent weeks the federal government made $350 billion available for small businesses in the form of forgivable Paycheck Protection Loans, with hundreds of billions of dollars more on the horizon. These are powerful loans for companies of up to 500 employees to cover 2.5 times average monthly payroll, up to $10 million.  See our latest article for latest details or send an email to info@next.law to schedule a consultation with NEXT’s senior lending lawyers.  

  1. Leverage state-level work share programs. 

A number of states offer work share programs.  These programs let employees receive partial unemployment benefits while working reduced hours. Companies that never considered using state work-share programs may find these programs useful now.  These require some advance planning and applications with the state, but might provide an option you never knew existed.

For more information see New York’s Shared Work Program, District of Columbia’s Shared Work Program, and California’s Work Sharing Program.

Conclusion

Most companies are considering a mix of layoffs and some of these less permanent measures described above.  Finding the right mix for your company takes time and effort. If you keep good records with your payroll and benefits plans, an experienced employment lawyer can help select the right mix and can work with your payroll and benefits providers to calculate a cost savings comparison.  This is particularly useful if you have a large and varied workforce where several options to consider.

Can NEXT help me rightsize my workforce to extend my cash runway? Yes!  NEXT is a new model of legal service for emerging growth companies.  NEXT has developed 75+ fixed-price legal service packages enabling growing companies to receive direct and hands-on legal advice from NEXT’s senior attorneys. We integrate a technology platform comprised of best-of-breed tools for a collaborative, communicative and efficient client experience.

Learn more about NEXT’s Workforce Guidance and Separation Packages and other Crisis Mitigation Packages designed to help emerging growth startups survive and thrive in response to COVID-19. Click here to sign up for our Startup Survival newsletter.  We’re sharing how we’re helping clients extend their cash runway. Send us your Startup Survival questions at info@next.law.

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