Why contractor compliance is crucial to your next funding round

Discover the risks of improper employee classification.

Contractors sitting at desks with check marks next to them.

Startups rely on funding to build capital for their business. It allows them to invest in the best employees, resources, and innovation. This money can spur growth and open up new opportunities for entrepreneurs. However, securing funding isn't always easy.

In fact, startup funding is slowing down in 2023. While there are upticks in certain fields, like artificial intelligence, funding is way down in other sectors. Global venture funding fell 18% quarter over quarter in Q2 2023, for instance, while deal volume is also down.

In the context of this tough competitive climate, startups seeking funding need to look as attractive as possible to potential investors. Compliance is one issue to consider if you're preparing to seek funding. You don't want to run afoul of any laws, as this makes you a risky investment.

Most startups focus on issues like getting their books in order and verifying that they have a clean history with the tax authorities before they seek funding. While that's important, it's not the only compliance issue to worry about. You also want to make sure you're complying with relevant labor laws.

Employee misclassification is a major issue to consider—especially if you hire internationally. While global hiring gives you the chance to harness a global pool of talent, acquiring the best for your company, it also involves risks.

An oversight when it comes to correct employee classification can have significant consequences—including financial penalties—not to mention failed compliance checks that will impede your odds of securing funding.

Discover the risks of improper employee classification and learn more about contractor compliance below.

What is employee misclassification?

Employee misclassification occurs when a worker is classified as an independent contractor or self-employed individual, but they in fact meet the legal criteria of an employee. Different countries have different rules regarding what qualifies as an independent contractor.

Worried you've misclassified a contractor? Get answers using Oyster's Contractor vs. Full-Time Analyzer.

Generally, if an employer determines how, where, and when a worker does their job, that makes the worker an employee. For independent contractors, the employer doesn't have the right to determine the details of how the services are performed.

Say you hire an accountant on an independent contractor basis for your business. You can give them deadlines, like getting the bookkeeping done by the end of the quarter, but you can't tell them exactly what hours to work and on what days.

Why does the classification of employee versus independent contractor matter? Employees are subject to specific legal and tax obligations. If you hire someone on an employee basis, you will most likely need to withhold certain taxes and social security contributions.

The global picture

Every country has its own rules regarding worker classification. If you're hiring internationally, it's important to respect this added layer of complexity and research the specific rules in the countries you're hiring in. Otherwise, you risk running afoul of government guidelines and getting into legal trouble.

When hiring in other countries, you also want to consider the other nuances of their labor laws. For example, different countries have different norms for working hours, vacation time, overtime, and mandatory benefits. For instance, the standard workweek in Germany is 40 hours per week, compared to 48 hours in Colombia.

What compliance checks take place during funding rounds?

If you're a finance leader or people manager who hires internationally, inform yourself about potential compliance issues before an audit occurs. Investors and lenders run thorough background checks before they give startups any kind of funding. You don't want yours to raise any red flags and jeopardize your odds of securing valuable financing.

Employee misclassification is one issue potential funders will look out for when running a comprehensive compliance check. They don't want to deal with the potential fallout of misclassification. Non-compliance with labor laws can result in governments imposing penalties, like fines and back taxes.

In some cases, companies may even face lawsuits if they are found to misclassify workers. Don't think that these things go unnoticed. Even well-known companies have gotten in trouble for these kinds of mistakes. For example, Nike could face fines of $530 million for possible worker misclassification.

Given the associated risks, it's no wonder that employee misclassification can deter potential investors. They'd rather prioritize companies with strong compliance practices that won't create such costly issues.

More broadly, misclassification raises doubts about a company's risk management practices. Potential investors may worry that if one thing is off—like employee misclassification—other things may be off too. Long story short, a case of employee misclassification won't inspire confidence—and confidence is what funders need if they're going to send cash your way.

How to mitigate the risks of misclassification

Do your due diligence to minimize the risks of employee misclassification globally. Researching local laws can help you determine what makes for an employee versus an independent contractor in a given country. There are also tools that can help—like Oyster's misclassification analyzer. Just enter some basic details to get started.

Oyster can help your company comply with local labor laws in over 180 countries worldwide. To minimize the risks of hiring abroad, make sure to conduct regular internal audits, create guidelines for hiring independent talent, and build a dedicated team to manage potential issues as needed. Finally, know when it's time to convert an independent contractor to full-time status.

Building a strong culture of global compliance

Appropriate employee classification is just one part of a strong global compliance culture. Establishing a robust compliance culture overall can help your company avoid legal issues and improve your odds of securing funding.

Partnering with a reputable, reliable partner like Oyster demonstrates your commitment to strong global compliance. Investors can rest easy knowing you're committed to stringent legal and ethical standards.

Improving your chances of securing funding

You don't want worries about employee misclassification of international contractors to jeopardize your company's funding chances. If you're a finance leader or HR professional, take action to ensure compliance with local labor laws. Partnering with Oyster can help minimize the risks. Build trust with investors and safeguard your company's long-term success.

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