Client Alert: The Crucial Role of Labor and Employment Law Due Diligence in IPO Success
Date: March 11, 2025
Anticipated IPO Boom in 2025
The IPO market has experienced a notable resurgence in 2024, with U.S. companies raising over $41 billion, a significant increase from the $24 billion raised in 2023. This uptick is attributed to factors such as declining inflation, Federal Reserve interest rate cuts, and a favorable business environment under the incoming administration. Notably, private equity-backed companies are re-entering the IPO market, indicating a potential revival following a two-year slump.
The Imperative of Labor and Employment Law Due Diligence
Before ringing the bell on Wall Street, private equity leaders must ensure that their portfolio companies are free from labor and employment law pitfalls. Conducting comprehensive due diligence in this area is not just a regulatory checkbox but a strategic necessity. Failure to comply with employment laws can lead to costly lawsuits and legal penalties. Negative publicity surrounding labor issues can damage a company's brand and reputation. Identifying and addressing potential issues before going public can save millions in post-IPO liabilities and help prevent reputational damage. With the increasing complexity of employment laws and heightened scrutiny from regulators and investors, companies must be proactive in assessing and addressing these challenges before going public.
Mitigating Labor and Employment Risks Before an IPO
Private equity leaders can take several proactive steps to mitigate legal, reputational and operational risks associated with labor and employment disputes before taking a company public, including the following:
1. Conduct Comprehensive Labor and Employment Law and I-9 Audits: The legal landscape is continually evolving, with new laws and regulations being introduced at federal, state, and local levels. Perform detailed audits of labor and employment practices within the portfolio company. Assess current practices against applicable laws and identify potential areas of risk. This self-audit includes reviewing employment contracts, wage and hour practices, pay equity and transparency, employee classifications, independent contractor agreements, workplace policies and notices, review of safety and injury logs and investigations, employee complaints and claims, and compliance with federal, state, and local labor laws and regulations. More specifically,
- Contract Review: Analyze existing employment agreements and compensation arrangements to determine if any adjustments need to be made before going public. Executive compensation packages will likely change as the company goes public and adapts to public market standards. Employment contracts for key executives may be renegotiated to comply with public company regulations and provide greater clarity on severance terms, change-in-control provisions, bonus claw-back provisions, and non-compete agreements. Will your employment agreements and policies have incentive plan performance metrics sensitive to shareholder concerns? Equity awards or shareholding requirements?
- Worker Misclassification Risks: Ensure that all employees are correctly classified as either exempt or non-exempt under the Fair Labor Standards Act (FLSA) and applicable state labor laws, and that employees are properly classified as such rather than independent contractors. Misclassification can lead to significant financial liabilities.
- Wage and Hour Compliance, Pay Equity Risks, and DEI: Review payroll practices to confirm compliance with federal, state, and local wage and hour laws. This includes overtime pay, minimum wage requirements, and meal/rest break policies. Also, consider conducting a pay equity analysis to determine if there are any pay discrepancies among employees performing comparable work and address them before the IPO to minimize the risk of potential gender, race or other discrimination claims and negative reputational harm to the company. Be mindful that DEI programs are currently being subject to greater scrutiny by the Trump administration and may be subject to legal challenge so companies considering an IPO may want to conduct an audit of any such programs to ensure they comply with anti-discrimination laws.
- Remote Work: Develop and communicate clear and compliant remote work policies that address wage and hour compliance, data privacy, and cross-jurisdictional employment and employment tax issues. Invest in technology and security measures to support remote work and protect sensitive employee data.
- Labor Relations: Labor disputes or organizing efforts can negatively affect share price post-IPO, as investors may perceive such issues as disruptions to business operations. Understanding the company’s labor environment, including any union activity or history, and preparing strategies to address or manage unionization risks before going public, is critical to avoiding long-term negative financial and reputational repercussions. If unionized, review any existing collective bargaining agreements for compliance and potential renegotiation needs.
- Employee Benefits/Executive Compensation Review: Employee benefits may be revised or expanded as the company gains access to broader capital resources. Public companies may offer additional benefits such as employee stock purchase plans and more diverse benefit offerings to attract and retain talent.
- Litigation and Claims: Identify any ongoing or potential employment-related litigation and analyze the company’s history of employment complaints and claims. Evaluate the potential impact of these cases on the company's financial health, employee morale, and public image. Identify and address potential systemic issues that could lead to class action lawsuits, such as pay disparities or improper worker classification.
- I-9 Audits: The Immigration Reform and Control Act (IRCA) requires employers to verify the identity and employment authorization of all employees, using a Form I-9. Non-compliance with I-9 requirements can lead to civil fines ranging from hundreds to thousands of dollars per violation. In severe cases, criminal charges may be brought against the company and its executives. When a company goes public, it is subject to increased scrutiny from regulatory bodies such as the Securities and Exchange Commission (SEC). Ensuring I-9 compliance demonstrates that the company has robust internal controls and may enhance investor confidence and potentially improve the company's valuation.
- Maintain Accurate Documentation: Document all employment decisions and actions to support compliance. Ensure that all employment-related documentation is up-to-date and compliant with current laws. Among other things, review employee handbooks, employee policies, training materials, and records of employee complaints, including internal and external charges of discrimination and litigation.
2. Develop robust employment policies and procedures: Ensure policies are clearly communicated through an employee handbook and on the company intranet and enforced consistently. Ensure current employee policies are legally compliant and anticipate what updates will need to be made when the company goes public. When a private company goes public, employee policies often undergo significant changes due to the company’s new regulatory obligations, expanded governance requirements, and a shift in corporate culture. Public companies tend to have more formalized structures and policies, and employees may need to adapt to new levels of scrutiny and accountability. These changes can affect areas such as compensation, benefits, performance appraisal standards, job descriptions, reporting and the general corporate culture. Review your employee policies and procedures, including compensation policies and programs, before an IPO, to determine what changes will need to be made to stay legally compliant. For instance, a public company will be subject to SEC regulations, requiring it to disclose more information about its financial performance, executive compensation and business practices.
Additionally, because public companies must comply with Sarbanes-Oxley requirements, which impact internal controls, financial reporting and management of financial risks, a publicly traded company will have policies and procedures relating to reporting and auditing. There will also be greater transparency and required disclosures impacting employees, such as reporting personal stock holdings, executive compensation and conflicts of interest. A publicly traded company will need a code of conduct, a policy prohibiting insider trading, and whistleblower policies, among others. It is crucial to implement employee training on these policies to comply with the heightened regulatory requirements of a publicly traded company, as well as regularly conduct training on preventing discrimination, harassment, and retaliation.
3. Provide comprehensive training and performance reviews/feedback: Train managers and employees on relevant employment laws, company policies and best practices, and on legal requirements of publicly traded companies (including rules on financial reporting, disclosure requirements and rules prohibiting insider trading). Implement formal and informal performance review/feedback processes. These tools can help prevent unintentional violations and promote a positive workplace culture.
4. Address Potential Legal Issues: Identify any potential legal issues or non-compliance areas during the audit. Take immediate steps to rectify these issues, such as reclassifying employees, updating policies, refreshing training, and addressing wage discrepancies.
Engage experienced labor and employment law counsel to assist in identifying and addressing potential legal risks. Their expertise can provide valuable insights and ensure that all corrective actions are legally sound, and self-audits/self-critical reviews undertaken at the direction of legal counsel may be protected by an attorney-client privilege/attorney work product privilege whereas those done without legal counsel may be more likely to be discoverable in litigation. Demonstrating robust labor and employment law compliance can enhance investor confidence and attract more capital.
5. Address Employee Retention/Employee Morale and Enhance Employee Relations, Communication and Engagement: While an IPO can be an exciting time for the company and its employees, workloads often increase substantially for employees during and after the IPO, which could negatively impact employee retention and morale. Further, employees whose compensation is heavily tied to illiquid company stock may have concerns about how the IPO will affect the value of their holdings or the stability of their compensation structure.
As part of the IPO preparation process, companies should implement strategies to retain key employees, such as offering equity incentives, enhancing communication about the benefits of going public, and addressing employee questions and concerns. Ensuring that employees feel secure and motivated during this transition is necessary for maintaining morale and minimizing turnover as the company navigates the IPO process.
Foster open communication channels between management and employees about the changes coming. Address grievances or concerns promptly to prevent escalation into disputes and prevent the risk of employees seeking external help, whether through unionization or an external complaint with a government agency. Determine whether any employees will need training to “upskill” before the IPO. Going public often brings about a shift in corporate culture, as the company faces new pressures related to shareholder expectations, stock performance and financial transparency. It’s more important than ever to ensure that Human Resources is focusing on clear and ongoing communication with employees.
6. Engage in pre-IPO Readiness: Conduct a pre-IPO readiness assessment that includes a review of labor and employment law practices. This assessment should identify any remaining risks and outline steps to address them before the IPO.
Prepare to communicate labor and employment compliance efforts to potential investors where there are concerns raised. Highlighting proactive measures taken to mitigate risks can enhance investor confidence.
Conclusion
As the IPO market gears up for a banner year in 2025, private equity leaders and their in-house counsel must prioritize labor and employment law due diligence and effective communication with employees about anticipated changes needed to adapt to new regulations, governance structures and opportunities. By addressing potential legal risks proactively, they can pave the way for a successful public offering, ensuring that their portfolio companies are not only compliant but also attractive to investors.
Please contact Whiteford attorneys in the Corporate and Securities Law Practice and Labor & Employment Law Practice for assistance in proactively addressing these challenges.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.