Newland's Business Notes



Due Diligence – New Job/Employee

Volume 12 Issue 1 -- January/February 2008

Most small businesses do not have Human Resources staffs.  Consequently when someone decides that they want to consider a new job, or an employer wants to hire a new employee, someone needs to investigate either the new hire or the new employer.  This process could be described as doing due diligence.

With new or smaller employers, like a one or two member LLC, if the owner is interested in hiring, say, a top scientist, the new hire may be offered the inducement of an ownership interest in the business. 

Suppose Roh, a top scientist from South Korea working with the Department of Defense, is offered a position with a relatively small company, Bhoat LLC, in Chicago . If Roh leaves his government position, he will give up a salary of $135,000 a year. Bhoat’s owner wants Roh so badly that, if Roh agrees to become a part owner (member) of the LLC, the name will be changed to Roh-Bhoat LLC.  Roh is taking a big risk and could be rowing upstream if Bhoat is not what it appears to be. What can Roh do?

First, Roh could ask for copies of Bhoat’s tax returns for the last 2 or 3 years. If Bhoat is a one-member LLC, the profit or loss would be reported on a Schedule C attached to the personal tax return (Form 1040) of the owner. If there are other members, then Bhoat would report its income on a partnership tax return (Form 1065).  The returns show many aspects of the business, such as profitability, types of expenses, and other activities such as amounts spent for advertising, legal fees, and salaries.  Roh might also ask to see any recent financial statements given to banks and lenders.

If Bhoat is reluctant to provide this type of information, Roh may wish to reconsider whether Bhoat is right for him.

Roh may want to check with 2 or 3 former employees and present employees of Bhoat.   Roh can also ask about recent audits or investigations by government agencies. 

If Roh is not sure he wants to become an owner immediately can Roh share in the profits of the LLC?  Yes, profit sharing arrangements can be negotiated between employers and employees in small and large entities but they are not common in smaller entities.  With a profit sharing agreement, Roh could share in the profits of Bhoat while learning more about the LLC.

Roh likes the sound of Roh-Bhoat LLC but he is aware that the Chicago LLC has previously engaged in some questionable atomic research and the sharing of information with South Korea .  Roh could have problems with his career if Bhoat LLC has made some bad decisions in the past. Until this atomic data sharing problem is resolved Roh is reluctant to risk his reputation. Becoming a member of an LLC does not guarantee future personal success if there are prior problems with the LLC.

The flip side of the Roh-Bhoat situation is that of the employer.  Small employers need to investigate new employees and members without the benefit of Human Resources personnel. One of the first things that should be considered is the reputation and skills of the would-be employee, along with past jobs. If Roh had been with a larger employer, there may be evaluations of him.  Bhoat LLC should also consider non-work related factors such as prior divorces and large amounts of debt.

It will cost money to have a criminal background check but it is advisable.  Many firms regularly do such checks.  Roh should have been told early that such a check is company policy and that he will be asked to sign forms authorizing a criminal background check.  Also the financial status of the would-be employee should be explored.

The potential downfalls related to a new hire for both employee and employer are daunting. Some employers hire people without doing any background checking and end up stupidly hiring an employee who has embezzled from a prior employer. Such results can be disastrous and can be avoided by doing minimal due diligence.

Due diligence will not guarantee business harmony, but not doing any due diligence is an invitation to later problems. Relying solely on instincts is risky.

Copyright 2008
Published by the law firm of Newland & Associates, PLC
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