Understanding Employer of Record Risks: A Comprehensive Guide For Decision-Makers
The popularity of Employer of Record services stems from the fact that they allow organizations to access global talent, streamline their workforce management and minimize compliance-related hassles, all while retaining the flexibility they need to focus on their core business objectives.
An analysis from The IEC Group shows that the growth of EOR services will continue, projecting the market for EORs to reach $9.8 billion by 2028.
A report from The Everest Group broke down the geographic adoption of EORs, with North America companies representing more than one-third of the global EOR services market.
This guide aims to shed light on the risks of outsourcing HR to an employer of record and empower you to make well-informed choices when it comes to working with EORs.
What Is An Employer Of Record?
Defining an EOR and deep-diving into what they do is an entire article in and of itself, so we’ll provide a high-level description here.
In its simplest form, an Employer of Record is a specialized service provider that takes on the legal and administrative responsibilities of employing a workforce on behalf of a client company.
In this arrangement, the EOR becomes the legal employer responsible for managing payroll, taxes, benefits, compliance, and other HR-related functions for the client company's employees.
This arrangement is an alternative to having a more straightforward "contractor agreement" which can give more flexibility but can be less desirable depending on the jurisdiction and how people prefer to work.
Pro Tip: “You may want to give the candidates a heads up if that’s how you’ll be employing them because not everyone knows how to be a self-employed contractor and, in some jurisdictions, it can take a while to register. - Mariya Hristova, author of "How to Hire Remote Employees and Tap into Global Talent.
EORs are sometimes mistakenly referred to as professional employer organizations (PEO) but PEOs operate in a slightly different manner. Check out this article that outlines the difference between a PEO and EOR.
Common Scenarios for EOR Utilization
Global Expansion: Many companies turn to EOR services when expanding their operations into new countries or regions. This allows them to quickly establish a presence without the complexities of setting up legal entities, navigating local labor laws and managing administrative tasks.
Temporary or Project-Based Workforces: Businesses with fluctuating staffing needs, seasonal projects or short-term initiatives find EOR solutions invaluable. EORs offer the flexibility to scale up or down without the commitment of permanent hires.
Compliance Management for a Distributed Workforce: EORs are often sought after for their expertise in handling complex employment regulations. They help clients stay compliant with local, national and international labor laws, minimizing the risk of legal issues.
Focus on Core Competencies: By outsourcing HR and administrative functions to an EOR, companies can redirect their resources and energy toward their core business activities, improving efficiency and productivity.
Legal obligations
Employers of Record assume several critical legal obligations, including:
Employment Contracts: Drafting and maintaining employment contracts that adhere to local labor laws, detailing terms and conditions of employment and handling contract renewals or terminations.
Payroll and Benefits: Managing payroll processing, including tax deductions, contributions and benefit administration, ensuring that employees receive their compensation accurately and on time.
Compliance: Staying up-to-date with ever-evolving labor laws and regulations, handling compliance with immigration, employment and tax laws, and conducting necessary audits and reporting.
Taxation: Meeting tax obligations, including withholding and remitting income and social security taxes, as well as ensuring compliance with local tax regulations.
Workers' Compensation: Providing workers' compensation coverage and managing claims when employees are injured on the job.
Record Keeping: Maintaining accurate records of employee data, contracts, hours worked and other HR-related information.
Financial Risks
While Employer of Record (EOR) models offer substantial advantages, they also come with a set of financial risks that demand careful consideration.
Hidden Costs
These expenses may not be immediately apparent but can significantly impact your bottom line.
Service Fees: EOR providers typically charge service fees, which can vary based on the scope of services required. It's crucial to understand the fee structure and assess whether it aligns with your budget.
Mandatory benefits: In some countries, there are mandatory benefits an employer must provide and an EOR will charge you for those on top of salary and their service percentage.
Severance and exit: EORs will charge for an employee’s severance pay plus a percentage fee on it (in some countries that can be fairly substantial) and for managing the exit of an employee as a separate charge
Additional Charges: Some EORs may levy extra fees for specific services, such as document processing, employee onboarding and HR advice. These can accumulate quickly if not monitored closely.
Currency Fluctuations: Dips or rises in the strength of one currency against another can pose a significant financial risk when working with EORs in international markets. Exchange rate fluctuations can impact the cost of payroll and other financial transactions.
Compliance Risks
Operating across borders has legal implications that can be confusing if you don’t have experience in that market previously. Labor laws, standards and regulations can vary quite drastically from one side of the world to the other. Here are few things you’ll consistently need to keep in mind.
Employment Laws
Non-compliance with local and international employment laws can lead to significant legal and financial consequences. Laws governing employment, such as minimum wage regulations, working hours, overtime pay, paid time off and employment contracts all fall under this category.
An example would be the Fair Labor Standards Act (FLSA) in the U.S. Aside from the regulations mentioned, it also sets standards for the employment of minors.
Failure to comply with FLSA regulations can result in penalties, back pay obligations and legal action against the employer.
Regulatory Changes
The regulatory landscape is ever-evolving and staying up-to-date with changes across markets can be as exhausting as keeping up with the geopolitical landscape.
Failure to adapt to regulatory updates can result in fines, legal disputes and damage to an organization's reputation.
Consider the impact of the General Data Protection Regulation (GDPR) in the European Union. Organizations handling personal data must comply with stringent data protection regulations.
Non-compliance with GDPR can lead to fines of up to €20 million or 4% of global annual turnover, whichever is higher.
Understanding Penalties for Non-compliance
Penalties for non-compliance can vary widely depending on the severity of the violation, jurisdiction and specific laws or regulations breached. I’ll illustrate this with a hypothetical scenario.
A company utilizing an EOR in France failed to properly vet their EOR's compliance with local labor laws.
Of particular concern was adherence to working hours regulation in France which states that the work week is typically 35 hours and legally, employees cannot work more than an average of 44 hours per week. The workday itself is not to exceed 10 hours.
Subsequently, they inadvertently violated employment regulations regarding overtime pay and employee working hours, by not only putting so much on employees’ plates that they had to exceed the 48 hours, but also failed to fully comply with the regulations on pay increased which state that the employee must receive a 25% increase for each of the first 8 hours of overtime, followed by 50% increase per hour after that.
In some cases, understanding collective bargaining agreements with unions could have saved the company some trouble by negotiating agreements for working more than the standard hours.
This resulted in fines per employee, employee grievances, and damage to the company's reputation in the French market.
To mitigate compliance risks associated with EORs, you’ll want to ensure you do the following:
- Thorough Due Diligence: Speak to the EOR about the countries you'd like to expand into if you know them specifically and ask them about what their expertise is in those locations. Do they have local HR experts, employment lawyers and finance/tax advisors either employed by them or in a partnership?
- Regular Audits: Periodically audit your EOR's compliance practices to ensure they remain in alignment with evolving laws and regulations.
- Seek Legal Counsel: Consult with experts well-versed in local employment laws to guide your EOR relationship.
Operational Risks
From an operational perspective, EORs can present some challenges if they aren’t aligned with your values or way of working. Some things you’ll want to keep an eye on include:
Business Continuity
Operational disruptions can be costly and damaging to your organization. Ensuring business continuity is crucial when working with an EOR, as any interruption in services can impact the bottom line and the organization’s ability to do business.
Mitigation Strategies:
- Disaster Recovery Plan: Collaborate with your EOR to establish a comprehensive disaster recovery plan that outlines procedures for handling unexpected disruptions, whether they are related to natural disasters, political instability or other unforeseen events.
- Diversify EOR Partners: Consider working with multiple EOR providers in different regions to minimize the risk of business disruption due to a single point of failure.
Data Security
Data security is paramount in today's digital landscape. When entrusting an EOR with sensitive employee information, the risk of data breaches and cyber threats is something you want to assess based on the following:
- Certifications - Verify their compliance with internationally recognized data security standards, such as ISO 27001, which demonstrates a commitment to data security best practices.
- Data Retention Policies - Assess how long they retain employee data and how it is securely disposed of when no longer needed.
- Incident Response Plans - Examine how they handle data breaches or security incidents in terms of their immediate actions and reporting structures and how they communicate with affected parties. .
- Penetration Testing: Inquire whether they perform penetration testing to proactively discover and address potential weaknesses in their security measures.
Mitigation Strategies
- Data Protection Protocols: Ensure that your EOR has robust data protection protocols in place, including encryption, access controls and regular security audits.
- Legal Agreements: Establish clear data security clauses in your contract with the EOR, outlining their responsibility for safeguarding sensitive information.
In the context of data security, the previously mentioned example of GDPR is highly relevant. It mandates stringent data protection measures for organizations handling personal data and imposes severe fines for data breaches.
Strategic Risks
Employer of Record (EOR) models offer various strategic benefits, but they also introduce strategic risks that can impact long-term business goals.
Loss of Control
When partnering with an EOR, organizations relinquish a degree of control over HR and workforce management processes. This shift in control can impact strategic decision-making and the ability to adapt swiftly to changing business conditions.
Mitigation Strategies:
- Strategic Oversight: Maintain a strategic oversight role, even when outsourcing HR functions to an EOR. Continue to set clear goals, objectives, and performance expectations.
- Effective Communication: Establish open lines of communication with the EOR to ensure that strategic decisions align with your organization's long-term objectives.
Brand Reputation
The actions and practices of your chosen EOR can directly impact your organization's brand reputation. Any negative incidents related to employment practices, compliance issues or employee dissatisfaction can tarnish your brand image.
Mitigation Strategies
- Partner Selection: Choose an EOR with a strong track record of ethical employment practices and compliance adherence to minimize reputational risks.
- Transparency: Maintain transparency with your employees regarding the EOR relationship, emphasizing your commitment to their welfare.
Long-term Viability
The long-term viability of your EOR and its ability to adapt to changing global employment trends and regulations can influence your organization's sustainability. An unstable EOR can pose strategic risks.
Mitigation Strategies
- Financial Assessment: Periodically evaluate the financial stability of your EOR partner. Ensure they have the resources to weather economic challenges and continue providing services.
- Contingency Planning: Develop contingency plans in case the EOR encounters financial or operational difficulties, ensuring minimal disruption to your workforce.
The COVID-19 pandemic highlighted the importance of assessing the long-term viability of service providers. Some EORs faced financial challenges during the crisis, which had implications for the organizations relying on their services.
Legal and Contractual Safeguards
To mitigate strategic risks, it's best practice to incorporate legal and contractual safeguards into your agreement with the EOR. These safeguards may include:
- Termination Clauses: Clearly define conditions under which either party can terminate the partnership, providing an exit strategy in case of unforeseen issues.
- Performance Metrics: Set measurable performance metrics and key performance indicators (KPIs) that align with your long-term goals and periodically review them with the EOR.
- Non-compete and Non-disclosure Agreements: Include non-compete and non-disclosure clauses to protect your intellectual property and prevent the EOR from competing with your organization.
Conclusion
While EOR services can be a tremendous asset to your organization that allows you to access a global talent pool, they come with some risks that have to be assessed before entering into the partnership.
A good mitigation strategy should prevent you from running into trouble, but regular iteration on policies involving your EOR is always a good idea.
If you’re currently in the market for an EOR provider, there’s a lot to consider. Check out our picks for the 26 best employer of record services (EOR), or our round-ups of the best EOR services in Canada and the best EOR services for hiring in the UK.