The Implications of Shadow HR on Finance and Legal

From an operational standpoint, not many things look the same as they did just a few months ago. 

Thanks to the massively disruptive COVID-19 pandemic, there’s a heightened sense of urgency to button up initiatives and fortify your company against the next threat. On-demand talent presents a welcome solution to a multitude of new issues, including layoffs and sharp drops in consumer spending. 

However, while you may feel your organizational leaders and shareholders turning the screws, it’s critical not to cut corners with your freelance hiring practices. Doing so can land your organization in hot water. 

In our previous post, we talked about the dangers of shadow HR—shadow HR being everyone who’s doing work for your company who’s not on your payroll. Whether you realize it or not, there’s a high likelihood that shadow HR is woven into the fabric of your organization (and was, even before the pandemic started). And while research reflects many benefits to using on-demand talent to get the job done, including cost-savings and saved time, there’s also the other side of the coin that needs to be considered.

Namely, the risks of shadow HR on your organization’s finance and legal departments.

The Implications of Shadow HR on Finance and Legal

The Financial Implications of Shadow HR

One of the most common threads we see in organizations with shadow HR issues that go unchecked is that the cost of freelancers exceeds the budget—yet no one realizes it, because the costs aren’t being tracked carefully, if at all.

For example, history and experience have shown us that most companies manage their non-payroll workforce through email, Excel spreadsheets and documents, making it easy to lose track of the hours that on-demand workers are clocking and what they’ve been paid.

In fact, it’s not unheard of for companies to realize they’re paying workers for days they’re not even technically working (vacation days), which happens when busy managers hurry through invoices and approve them without reviewing them closely.

Indeed, on-demand workers that fly under the radar can impact your organization in many areas, including:

  • Overspend: Workers are getting paid more than they should be or more than the project’s budget allows.
  • Underspend: Budgets are not getting used effectively because of the workers involved in the project not being properly tracked.
  • Misappropriation of tax documents: On-demand workers may not be getting the right paperwork at the right times (or at all), which could lead to issues if your organization gets audited.

Additionally, one of the biggest financial and legal risks is 1099 forms, which your business has to submit for each freelancer you employ, even if the freelancer doesn’t request one. If this doesn’t happen, your company runs the risk of incurring exorbitant fees and penalties, even if it’s just a single freelancer who didn’t submit one.

The Implications of Shadow HR on Finance and Legal

The Legal Implications of Shadow HR 

While managing shadow HR can feel like a delicate dance between your organization’s HR and legal departments, at the end of the day it’s the legal department’s responsibility to dot all the i’s and cross all the t’s when it comes to freelancers, including:

  • Keeping track of standard temp worker legal documentation,
  • Ensuring all freelancer contracts are up-to-date (and refreshing them if they’re not), and
  • Ensuring all appropriate legal documents are signed.

However, if your company doesn’t fully understand their liability when it comes to on-demand workers and shadow HR, this is where trouble strikes. Below, we explore some of the most prevalent legal issues organizations encounter with freelance workers who aren’t properly tracked or documented.

Intellectual Property 

Intellectual property is a huge liability when it comes to shadow HR. If a freelancer provides your business with assets such as code, designed content, or a written piece, then legally this freelancer owns these assets unless you acquire a written contract that transfers ownership. If you can’t prove that your company has ownership of the assets, this opens you to the risk that someone else will claim them as their own and could potentially sue your organization.

Security

For many reasons, security is among the top risks when it comes to employing freelancers. Because processes for hiring, onboarding, and training on-demand workers are oftentimes disparate and inconsistent, this can lead to freelancers having access they shouldn’t have or not being locked out of systems once they complete their work with your business, for example.

One 2018 report conducted by Risk Value showed that 60 percent of survey respondents felt that freelancers were the weakest organizational links when it came to overall security.

Lack of Liability Insurance

You may think that if you hire a freelancer as a 1099 subcontractor, you won’t be responsible if something happens to that freelancer on the job. But say that your freelancer gets injured while on the clock. If he or she didn’t sign liability insurance before coming aboard with your company, and they don’t have liability insurance, the liability could become your responsibility.

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How Can Your Organization Avoid These Issues?

Shadow HR impacts most of today’s businesses. However, this hardly means yours is doomed to a future of legal issues or unchecked financial hiccups. The easiest way to resolve the problems inherent with shadow HR is to implement a single system of record. Because when it comes down to it, freelancers can’t (and shouldn’t) be one-off non-payroll employees — they deserve a system designated specifically to the management of on-demand talent. (This could look like any number of SaaS offerings available.)

Once you have this single system of record, it’s time to implement the rules and governance policies that align with organizational, regional, and national compliance laws. Keep in mind that this system needs to be simple enough for the users to not want to bypass—and yet fully controlled so that governance stays intact. Putting these measures in place puts your company in a much better position to move into the future with the workers you want and the legal and financial protections you need.

Written by
Shahar Erez

Co-Founder & CEO @StokeTalent

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