Startups must make a few key employment law decisions as they begin hiring, including whether to classify workers as independent contractors or employees, whether to classify employees and exempt from minimum wage and overtime, and what kinds of onboarding documents employees will sign. This brief video blog discusses these issues.
Good afternoon, everyone. This afternoon I wanted to talk a little bit about employment law issues that startup founders face. And so the first decision that startups need to make is how are they going to classify the workers they’re going to hire? And there are two main types of workers. The first is an independent contractor and the second is an employee. So I get this question a lot from startups. They say, “I would prefer to hire only independent contractors because I would save a lot of money on different kinds of payroll taxes and benefits if I could hire an independent contractor. Can I just make everybody independent contractors?”
And the answer to that is generally no. Under the law, there are guidelines which tell us which kinds of people can appropriately be classified as independent contractors. And it’s very tricky because there are many different laws which dictate how these people can be classified. For example, for IRS purposes, the IRS has a set of factors that it uses to determine whether people can be independent contractors. For purposes of worker’s comp, there are factors that are considered as to whether people can be independent contractors. In the context of wage and hour claims, courts consider different factors as to who can be appropriately classified as independent contractors.
But the uniting aspect of all these different tests for independent contractor status is the level of control that the company exercises over the person. And if the company exercises a high level of control over the worker, that worker would generally need to be classified as an employee. So, for example, if you are generally telling employees when to report, what policies they have to follow, how they have to do the work and so forth, they’re generally going to need to be classified as employees.
So what I advise my clients is, in most places, the workers who drive for Uber are classified as independent contractors. And how do they get away with that classification? Well, Uber drivers are able to work whenever they want to work. They can decline whatever shifts they don’t want to work. They drive their own vehicles, they set their own rules for what kinds of fares they accept, where they drive and so forth. Uber technically is just an app. So its workers are not even doing the business of the business, which is a ride-sharing app. And so I generally tell my startup clients, the more you can make your business look like Uber, meaning, the more you can remove yourself from the control elements of the environment, the better. If you are planning to exercise a high level of control over your workers, then your best bet is to classify them as employees.
So the next question that startups should be asking themselves from the employment perspective, let’s say, you’re going to move forward with hiring employees, the next question is, how should you classify your employees? And again, this question comes up all the time from startups. They say, “I don’t have cash flow. I would really just like to pay my employees in equity. So no wage payment, but they will receive a portion of equity in the company.” That also is generally not okay. Workers have to be paid at least the minimum wage and overtime unless they fall under an exemption, which would permit them to be exempt from receiving those kinds of payments. And there is an exemption for business owners. And business owners are classified as workers who own at least 20% of the company.
So if you’re dealing with somebody in a startup who has at least 20% equity, then, yes, it is okay if you decline to pay the minimum wage in overtime. But otherwise, all of your other workers should be making at least minimum wage and overtime unless they fall under another exemption. So there are other exemptions, the most common of which are the administrative executive and professional exemptions. And all of them have certain factors. If your employees meet those factors, then they can be exempt from being paid overtime. So in some situations, you can pay employees a flat salary and then you wouldn’t have to worry about overtime concerns.
This video blog is really, it’s intended to be a high-level overview, but if you have questions about the factors for each of those exemptions, please reach out to your NEXT startup attorney and we can talk you through those factors.
The next most common question that I get from startups is papering the terms of the arrangement. So you have decided you’re going to hire some employees, you’ve decided the classification of your employees, and now you need to paper things. So I get a lot of questions as to whether they need to be drafting employment agreements or offer letters. So in general, unless you’re going to be offering severance benefits, which means somebody will get a payout upon termination, my recommendation would be that you keep things simple and only use an offer letter. An offer letter sketches out the main terms of employment, but it’s strictly speaking, not binding the company too much. And you would want to retain the most control as you can, the ability to terminate somebody at will and not promise too much unless you have to in an employment agreement as sort of like a recruitment technique. If you are really competing hard for top talent, then somebody’s going to be looking for an employment agreement that locks the company into a certain level of severance or salary or so forth.
And then startups also frequently ask about restrictive covenants. And by that I mean non-solicits, NDAs, and non-compete provisions. You would typically be papering those in the initial onboarding documents. So if you’re going with an offer letter, I would generally attach those to the offer letter. If you’re going with an employment agreement, I would build those into the employment agreement. And each state law is a little bit different in terms of whether non-competes or non-solicits can be enforced. I would say as a general trend, the Western states are a little bit tougher on non-competes and non-solicits. Other places, they can still be enforceable. So please reach out to your NEXT startup council if you have questions about the enforceability restrictions agreement. Thanks everyone for listening about the top employment concerns for startups.