By: Mark Howitson
Employee vs. Independent Contractor
Whether a person is an employee or independent contractor is determined by law, and the law often disregards what the parties actually call their relationship. Emerging growth companies are tempted to call someone an independent contractor rather than employee because independent contractors do not receive benefits and do not need to be paid minimum wage. Also, sometimes an individual wants to be considered an independent contractor for any number of personal reasons.
The first problem is properly documenting the relationship. Even though a court might pay little heed to how the parties characterize themselves, there are several key terms you will want in the agreement governing the relationship. For example, in many states, the presumption is that the intellectual property (IP) an independent contractor creates during the work for the principal belongs to the contractor - NOT the principal. This is different than the employment relationship where the employer owns the IP created by the employee. It is therefore critically important that the individual sign a proper consulting agreement that provides, among other things, that the intellectual property the person creates belongs to the Company. The last thing you want is to be forced to negotiate with the contractor years later to secure IP rights on the eve of a merger or funding.
The second problem is whether the person is actually properly classified as a contractor. Courts use a multi-pronged fact-intensive test. Central to this analysis is the extent to which the principal has the right to control the manner and means the individual uses to accomplish the desired objective. In the employment context, the employer has a substantial right to control the manner and means used to accomplish a task, but in the contractor context, the principal would only dictate the desired outcome. In addition, contractors are typically NOT at-will, and they should be allowed to work for others while performing services at your company. Contractors should not be given an office, should use their own tools and other items, and should be treated as visitors to your facility.
Failure to properly classify an individual can lead to expensive liability for back wages, overtime, and benefits (including stock options).
Poor Documentation
The key to any good defense against an employment claim is good documentation. Many start-ups fail to properly document performance problems or the basis for a termination. If you spot a performance problem, you should document it. How, you ask?…Email. You can send the employee a brief email explaining the problem and copy the person's personnel file. If you warn the employee verbally about something, quickly go back to your office and write an email to the file about the substance of the warning. Years later if a dispute arises, these emails may be the best friend because they will refresh the memories of key players and lend credibility to an employer's version of events.
Minimum Wage
Many start-up employers erroneously believe that they do not need to pay minimum wage if they give the employee something of equal or greater value - so called "sweat equity". Wrong. The law in this area is very paternalistic. Usually, an employee cannot agree to take less than minimum wage, and even if you give the employee stock options that may be worth millions, you can still be liable for minimum wage violations. The solution to this problem is to timely pay everyone the applicable minimum wage.
Overtime Exemptions
Start-up employers also often erroneously think that everyone can be paid a salary and that salaried individuals are not entitled to overtime. Not so. The law sets forth who may and may not be classified as exempt from overtime requirements. Even if an employer calls the person salaried, and even if the employee wants to be salaried, if the employee does not qualify for an overtime exemption, the employer must pay overtime. Litigation regarding failure to properly classify can be lucrative for an employee; an employee may sue for all of the overtime they worked but were never paid for. Given the typical long days (and nights) of work put in at most start-up companies, the overtime liability for a group of employees can be substantial. The last thing you want to disclose during a merger or large financing is a large potential overtime liability that needs to be paid. The key here is to understand how the exemptions work and only pay salaries to those employees who absolutely qualify.
Rash Decisions and No Warning
The thing that sends an employee to see an employment lawyer is the feeling that they were given no warning that their performance was faltering or the feeling that the company would not listen to his or her side of the story. Given the usually thin staffing at start-ups, there is significant pressure to make quick personnel decisions. This leads to disgruntled ex-employees, so make every effort to warn the employee if things are not going well. Document the problems. When problems do arise, make an effort to listen to the employee's side of the story. Try to give the employee helpful feedback and at least one chance to remedy the situation. The most difficult cases to defend are those where the only feedback in a personnel file is glowing, but the person is terminated for poor performance. The obvious inconsistency makes the employer look like a liar, and start-ups seem to fall into this problem more often because managers feel to busy to deal with performance issues.
These are only a few of the key issues start-ups seem to face with regularity. Most can be reduced by using some forms from the law firm that provides the company with legal advice. Most firms should be willing to give you basic offer letters and consulting agreements for free. You should also ask for a list of the criteria to be an exempt employee. Use these to make sure people are properly classified. Firms can also provide basic performance management forms like written warning, verbal warning and final warning templates. Use these forms to get your documentation going and to eliminate surprises.
