Employment Issues Startups Face

Getting out in front of employee issues as a startup can help you avoid some challenging issues down the line. Many of these issues can be avoided by putting in place some standard policies and documentation that deal with many employee issues.

“Getting out in front of employee issues as a startup can help you avoid some challenging issues down the line.” 

Top Employment Issues

Below is a list of the top employment law issues startups face and what to consider when faced with these matters.

• Lack of Employment Documentation. Business startups often encounter problems when they do not maintain adequate employment documentation. Consequently, startups should have prepared a core group of employment documents to be signed by most, if not all, employees. A starting list of employment documents for a new company would typically include the following:
  • Offer Letters. “At-Will” employment offer letters (signed by the company and the employee, acknowledging that the employee or employer could terminate employment “at-will”)
  • Assignment of Intellectual Property. Confidential Information and Inventions Assignment Agreement
  • Policies. Employee Handbook (setting forth company policies on vacation, conflicts of interest, internet usage, etc.)
  • Authorization Forms. USCIS Form I-9 (to document verification of the identity and employment authorization of each new employee)
  • Wage Forms. IRS Form W-4 (the employee’s withholding allowance certificate)
  • Benefit Forms. Benefit forms, for benefits available to employees and family members (e.g., health insurance, dental insurance, 401(k), etc.)
  • Stock Option Agreements. Stock Option documents (if a corporation has been formed), including a Stock Incentive Plan, Notice of Stock Option Grant, and Option Agreement

These documents set a foundation for the proper legal relationships between the company and employees.

• Employee Classification. It’s crucial for employers to classify their workers correctly to avoid lawsuits and substantial government penalties.
  • Employee v. Independent Contractor. Whether workers are correctly classified as employees or independent contractors has many legal implications. When hiring an employee, employers must pay federal and state taxes, unemployment insurance, health insurance, among other costs – all of which they can avoid by hiring a contractor. The test to determine whether a worker is an employee or contractor boils down to one central issue: control – does the employer control where, when and how the work is performed? If so, the worker is very likely an employee. Be careful as penalties for misclassifying employees as contractors can be huge.In California, state penalties alone range from $5,000 to $25,000 per violation, and on top of that, the IRS imposes a penalty of 1.5 to three percent of the employee’s wage. This is in addition to any lost wages and overtime the employer may owe.
  • Exempt v. Non-Exempt. A common misconception, particularly among early-stage companies, is that salaried employees are not entitled to overtime pay. In fact, whether or not employees are salaried has little to do with whether they can collect overtime. To determine whether an employee is exempt from overtime pay, an employer must determine if the employee qualifies for an exemption, the most common of which are administrative, executive and professional. Under each of these exemptions, employees must have the authority or power to make independent choices – free from immediate direction or supervision – in matters of significance to the company. In other words, employees’ titles don’t affect whether they are exempt. Only their actual job responsibilities matter. Keep in mind that there is usually an income requirement for employees classified as exempt. In California, for example, in addition to meeting all of the aforementioned criteria, an employee must be paid at least two times the minimum wage ($41,600 annually) to qualify for an exemption.
• Creation of Employee Handbooks. Employee handbooks serve many purposes – they promote a company’s culture, articulate the company’s discretionary employment policies and help prevent future employment-related litigation. While there are many benefits to having an employee handbook, early-stage companies often aren’t ready and don’t have the resources to cementing their employment policies. For instance, when a company only has a handful of employees, it may not make sense to spend a great deal of time legally outlining a paid parental leave or remote working policies. But as they build out their teams, startups should prioritize creating an employee handbook to ensure they’re in compliance with the law, including disability leave, parental leave and sexual harassment laws. This is particularly important for early-stage startups, which don’t have dedicated HR teams.
• Paid Time Off Policies. Startups must decide how much sick and vacation time they will allow employees to take each year. Under a traditional paid time off (PTO) system, an employee accrues a certain number of paid days off per year, and the employee can use those days off for sick leave, vacation pay or other approved reasons. When an employee leaves the company, the employer must pay the employee out for any days they have accrued and haven’t used. This can be a huge cost for employers. This is partially why “unlimited” time off has become a trend among startups. Under an unlimited vacation policies, employees who leave the company do not create the financial burden of an unexpected accrued leave pay out. Practically speaking, unlimited time off policies have largely benefited employers, and employees generally take less days off. But unlimited time off policies are still very new legal territory. Employers need to ensure that their policy complies with their state’s paid sick leave law and also that they limit payments for employees who are sick for long periods of time.
• Employment Contracts. Startups should determine whether to hire an attorney to draft an initial set of employment documents (such as offer letters, separation agreements and stock options grants) or to download these documents off the internet or take them from other companies and avoid a lawyer altogether. After receiving a draft of employment contracts, cash-strapped startups often customize the documents themselves for future hires and firings. Others use an attorney each time documents are signed. For key hires, such as C-level executives, and key departures, such as co-founders, startups should hire outside counsel. It’s worth keeping in mind that even the smallest phrasing change in employment contracts can have significant ramifications, so hiring an attorney to draft and review these documents is the ideal route once revenue starts coming in.

These are just a few of the many employment law issues faced by startups in their first year. It’s wise for startups to hire trusted legal counsel with experience in employment law to advise them as they scale in order to avoid major costs and penalties.