This is a sponsored guest post by Ballard Spahr. Ballard Spahr is a Technical.ly Ecosystem Builder client.
Understanding the ins and outs of being an employer is critical for building the foundational underpinnings of your startup’s culture and ability to retain talent. As employers, startup founders must consider federal laws and varying state and city laws, a thicket of rules made all the more complicated by the increasingly remote-work world in which we live. Mistakes concerning classification and employment contracts can be expensive to fix, hurt morale, and result in an inability to attract top talent.
The best approach is to carefully consider employment matters early on and discuss the pros and cons of key decisions with an employment lawyer. Below, we discuss some of the key decisions that many startups face.
So you’re ready to expand your team? Start with the basics: classification
Before diving into interviews and offer letters, it is a good idea to step back and reflect on structure, payment, and logistics. Do you have a traditional W-2 employee or a 1099 service provider? This is a question of law. Startups might hire employees or independent contractors, but it’s not as simple as asking the new team member to sign an independent contractor agreement or an employment offer letter. Getting classification wrong can mean tax liability, wage claims, and disputes over benefits and equity.
To determine who should be considered an employee, state and federal regulators evaluate the worker’s relationship with the company, such as whether:
- the company controls how the work is done;
- the worker may take on projects from other companies;
- the company or worker provides required tools, sets working hours, or provides a physical workspace; and
- the worker is hired for a particular project for a fixed period, or expects to be engaged indefinitely.
Determining whether a member of the team is an employee or contractor is difficult because the Internal Revenue Service, federal Department of Labor, and individual states have varying legal tests. Sometimes the test applied will depend on which federal or state law issue is involved. States like California, Massachusetts, and New Jersey apply a restrictive test that can render many workers often thought of as contractors as employees. As a result, unsuspecting startups can often run into misclassification issues.
There are also other logistics that require careful consideration. Employers must ensure that all employees are legally authorized to work in the United States and that there is a process in place for checking and retaining the related paperwork. Employers must have federal and state tax accounts and make sure that the right amount of taxes are withheld each pay day. Each employee should sign offer letters, confidentiality agreements, other contractual obligations if necessary, and receive federal, state, and local notices that are required by law. These processes can be a headache, but some vendors like payroll providers may save some startups time and confusion.
You have employees. Now what?
Document, document, document. This starts with documenting the decision to hire an employee and the key terms of employment with an offer letter. A good offer letter should include the job title, start date, salary and, in almost all circumstances, that the employment is “at-will.” It is also important at this stage to put the employee on notice of any contractual obligations that may apply to their work with the company and restrictions that may be in place even after they leave. These include confidentiality and intellectual property agreements, arbitration obligations, and any non-competition and non-solicitation agreements or clauses. Offer letters also commonly include nondisclosure clauses and intellectual property assignment clauses. Nondisclosure clauses are important for protecting a company’s confidential information. Even if you trust your employees, it is good practice to bind them to confidentiality obligations because it signals to third parties that the company is serious and professional. Further, the presence of these agreements can be helpful in proving the existence of trade secrets.
A non-compete typically restricts an employee’s ability to enter the same business as the employer or to otherwise work for a competitor immediately after leaving. A non-solicit typically restricts an employee’s ability to encourage their peers at the company to leave their employment for other employment or to reach out to customers and clients to take their business to a new company.
Although these clauses can be helpful to the employer in some circumstances, enforceability of these sorts of agreements can vary across states. For example, DC has banned non-competition agreements for employees making less than $150,000 per year. California courts will usually not enforce either non-competes or non-solicits; Colorado has specific rules that limit the enforceability of either type of agreement; and Massachusetts has specific rules for enforcing non-competes. Even in those jurisdictions in which these agreements are permitted, they must be strictly limited to reasonable geographic and temporal limits.
And all employers should be attuned to developments at the federal level. Just this year, the Federal Trade Commission has proposed making nearly all non-competition agreements impermissible, while bills pending before Congress take a similar, though somewhat more moderate, approach.
Until either federal body’s proposal becomes law, the web of varying state laws creates complexity for many companies. This is especially true in today’s virtual working environment. For example, consider a Pennsylvania company whose entire workforce lived and worked in Pennsylvania in 2019. Today, if it has employees working remotely in California, Massachusetts, and Colorado, it would need to consider whether the employee agreements that bind those employees would be enforceable under these varying state laws. As a result, it’s helpful to consider non-competes and non-solicits but know that, without federal developments, enforcement can depend on the nuances of each state’s laws, which can also change in the future.
Once a founder decides to hire an employee directly, the founder should consider carefully how the employee will be paid.
Consider if there are sufficient liquid assets to pay an employee regularly for all time worked. During low cash flow periods, an employer must continue to pay employees according to their terms of employment. Before bringing on a new member of the team, it is important to plan how the person will be paid during strong and weak periods of the company.
Note also that employees may be considered “exempt” or “non-exempt” from overtime requirements under either federal or state law, when either or both may apply, but this classification too can be tricky. It is not as simple as paying the employee a salary to avoid overtime. Instead, companies also must consider the employee’s duties and any state and local requirements to make sure they are truly exempt. It’s much safer to get these decisions right from the start then to face the litigation risks and regulatory headaches for minimum wage or overtime violations that can result after the fact.
Slow down decisions on worker requests and employee relations.
Once employees are hired and on-boarded, an employer can of course expect them to do their jobs consistent with reasonable performance expectations. But don’t forget there is a human element to managing your workforce and that employees who make accommodation requests of the company that should not be ignored. Moreover, some of these requests trigger legal obligations that, if not given careful thought, can result in bad feelings, worker disaffection, and liability.
Consider an increasingly common scenario in 2023: An employee requests to work from home indefinitely because of stress or a medical condition that they hadn’t previously disclosed. At one time, this kind of request might have been rejected because employers would believe that a particular job required the employee to be in the office or that the underlying condition didn’t require the accommodation requested, and courts may have agreed. Now, many employers have successfully managed a fully remote workforce for several years, and it is less clear that courts will give employers wide deference in requiring their workforce report to a physical office. Moreover, there is increasing recognition that some stress-related conditions and other mental health issues, not previously disclosed or discussed, qualify for legal protection.
Ultimately, the most important legal obligations that an employer will have in these scenarios is to consider requests like these carefully, refrain from retaliating against any employees who make them, and, if necessary, make those accommodations that would assist a qualified employee who can perform the essential functions of his or her job.
Because the law is still evolving in this space, an employer should also seek expertise when an employee seeks a leave or accommodation that presents new questions. These kinds of requests are highly regulated and a startup that is not well versed in employment law can easily run into trouble.
Organizing, including creating employee unions, also presents another emerging trend that has entered the startup community. Although unions have historically been more popular in industries with clustered, in-person workers, such as manufacturing, unions have become more popular in the technology industry and even in startups. All private-sector employees, whether unionized or not, have legally protected organizing rights, and dealing with unionization efforts and unions that have formed are both highly regulated. Before taking any actions related to employee organizing, a company should make sure that it understands the legal and cultural issues that can arise in this environment.
The key for these scenarios and employee relations issues is to avoid the quick and emotional decision that can create legal peril. By slowing down the decision-making process and engaging an employment expert when needed, a startup can mitigate its legal liability and set itself up for continuing growth.
The end of the employment life cycle: termination
Before making the difficult decision to terminate an employee’s employment, remember the advice above: document, document, document. Mature companies might have an employee handbook with clear policies and guidelines, but some startups may not. Either way, it is crucial to document performance or disciplinary issues with employees throughout the course of the employment relationship. This documentation should include the policies or expectations that have not been met. If you get to the point of separating the employee, what has – and has not – been communicated in writing will come up in a difficult termination meeting (and possibly a lawsuit).
Many employment litigation matters arise out of the “New Supervisor Scenario.” An employee has been performing poorly for several years under the supervision of a supervisor who fails to document the problem. One day, the poor performer receives a new supervisor who decides to begin taking action, leading to the poor performer’s termination. The terminated employee might feel blindsided and, if he or she is a member of a protected classification (e.g., race, sex, religion, pregnancy, disability, or sexual orientation to name only a few), then the employee might wonder if there was an illegal reason for the termination. He or she may also have enough evidence to pursue a costly lawsuit.
Better and consistent documentation can help avoid both the surprise and the feeling of unfairness that could lead to litigation. Even if a startup has no plans to terminate an employee, it is best practice to document performance issues to ensure that an employee’s personnel record is accurate and up to date. Documentation is also a helpful tool to enable the employees to do their jobs well — it memorializes expectations, discussions, and progress that may get lost if only addressed in informal oral conversations.
Employment matters present many complex issues at several stages of a company’s development. Startups should proceed with care and engage employment law experts at key inflection points to mitigate their liability and to build in a way that promotes its culture and lays strong foundations for continuing success.
Kim’s Korner is a series of articles by Ballard Spahr’s emerging company and venture capital attorneys. The column is not legal advice. The substance of the column is derived from our experience working with founders and details many of the current critical issues facing startups.
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