Common Employment Pitfalls for Startups

June 8, 2017

By Matthew Pelkey

Starting a business comes with a lot of learning curves, including learning how to properly manage employees.

It is almost guaranteed that founders will run into some employment questions while growing their business. As legal practitioners we always hope that our clients will call us before making decisions with legal consequences, but alas, that is not always the case. And while every situation is unique (and you should always seek legal counsel to answer questions specific to your facts and circumstances) here are four common employment law pitfalls with startups:

  • Independent contractors must be…[spoiler alert]…independent.

The old saying goes, if it walks like a duck and talks like a duck, it’s probably a duck. The same holds true for employees. For some reason though people tend to forget this rule when utilizing “independent contractors”. As a general rule, just because you give someone a 1099 and tell the world they are “an independent contractor”, even if they agree to it in writing, does not an independent contractor make. The true test for whether someone is an independent contractor is a far more nuanced, multi-factored test. The more factors indicating the exercise of control over a person, the more likely they are to be considered an employee.

The safest way to ensure that your independent contractor will not be classified as employee? Make sure the contractor is actually operating a business, has a proper entity formed, has an EIN, has workers compensation and unemployment insurance, and files their own payroll tax. The independent contractor should also have other clients and be able to freely compete in the marketplace.

  • Pay. Your. Interns.

It is not uncommon for startups to utilize interns. A problem can quickly arise however when startups do not pay their interns at least minimum wage. See, unless the student is getting academic credit through a school or university, an unpaid intern is really just unpaid labor—which in case you aren’t aware can create a whole host of problems for a company from regulatory enforcement to civil litigation. Both the U.S. and New York departments of labor require that internships be for the purpose of teaching the interns. Ultimately the intern must be a burden on the employer and cannot be there for the benefit of the employer.  If the intern looks like and acts like an employee—they’re an employee.

Basic rule? Pay your interns—don’t stiff them. The headaches down the road simply aren’t worth it.

  • Overtime rules didn’t change after all…but then they did.

Pretty much every U.S. employer was aware that the U.S. Department of Labor was set to increase overtime rules for exempt employees-requiring that the minimum annual exempt salary be at least $47,476 effective December 1, 2016. But then a nationwide injunction was issued by a Federal Judge in Texas and the proposed federal increases were put on hiatus.  Then a new administration took over the oval office…and well…few were left holding their breath as 2017 rolled in.

What went less noticed amidst the celebration of the New Year however was that New York also modified its overtime rules to increase the minimum salary required for exempt employees. Effective December 31, 2016, the NYS Department Labor increased the minimum salary requirements for executive and administrative employees from $675.00 to $727.50 weekly or $37,830 annually (New York City and Long Island are higher). On December 31, 2017 that minimum exempt salary for Upstate New York will increase to $780 per week or $40,560.

Whether an employee is properly classified as exempt isn’t as simple as some employers might think though. The default rule is that every employee is entitled to overtime unless they are exempt. If they are not exempt, they must be paid overtime—even if they are salaried.  Just deciding to pay an employee a salary is not dispositive of whether they are exempt. Neither is the title you give the employee. The real test is what exactly the duties of the employee are and whether the actually qualify as exempt.

Step 1. Make sure your exempt employees are actually exempt. Step 2. Make sure you are paying your exempt employees at least the minimum exempt salary. Otherwise you must pay overtime.

  • Employment Agreements—till death do you part.

As with most relationships, when an early stage startup first brings on an employee, most people think to themselves, “We don’t need an agreement. We trust each other. We’re friends. It’ll be fine”. Just like with a prenup, most people don’t want to think about the inevitable end of the relationship. But relationships ultimately do end in one way or another and just like with a marriage, it is important to plan for that scenario with employees—especially key employees. The goal should be to define expectations and create an agreement that allows both parties to understand what happens during and after employment.

Specifically, it is important to confirm whether or not the employee is at-will in the employment agreement. Setting out any equity interests (what is issued and what isn’t) is likewise crucial to avoiding any disputes down the road. Unfortunately, this is a common area of litigation for startups. Both parties will of course also be interested in what, if any, severance pay will be available to the employee upon separation of employment. Ensuring that intellectual property rights are understood and that the agreement addresses assignment of inventions should similarly be a priority.

And last but certainly not least, there is sure to be some back and forth regarding restrictive covenants (and rightfully so). Non-compete, non-solicitation, non-disclosure, and protection of trade secrets—all can be vital to a company after the departure of a key employee. The absence of proper restrictive covenants can end up costing a company dearly in lost business, lost assets, and in a best case scenario, litigation costs. While a severance package may be used to mitigate some of the risk from claims or litigation, a company would be wise to not leave such matters to chance.

The permissible scope of restrictive covenants is heavily dependent upon which state you are in. In California for instance they are almost entirely unenforceable. Here inNY, while they are enforceable, there must be a specific protected interest of the employer and time and geographic scope must be reasonable. And make no mistake, a Court in New York is going to carefully scrutinize the scope of restrictive covenants in any action to enforce an employment agreement. The key here is to make sure you have restrictive covenants, but don’t place overly broad restrictions on future employment.

Employment matters may seem trivial to a startup’s founders when faced with a million other things to worry about, but one would be foolish to overlook the potential consequences. Liability can often be significant, and owners can even end up being personally liable here in New York. Factor in that much of these consequences become compounded, and a simple employment matter can quickly become the last mistake your business makes.

Original article can be found on the Upstate Venture Connect website: