Key Considerations for Emerging Companies: Employment Law Risks

July 22, 2021
Firm Publication

The first few years of operations can be an overwhelming task for emerging companies, especially when it comes to navigating the wide range of employment laws that come with hiring new members of the team. Below is a list of issues to be aware of as you build and structure your workforce, and best practices for circumventing legal risk.

Hiring

Federal and state law govern many aspects of the hiring process, including what questions may be asked, the use of background checks, drug testing, and eligibility for employment. For example, federal, and most state, civil rights laws prohibit employers from making hiring decisions based on protected categories – such as gender, race, age, religion, disability, color, among others – which impacts which questions should and should not be asked during the interview process. This can also include inquiries of or disqualification for any applicants’ use of medical or recreational marijuana. Further, some states prohibit inquiries into an individual’s criminal background until after a conditional offer of employment is made, and even then federal law prohibits taking adverse action against an applicant based on background check results until certain steps have been taken to provide the applicant with an opportunity to respond. Once an applicant is hired, employers must also verify that the individual is eligible to work within the United States within a certain period of time, and, depending on the state, the employer may be required to use E-Verify to do so. Given these nuances and potential pitfalls for legal risk, some startups may find it beneficial to partner with a professional employer organization (PEO) to provide human resources services until the business is able to hire its own internal human resources staff.

Employee Classification

Whether an individual is properly classified as an independent contractor (consultant) or an employee is a threshold issue for startups that should be carefully considered based on the specific nature of the job duties and control over the work being performed. Independent contractor status is desirable for many businesses because it can save the company as much as 20-30% in labor costs; however, the IRS and state laws set forth particular tests to determine whether an individual can legally qualify for independent contractor status. And, the current legal environment is trending away from the broad use of independent contractors as state and federal agencies have recently been cracking down on misclassification, which comes with steep penalties for unpaid payroll taxes as well as potential unpaid overtime claims. Getting this classification right from the outset can eliminate these risks. As a best practice, all independent contractors should be subject to a written agreement outlining the specific terms of their services and confirming the parties’ intent with respect to the relationship. For those individuals who must be classified as an employee, employers must go one step further to determine whether that employee should be classified as “exempt” or “non-exempt” for purposes of wage and hour laws, which generally entitle non-exempt employees to overtime compensation equal to at least one and one-half times their regular rate of pay for all hours worked in excess of 40 hours in a workweek. These exemption requirements are set forth by law, and require an analysis of each employees’ specific job duties. Having in place written job descriptions outlining those duties is a helpful first step for any startup as it determines which positions can be properly considered “exempt.”

Wages

Emerging companies should also pay close attention to the applicable state and local wage and hour laws for purposes of paying wages to employees. This includes any minimum wage requirements, wage payment timing, meal and rest break requirements, authorized deductions from wages, and the payment of bonuses and commissions. These laws can significantly vary between states, and startups should understand that remote employees will likely be governed by the laws of the state in which each employee lives and works, as opposed to the state in which the company is physically located. And, while some cash-strapped startups may be tempted to request employees defer their wages or offer new employees stock options or other benefits in lieu of wages as the business gets off the ground, those arrangements violate minimum wage laws regardless of the employee’s exemption status.

Employment Contracts

Spending the time and resources to draft a set of employment agreements for key employees is strongly encouraged, even for those businesses that are just getting off the ground. Oral agreements regarding wages and benefits can lead to significant misunderstandings, so clearly establishing all compensation terms in writing, whether through an offer letter or formal employment agreement, is a best practice for eliminating that risk. This is also true of the parties’ expectations and rights upon a termination of employment, including bonus and severance entitlement as well as non-compete obligations. While it may be counterintuitive to discuss the mechanics of a termination with a newly hired employee, ironing out those details at the outset can certainly reduce the tension and disagreements between the parties in the event the employment relationship ends. Companies are compensating employees to create sale leads, come up with ideas, and to create work product and inventions. Written agreements prohibiting the use and disclosure of this information, as well as other confidential and proprietary information and trade secrets are necessary for protecting against competitive activities during and after the employee’s employment. This is especially true in the tech industry, or any industry in which the employee will be creating intellectual property.

Employment Policies

As the employee headcount grows, certain federal and state employment laws become applicable to the workforce, such as paid and unpaid leave requirements, civil rights laws, termination notice rights, disability accommodation requirements, training obligations, and demographic reporting. Maintaining a comprehensive employee handbook will set forth the company’s policies with respect to these laws, as well as its expectations regarding other aspects of employee conduct and job performance. To the extent an employee fails to live up to the company’s expectations, these written policies will serve as a backbone to support any disciplinary action arising out of the employee’s behavior and can eliminate potential legal risk associated with that discipline.

This is certainly not a comprehensive list of issues emerging companies may face in the employment context, but recognizing these various complexities of the human resources function is a necessary step to building a successful workforce. If you have any questions about how these issues might impact your business, please contact the author.


Series: Key Considerations for Emerging Companies

Early stage companies have particular legal needs. Bass, Berry & Sims has advised such companies at all phases, from startup to IPO. Our Emerging Companies Practice Group is releasing a “Key Considerations” series, in which we will share our experience by outlining the most critical factors a company should consider in the most relevant subject areas. Previous installments in our series focused on:

Keep an eye out for future installments over the course of 2021.