Two Employment Law Issues Startups Should Know About

by Varnum LLP

It's no secret that the first year of operation can make or break a startup. Don't let overlooked employment issues be your startup's downfall. Below is a brief overview of two major issues startups face in their first year.

Pay (and Classify) Your Employees Properly

It's not uncommon to see startups offer potential employees stock options in lieu of wages for the first year until the business gets off the ground. Unfortunately, this is absolutely illegal. Providing only equity in a business violates both state and federal minimum wage laws. Federal minimum wage is $7.25 an hour, however, Michigan requires at least $8.90 hour and is set to increase to $9.25 on January 1, 2018. Other states and municipalities have enacted their own minimum wage laws. Startups should be aware of the minimum wage for wherever they are doing business.

Moreover, it's important to know whether your employee is exempt or non-exempt from overtime compensation. Non-exempt employees are entitled to a rate not less than time and one-half their regular rate of pay for every hour worked in excess of 40 hours in a given workweek. Employees that make at least $455 per week and whose job duties fall in an exemption category such as computer or creative professionals are ineligible for overtime compensation. Additionally, employees cannot voluntarily waive their non-exempt status so don't ask them to.

Startups also regularly fail to properly classify their workers as employees instead of independent contractors. Sometimes this is merely accidental and other times it's a conscious decision by the employer to avoid paying overtime, various taxes, or employee benefits. Employers often use titles such as "consultant" or "freelancer" for their workers rather than considering them employees. Regardless of what title a startup uses, the primary differentiating factor between an employee and independent contractor is the degree of control the startup exerts over their work. The consequences for mischaracterizing a worker can range from a simple monetary penalty to criminal penalties of up to $1,000 per misclassified worker and one year in prison.

Use Restrictive Covenants to Protect Intellectual Property

Trade secrets and intellectual property are integral to a startup's business. Unfortunately, many startups fail to protect these assets through the use of restrictive covenants such as non-disclosure agreements (NDAs), non-solicitation agreements, non-competition agreements, or confidentiality agreements. If your startup has proprietary information, it is essential that you use restrictive covenants.

Crafting a restrictive covenant is a bit of an art form. An enforceable restrictive covenant should be narrowly tailored to protect a startup's business interests while also being reasonable enough that it will be upheld in court. And if you do business in a state other than Michigan, keep in mind that some states to do not enforce certain restrictive covenants. For instance, California will not enforce a non-competition agreement signed within the state. Startups should contact an attorney to assist them in drafting any agreements before having a new hire sign them.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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