4 employment law mistakes startups can stop making today

As the old saying goes, your people are your business’ most important assets. And that’s true for startups as well.

As we’ve seen over the past several years, attracting and retaining talented workers remains one of the biggest challenges startups face. Without enough employees, finding product-market fit and scaling a business can be extremely difficult, if not impossible.

While startups like to “move fast and break things,” when it comes to building a workforce, it’s important to slow down and ensure you’re complying with employment laws and putting in place sound employment practices.

In this article, we’ll run through four employment law mistakes that startups should avoid making. But first, let’s review the scope of laws that may affect your startup as well as some of the risks of non-compliance.

Which employment laws apply?

All businesses have to figure out which employment laws apply to them. There are federal, state and local laws and regulations that may impose obligations on your startup, and these may be about everything from paid leaves to whether a non-compete agreement is enforceable.

The difficulty of figuring this out gets compounded when a business has different locations, because laws vary from state to state and city to city. Beyond jurisdictional distinctions, different laws and regulations will apply based on factors like the company’s size and number of employees. For many federal laws, 50 employees is an important threshold — for example, private employers with fewer than 50 employees are not covered by the Family and Medical Leave Act, but they may be covered by state family and medical leave laws.

The patchwork of various employment laws and regulations that may apply to your startup can be confusing. That’s why it’s important to focus on these issues and get help when necessary so your startup can understand and comply with its obligations.

The risks of non-compliance

Employment law is not an area you want to do-it-yourself. Sure, you can find plenty of employee handbook forms online that can shave off the cost of hiring an attorney, but the long-term costs of doing so can be far greater than any short-term savings.

Potential risks of non-compliance include:

• Fines: Government agencies can and will audit your business and levy fines for not being in compliance with various employment laws. For example, employers must verify I-9 employee eligibility verification forms and keep them on record in case of an audit. Fines for non-compliance can range from a few hundred dollars for a minor technical error to tens of thousands of dollars for a repeat, knowing violation.
• Litigation: Lawsuits by employees or former employees are among the most common legal disputes startups face, and these can significantly affect morale and reputation.
• Reputational harm: Even if a fine or lawsuit isn’t involved, employment-related issues can lead to significant reputational harm for a startup and its leaders. Consider what happened with digital mortgage broker Better.com and its botched mass layoffs, which led to a flood of negative coverage about how the company and its CEO was tone deaf, uncaring and out of touch.

To mitigate these risks, startups should avoid these four common employment law mistakes.

Mistake #1: Misclassifying employees

You may have heard about the class action lawsuit against Uber that it recently settled for $8.4 million. That case involved misclassification of employees, which, if not done properly, can lead lawsuits and significant government penalties. Some class action lawsuits even seek to hold the CEO personally liable under state wage and hour laws, or the federal Fair Labor Standards Act.

Classification involves treating a worker as either an employee or an independent contractor. It’s an important distinction, because if a worker is an independent contractor, the employer can avoid paying federal and state taxes, unemployment insurance and other costs associated with employment.

For a cash-strapped startup, it can be tempting to classify someone as an independent contractor rather than an employee because it saves money. But this is one of those areas where being penny-wise often means being pound-foolish. The costs of getting it wrong can be steep.

State and federal laws, as well as court opinions, draw the distinction between employee and independent contractor in different ways, but in general, it comes down to the issue of “control.” How much control does the employer have over the manner in which the work gets done — where, when, what and how? The more control there is, the more likely it is that the worker is an employee.

Mistake #2: Failing to pay overtime (or pay at all)

Many startup founders get their businesses off the ground through massive sweat equity. Hard work is part of startup culture. However, when workers hustle and grind but don’t get paid accordingly, problems can mushroom out of nowhere.

One common problem area is failing to pay salaried employees for working overtime. Just because an employee is salaried doesn’t mean they are not entitled to overtime pay. The key question is whether an employee is “exempt” — under the Fair Labor Standards Act, exemptions apply for employees in fields such as executive, administrative, professional, outside sales and computer-related occupations.

While it may seem that most jobs at a startup fall within one of these categories, as with the employee/independent contractor classification, it’s less about the title and more about the role itself when determining if an employee is exempt. The less autonomy and responsibility an employee has, the less likely it is they will be considered exempt. There are also state-specific and federal minimum compensation requirements that must be met for an employee to be considered exempt.

Other related problem areas include hiring unpaid interns, or utilizing “work now, pay later” deferred compensation or equity-only schemes. If someone is working for your startup, they must be paid. A promise to hire or pay later can lead to problems.

Mistake #3: Not putting it in writing

Mismatched expectations between employers and employees are the source of many employment disputes. Accordingly, when hiring, it’s a good idea to have a new employee sign an offer letter that describes their pay, benefits and responsibilities to avoid later misunderstandings regarding these issues.

It’s also important to document performance issues with employees. If you ever have to justify an employment decision or termination after the fact, such as in a wrongful termination lawsuit, having comprehensive records about the issues underlying a termination — with a focus on behaviors, not personality traits — can make a big difference in the outcome.

Finally, it’s important to keep in mind that contracts with employees cannot be used to circumvent employment laws.

Mistake #4: Using an employee handbook form from the internet

A poorly written employee handbook is often worse than no handbook at all. It can confuse employees, lead to inconsistent and ineffective workplace practices and policies, and create liabilities.

As alluded to above, don’t simply grab a form employee handbook off the internet and paste in your company’s name and logo.

An employee handbook is an important instrument that should document how your company operates, its unique policies and culture, and its expectations for employees. Because employment laws vary by state and locality, it must be contextualized for the legal frameworks of the jurisdictions your startup operates in.

Be proactive to set the stage for growth

Many startup founders are so busy trying to grow that they never take the time to lay a foundation for growth, an important part of which is establishing effective and compliant employment practices. By being proactive with addressing employment law issues early on, a startup can set itself up to scale more seamlessly.