U.S. Startups & Employment Law

Startup companies are particularly vulnerable to violating employment laws due to their limited financial resources and manpower. Typically, startups cannot afford a legal team or a human resources department, leaving them uninformed about the nuances of employment regulations. This lack of understanding can result in costly mistakes for these fledgling companies. Familiarity with employment laws, particularly wage laws, is an essential aspect of building and managing a team.

Most startups, during their initial phase, have a limited reserve of cash. To conserve this resource, startups may compensate founders and early employees solely with equity, which could lead to potential legal issues if it violates wage laws. This article delves into the various ways that startups may inadvertently violate these laws and exposes the company, its founders, directors, and officers to liability. It also offers guidance on ways to mitigate such risk.

In essence, startups should be aware of specific employment laws to avoid breaking them, and it is crucial to understand how to balance their compensation structure while abiding by these regulations. Failure to do so may lead to dire consequences for the company and its stakeholders.

The Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) is a federal law that establishes regulations for minimum wage, overtime pay, record-keeping, and child labor standards. This legislation applies to both full-time and part-time workers across a broad range of organizations, including private companies and government agencies. While the FLSA serves as a foundation for employment standards, state and local governments can also have their own unique employment laws.

In Washington State, the current minimum wage is $9.47 per hour, and for companies with fewer than 500 employees (including startups), the minimum wage is $11.00 per hour in Seattle, with an annual increase that will reach $15.00 per hour by 2021. Employers who fail to comply with these minimum wage requirements, and do not fall within any statutory exemption from paying minimum wage, may be subjected to legal action for unpaid wages. Wage claim disputes typically arise when a dispute occurs between an employee and the company. However, these issues can be significant when they do arise. For instance, Washington State provides for double damages for any unlawfully withheld wages, attorney’s fees, and costs related to the wage claim. It is also essential to note that equity does not count as wages within the context of minimum wage statutes, and therefore cannot be used to circumvent the wage requirements.

However, some exemptions to the FLSA exist. The top three exceptions include the Executive Exemption, Administrative Exemption, and Professional Exemption. Additionally, there is a Computer Professional exemption, which pertains to IT employees and can be relevant to startups.

Founders are corporate officers and therefore employees

As corporate officers, founders are also considered employees and are therefore entitled to compensation from the company. The IRS has a list of "statutory employees," and corporate officers are included on this list. As a result, it can be challenging, if not impossible, to classify a founder who is also an officer as anything other than an employee. If they are an employee, the company must comply with minimum wage requirements, unless they fall under an exemption, which will be discussed below. If a company fails to pay a founder at least minimum wage, there is a possibility that the former founder could pursue a wage claim against the company. Wage claims can be challenging to navigate and can result in messy legal disputes.

Many founders assume that majority founders are unlikely to sue the company because they would essentially be suing themselves. This may be true during the early days of a company, but as it grows and seeks investment, potential investors may require representations related to any outstanding or potential claims, including employment-related claims. This assumption can also become problematic, particularly with minority founders. Minority co-founders may have less of an incentive not to pursue wage claims against the company, and as a result, the risk of non-compliance with wage regulations is higher for minority co-founders.

Exemptions for certain employees

At the federal level, certain employees who are primarily engaged in executive, administrative, professional, or outside sales services may be exempt from minimum wage and overtime pay requirements. To qualify for these exemptions, the U.S. Department of Labor has established specific criteria that must be met. However, even if these criteria are met, the employer is still required to pay the employee a minimum amount of compensation. For example, an executive must be compensated a minimum of $455 per week.

This exemption is applicable on a federal level. However, Texas has its own policies in place regarding this exemption. Texas has outlined its own set of requirements for who qualifies as an "executive" employee. According to Texas policy, employers must comply with both state and federal regulations. In cases where there are differences between the state and federal regulations, the employer must follow whichever policy is more favorable to the employee.

To qualify for the minimum wage and overtime pay exemption in Texas, an employee must meet three specific criteria. First, the employee must receive a minimum salary of $250 per week. Second, the employee's primary duty must be managing the company. Lastly, the employee must regularly and customarily direct the work of two or more employees. By meeting all three of these criteria, the employee may be exempt from minimum wage and overtime pay requirements in Texas.

Exemptions for owners

The Fair Labor Standards Act (FLSA) provides an exemption for individuals who own 20% or more equity in a company. This exemption applies at the federal level and many founders fall within this category. However, the issue arises when it comes to Washington state law, which does not have a similar exemption. Therefore, for startups in Seattle, it is necessary to comply with the wage laws of both Washington and Seattle, rather than relying on the federal exemption.

To ensure compliance with wage laws and the proper classification of employees and contractors, it is crucial to review and understand the relevant regulations. During the early stages of a company, it is advisable to hire contractors for as long as feasible. Before hiring the first employee, employers must understand their obligations and ensure that they meet the minimum wage laws. Proper payroll setup, submission of tax withholdings to the IRS, and filing of any required employment tax returns with the IRS are also necessary steps.

It is important to note that founders are often considered "employees" by the IRS and state regulators. Therefore, even if the founders are the only employees, the company must comply with employment regulations. It is essential to always get the terms of the relationship between the company and the employee in writing. Handshake deals and informal, verbal agreements should be avoided as ambiguity concerning wage law claims almost always will be construed against the company.

In summary, these basic regulations are important to know for any startup looking to hire employees. Violating the law can result in costly fines and settlements in the case of a lawsuit.?

But startups should also know that the FLSA does not govern vacation, holiday, severance, sick pay, pay raises or fringe benefits. Nor does it govern the amounts of time employees receive for meals, rest periods, holidays, or vacations. The FLSA also doesn’t include regulations related to employee terminations such as requiring employees to provide a discharge notice, reason for discharge, or immediate payment of final wages. These are up to each company’s discretion.?

Equal Pay Act?

Although the Fair Labor Standards Act (FLSA) only mandates minimum wage and overtime pay, employers must still provide fair compensation, vacation, and benefits to their employees. The government enforces this through the Equal Pay Act, which requires that all employees receive equal pay for equal work, regardless of their gender.

This means that employers must pay men and women equally for jobs that require the same amount of skill, effort, and responsibility under similar working conditions. If there is a pay discrepancy, the employer cannot reduce another employee’s pay to resolve the issue. Instead, the lower-paid employee must receive a raise to bring them up to the same level as their counterpart.

Economic Realities Test?

Understanding labor laws can be a daunting task, but fortunately, the government has developed additional resources to help employers. One such resource is the Economic Realities Test, which was created to differentiate between a worker who is an independent contractor and one who is an employee. This test is essential in determining who is exempt from FLSA regulations.

Exemptions typically apply to executives, administrators, professionals, and information technology workers, most notably salaried employees at a company. For many salaried employees, mandates regarding overtime pay do not apply because their work is dependent on task completion rather than the number of hours worked.

It's a common misconception, even among lawyers, that salaried employees are automatically exempt. However, the exemption is based on job duties, not salary alone. The misunderstanding may have arisen because federal guidance on worker classification changed over time. In 2015, the Department of Labor issued informal guidance on the classification of independent contractors, but withdrew it in 2017. Consequently, many classification decisions are left up to the courts to decide.

For this reason, it's crucial for startups to familiarize themselves with labor laws and seek professional assistance when issues arise to protect themselves.

CONCLUSION

In conclusion, startups and early-stage companies often operate in a fast-paced environment with limited resources. In such an environment, it can be easy to overlook compliance with employment laws. However, it is crucial for startups to have a good understanding of these laws. Ignoring or neglecting employment law requirements can lead to costly lawsuits and damage the company's reputation. That's why startups should consider hiring an attorney who is knowledgeable about employment law. An attorney can help companies navigate the complexities of employment law, minimize the risk of litigation, and create policies that promote a positive work environment. With the help of an attorney attuned to the unique situations of startups and early-stage companies, startups can position themselves on the right side of the law and demonstrate to their employees and customers that they are committed to treating their employees fairly and ethically.