Hiring Your Startup’s First Employee | The In’s and Out’s of the First Hire

The following is a guest post from fnBlog Contributor Matthew Faustman, founder of UpCounsel.  Check out other great startup advice like Startup Legal Tips and Free Legal Documents at the UpCounsel Blog.

This guide covers hiring an at-will employee in California, but can have general applicability in other states.  It was created by 2 California employment attorneys independent of UpCounsel.  Hiring your first employee is a big project because there are a number of additional administrative tasks. The physical work can be taken care of in half a day, but the whole process can take up to 1 week.  The following guide has 16 steps, but many can be accomplished at the same time or on the same day.  Major legal concerns include intellectual property protection, state and federal labor regulations and the freedom of terminate the employee at-will.

Legal Documents You Will Need

• Employee Offer Letter
• Confidentiality and Intellectual Property Assignment Agreement
• Board Minutes and Equity Agreement for options or restricted stock (Optional)

Before you Begin

1. Make sure your company is formed
2. Adopt Employee Stock Incentive Plan (Optional for Corporations)

1.  Get an EIN (Recommended) ~ 5 mins

• Explanation: An Employer Identification Number (“EIN”) is your businesses tax ID. Like a Social Security number for an individual it is what the government uses to keep track of your business.
• What to do: Go to the IRS EIN website and fill out the application – your EIN will be generated and sent to you within minutes.

2.  Employee Interview (Optional)

• Explanation: Interviews are sometimes utilized by employers in one fashion or another. There are federal and state regulations regarding what can be asking in a job interview.
• What to do: Avoid any question about legally protected categories such as sexual orientation, age, religion, race, gender, national origin, or disability.
• Major Legal Concerns: Asking any of the above questions could be considered a form of discrimination and is illegal which may lead to a lawsuit. Yes, even startups can be subject to such lawsuits under these standards.

3.  Background Check (Optional)

• Explanation: An employer is free to gather certain background information on a potential new hire. As a general rule, a pre-employment background screening firm should not provide an employer any information that an employer could not ask about at a face to face job interview such as sexual orientation, age, religion, race, gender, national origin, or disability.
• What to do: Use a reliable 3rd party background service.
• Major Legal Concerns: Asking any of the above questions could be considered a form of discrimination and is illegal. Yes, even startups can be subject to such lawsuits under these standards.

4.  Draft, Sign & Send Employee Offer Letter (Recommended) ~ 15min

• Explanation: A letter from the company to a prospective employee offering employment in the company under certain terms. Typical terms found in the offer letter include: the employee’s start date, salary/wage, options, benefits, and that the employee is an at-will employee. An employer would choose to use an Offer Letter over an employment contract as one way to ensure that there is no misunderstanding that the relationship is “at-will.”
• What to do: Draft/Sign/Send Employee Offer Letter to the potential employee and have them sign it and return it to the company. You can specify in the offer letter when you would like to have the offer letter signed and returned by.
• Major Legal Concerns: Ensuring there is language in the offer letter pointing out that the relationship is “at-will.”
• Example Doc: Employee Offer Letter

5. Draft & Send Confidentiality and Intellectual Property Assignment Agreement (Recommended) ~ 15min

• Explanation: Primarily assigns to the company any future intellectual property related to the company developed by an individual founder while that founder is at the company. It is a common practice for all founders, officers, managers, employees and consultants.
• What to do: Send the drafted and signed Confidentiality and Invention Assignment Agreement to the potential employee along with the Offer Letter.
• Major Legal Concerns: Failing to properly execute this agreement may allow your employee to openly discuss your company’s secret intellectual property and walk away with company related intellectual property that they created during their employment if they are ever terminated.
• Example Document: Confidentiality and Invention Assignment Agreement

6.  Employee Starts First Day of Work

7.  Give Equity To Employee (Optional for Corporations) ~ 30min

• Explanation:  A company may wish to grant options or issue stock to an employee. The company will need to have an employee stock option plan in place. See Creating and Understanding Your Employee Stock Option Plan.
• What to do:  Wait until AFTER the employee has started his/her first day of employment. Have the Board approve an equity grant to the employee and then have the employee sign an agreement granting them the equity. Equity can be in the form of an option or restricted stock.

8.  Employee Eligibility Verification (Recommended) ~ 15min

• Explanation: Federal law requires employers to verify an employee’s eligibility to work in the United States. This is typically done by having the employee complete an I-9.
• What to do: Within three days of a employees start date, have the employee complete an I-9 form and supply photo copies of approved documentation like a passport or social security card. The I-9 is not sent to any government agency, but must be kept on file for three years after the date of hire or one year after the date of the employee’s employment termination, whichever is later.
• Major Legal Concerns: Failing to keep an I-9 on file can result in fines if your company is audited.
• Gov’t Form: Official I-9 Form

9.  Distribute California Wage Theft Act Protection Information (Recommended) ~ 5min

• Explanation: Under the Wage Theft Protection Act of 2011 employers must provide each employee at the time of hire with a written notice with language from the Act informing them of certain wage rights in California.
• What to do: Distribute written notice to employee on their first day of work.
• Major Legal Concerns: Failing to distribute notice can result in fines or a potential lawsuit under the Act.
• Gov’t Form: Notice to Employee

10.  Register with California’s New Hire Reporting Program (Recommended) ~ 15min

• Explanation: The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 requires all employers to report newly hired and re-hired employees to a state directory within 20 days of their hire or rehire date.
• What to do: A new hire can be registered with the California e-services for businesses. Registering with the service takes a few minutes and process is relatively painless.
• Major Legal Concerns: Failing to register a new employee can result in major fines from the state.

11.  Set up Payroll and Records for Withholding Taxes (Recommended) ~ 2hrs

• Explanation: The IRS requires an employer to make certain witholdings from their employees payroll and keep records of employment taxes for at least four years. This includes properly filings W-2s, W-4s and state tax forms. These services are usually provided through any reputable payroll service.
• What to do: Payroll and employment tax accounting can certainly be done on their own. Again, most payroll services will perform these services as part of their product.
• Major Legal Consequences: Improperly withholding employee taxes can result in fines from the IRS.

12. Set up Unemployment Insurance Through Payroll (Recommended) ~ 30min

• Explanation:  The Unemployment Insurance Program funds unemployment payments. The UI program is 100% funded by employers who pay taxes on wages paid to employees.
• What to do:  Have your payroll service deduct Unemployment Insurance in each payroll period.

13.  Set Up Disability Insurance Through Payroll (Recommended) ~ 30min

• Explanation: California State Disability Insurance funds short-term disability income replacement. The costs of the program are covered by taxes paid by employees, optionally by employers.
• What to do: At the option of your employees have your payroll service deduct Disability Insurance in each payroll period.

14. Obtain Workers’ Compensation Insurance (Recommended) ~ 1hr

• Recommended: Businesses with employees are required to carry Workers’ Compensation Insurance coverage through a commercial carrier, on a self-insured basis or through the state Workers’ Compensation Insurance program. Entrepreneur has put together a great Worker’s Comp 101 tutorial for all your beginners that want more information.
• What to do: Workers Comp insurance can be taken out at years end or during each pay period through a payroll provider.

15. Post Required Notices (Recommended) ~ 30min

• Recommended:  Employers are required by state and federal laws to prominently display certain posters in the workplace that inform employees of their rights and employer responsibilities under labor laws. These posters are available for free from federal and state labor agencies. Visit the Workplace Posters page for the specific federal and state posters you’ll need for your business.
• What to do:  Print and post the Federal Postings, CA State Postings and local postings (for example San Francisco requires you to post the city’s minimum wage posting).
• Major Legal Concerns:  Failing to post these notices can result in fines if your business is audited.

16. Comply With Local Labor Ordinances (Recommended)

• Explanation: Many major cities have employment ordinances which go above and beyond the state requirements. For example, California requires a minimum wage of $8.00, but San Francisco requires a minimum wage north of $10.00.
• What to do: Guides for San Francisco, Los Angeles and San Diego are being created now by our attorney network. They will be available in the near future.

DISCLAIMER

 A version of this post first appeared on Jan 9th, 2012.