For those of you who just joined in, I am a corporate partner at a Gunderson Dettmer – a Silicon Valley based law firm that works exclusively for technology companies and VC’s. I make my living working for startup companies but I want to help you spend less money on lawyers.
I spend an awful lot of time (usually on short notice the night before an important deal is supposed to close) fixing preventable problems. An awful lot of these problems relate to hiring, compensating and incenting early employees. All of them cost money and time that I would rather see invested in building teams and product.
Over the next few Wednesdays I’ll be posting a few short pieces that may help you avoid, last minute fire drills, unnecessary accounting or legal fees, angry investors and perhaps an occasional lawsuit or regulatory audit. Hopefully by highlighting a few of the most common employment related problems I can help you avoid them.
5 of the Dumbest (and costly) Mistakes Startups Make with Their People, Part 3
3. MISTAKE # 3 OF 5: Employees Versus Independent Contractors
Founders also need to be aware of the distinctions between employees and independent contractors/consultants.
Often, early stage companies will seek to characterize an individual as a consultant to avoid wage issues. Unfortunately under the law it is not as simple as calling someone a consultant and giving them a consultant agreement.
If the characterization is challenged, the relevant test can be complicated and is highly fact-specific looking at questions like whether the individual works for multiple firms, sets his/her own schedule, is obligated to comply with company policies, has to personally provide services, offers his/her services to the general public, etc. In short, if the individual acts like an employee, they may well be an employee under the law. The risk, of course, is that in characterizing an individual as an independent contractor, the company does not issue a W-2 and does not take income tax withholding or pay the employer portion of taxes like social security and disability.
If the individual is found to have been an employee, the Company will be on the hook for the failure to withhold taxes and there can be late penalties and interest as well.
In addition, you can find yourself right back in the position of having an overhang of potential claims for unpaid wages, overtime and other benefits.
Again, this is an area where startups need to be thoughtful about how they manage and document the issues. VCs may or may not flag these issues as being problematic for an investment. However, always keep in mind that the risk of adverse public companies or late stage companies who may be potential buyers may take a sharply different view of what level of audit risk is acceptable. Thinking through these matters upfront with someone who has “seen the movie before” (whether they be a business advisor, other entrepreneur or an attorney) is essential.
Next week I will address mistake #4 OF 5: Failing to File Those 83(b) Elections.