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Five Common Employment Law Hazards for Start-Ups by MichaelL.Rosen Hazards forStart-Ups Employment Law Five Common

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Contents

Five Common Employment Law Hazards for Start-Ups...... 3

1. Exposure to Liability in the Hiring Process...... 4

2. Failure to Adequately Document Terms and Conditions of Employment...... 8

3. Misclassification Issues...... 10

Employee or Independent Contractor...... 10

Exempt or Non-exempt...... 13

4. Failure to Comply with Wage Payment Laws...... 16

5. Inadequate Protection of Intellectual Property...... 17

About Foley Hoag...... 21

Michael L. Rosen...... 21 “…advanced understanding and planning can do a great deal to minimize the downstream risks…” Five Common Employment Law Hazards for Start-Ups by Michael L. Rosen

Emerging, venture capital-backed companies typically face a host of legal considerations but have limited personnel and monetary resources to address all of them comprehensively. Often lacking in-house human resources and legal expertise, many emerging companies employ a “band-aid” approach to HR-related issues, addressing problems only as they arise. There are, however, a few common employment law issues as to which a bit of advanced understanding and planning can do a great deal to minimize the downstream risks of expensive legal headaches.

Distilled here are five employment law hazard areas that managers at early-stage companies often encounter. These areas, I have found, are where employment-related disputes most consistently arise at venture-backed start-ups.

3 4 Five Common Employment Law Hazards for Start-Ups

not simplytakethecandidate’s word thatheorsheisnotsubject as towhatimpactthe hiringmayhave.Thecompanyshould subject to,andshould involvelegalcounseltogivethemguidance finding outaboutprecisely what restrictions theirhires are already companiesneedtobeproactiveStart-up andorganized about hire wassubjecttothisrestriction. company maybeexposedtolegalclaims evenwithoutknowingthe already solicitedhisoldcustomersorco-workers,thehiring solicitation agreement. Inthelatterexample,ifnewhire has a restrictive covenant,suchasanemployeeorcustomernon- be anon-competitionagreement, of oritcouldbesomeothersort covenant thatthehiringemployerdoesnotknowabout.Thiscould A commonscenarioisanewhire thatissubjecttoarestrictive vexing legalproblems. A lackofcareful managementofthehiringprocess canresult in permanent recruiting mode,andtheyare anxioustobringintalent. previous employers.Small,VC-backedcompaniesoftenare ina conduct engagedinbytheseindividualsastheyleavetheir hires andtheirprevious employersandbecauseofproblematic because oftheexistencerestrictive agreements betweennew unwittingly gettingintolegaltrouble inthehiringprocess, both including litigation.Againandagainweseeemerging companies groundexclusively competitors—isfertile forlegalproblems, butnot The movementoftalentbetweencompanies—particularly 1 the HiringProcess Exposure toLiabilityin

Five Common Employment Law Hazards for Start-Ups 5

ndeed, simply asking a candidate a candidate simply asking Indeed, covenant. to a restrictive sufficient may not be non-compete he signed a whether obtain to straightforward is not so The situation information. relevant and employees is not precise, in this area because terminology signed in the past. Hiring what they have often do not understand discover what questions to ask detailed, direct companies should hiring companies be in place. Specifically, may existing restrictions agreements, non-disclosure about pre-existing should inquire of and assignment concerning developments agreements and non-solicitation agreements, inventions, non-competition whether any of these Companies also should ask agreements. equity- included in a candidate’s covenants are sorts of restrictive or in stock agreements), (option or restricted agreements related is any arrangements. If there bonus plans and/or commission in of post-employment restrictions question about the existence the need to obtain and review such documents, hiring companies assurances that, a candidate’s documents, rather than accepting agreement. a non-disclosure for example, he only signed Start-up companies need to be proactive proactive be to need companies Start-up out finding about organized and are hires their restrictions what precisely to…” subject already “ 6 Five Common Employment Law Hazards for Start-Ups existence of post-employment restrictions. determine whetherthecompanycanhire theemployeedespite Onceinhand,restrictive covenantsshouldbereviewed to “ and confidentialinformation.Thelastdecadehasseenanotable defendants inlawsuitsallegingmisappropriation oftradesecrets ensuring thattheydonotunwittinglyfindthemselvesnamedas restrictions, hiringcompaniesneedtobeespeciallyvigilantabout Whether ornotthecandidateissubjecttopost-employment liability intheeventthatemployee’s representation wasfalse. in thehiringdocuments.Thismayhelpinsulatecompanyfrom subject toarestrictive agreement, thatfactalsoshouldbestated to abidebyit.Iftheindividualhasrepresented thatheorsheisnot that theindividualissubjecttoaspecificagreement andis required contract. Inparticular, thecompanyshouldstateitsunderstanding letteroremployment its understandingandexpectationsinanoffer employment restrictions, thecompanyshoulddocumentprecisely Once adecisionismadetohire acandidatesubjecttopost- candidate’sparticular circumstances iskey. Careful considerationoftheapplicablestatelawasappliedto an assessment of the legal risks, if any, posed by the potential hire. within the same industry.” particularly where employees are moving and strategic approach to the hiring process, …hiring companies should take acareful T ypically, this will involve Five Common Employment Law Hazards for Start-Ups 7 increase in claims in this area, largely stemming from the evolution from stemming largely in this area, in claims increase ability companies’ in particular, workplace and, in the of technology of departing activities employees. the computer-related to track computer activities when now look at employees’ Many companies some instances using in notice of a departure, they receive employees to uncover activities that tools forensic sophisticated Because of these could not be detected. may have believed strategic and a careful companies should take practices, hiring employees are particularly where to the hiring process, approach moving within the same industry. the outset. from process This means managing the hiring clear instructions about what they can Candidates should be given they Ideally, and cannot do prior to starting with the new company. any not to take, delete or destroy should be advised in writing all of and to return information, documents, including electronic immediately upon termination. In property their prior company’s be given clear instructions about what addition, candidates should to have with customers and permitted are they contact, if any, they leave. Also, before co-workers about the departure hiring should never be made on the communications about the even if using a personal e-mail time or equipment, prior employer’s account. Such conduct can only raise suspicions about improper a hiring company may be exposed to several conduct. Ultimately, such as possible claims, even absent a non-compete agreement, tortious of fiduciary duty, breach of trade secrets, misappropriation and violation of with advantageous relationships interference federal and state computer fraud statutes. 8 Five Common Employment Law Hazards for Start-Ups

become a concrete agreement. gets properly documented, or a set of e-mails that never really companies are sued as a result of some conversation that never common source of disputes within start-ups. termination, and change-of-control contingencies — is a particularly equity rights — including vesting terms, exercise price, rights at should be spelled out clearly. agreement. employee’s execution of a non-disclosure/non-competition becoming available, or the fact that the hiring is contingent on the as the fact that the hiring is contingent on specific funding letter— generally anoffer should spell out any contingencies, such reason, withorwithoutnotice.”Second,thehiringdocument— may terminatetheemploymentrelationship atanytimefor “Y document thatfact.Thefollowinglanguagetypicallywillsuffice: letterorinitialemploymentagreementoffer shouldclearly company’s intentionistoretain employeesonanatwillbasis, — shouldaccomplishsomespecificthings.First,assumingthe letter,an offer employmentcontractand/orotherdocumentation documentation. Thatdocumentation—whetherittakestheformof early onsucharrangementsshouldbeformalizedwithbasic beginwithverbalagreementsstart-ups andhand-shakes.Ideally, document basictermsandconditionsofemployment.Many A related problem inthehiringprocess isthefailure toadequately ou will be employed on an at will basis, meaning that either party ou willbeemployedonanatbasis,meaningthateitherparty 2 T hird, the individual’s rights to stock or stock options Conditions ofEmployment Document Terms and Failure toAdequately T he failure to adequately spell out M any early-stage

Five Common Employment Law Hazards for Start-Ups 9

The failure to adequately spell out equity equity out spell adequately to failure The imilarly, at many emerging companies, commission and bonus and bonus commission companies, many emerging at Similarly, setting and as goal a work in progress, are arrangements This is an in flux. constantly are revenues about future expectations fuels disputes about what phenomenon, but it also understandable leaves. One common employee when he or she is owed to an the employee leaves the situation where is problem example of this realized. are revenues the but before a sale or profit, after making is terminated close to involves an employee who Another variation paid out. are bonuses year end, before following employment is of commission arrangements The problem It makes good sense early one with many companies. a recurring and to document how commissions on to do a little bit of thinking various contingencies. to be calculated given and bonuses are plans need not be complicated, Such commission and bonus by the A one or two-page plan, signed overly-legalistic documents. formula, and spelling out appropriate employee, documenting the of termination, can help avertwhat will happen in the event at termination. disputes about compensation rights…is a particularly common source of of source common a particularly rights…is start-ups.” for disputes “ 10 Five Common Employment Law Hazards for Start-Ups as timely payment of wage laws, minimum wage and overtime as timelypaymentof wagelaws,minimumandovertime including taxwithholdings andwagehourrequirements (such contractors istoavoid thesesignificantlegal requirements, employment relationship. Onereason companiesengage avoids thepanoplyoffederalandstate laws governingthe Fundamentally, aproper independentcontractor classification proposition tocuttiesbyterminatingthecontract. have enoughworktokeepherbusy, itisarelatively simple company latercannotafford topaythecontractorordoesnot ifthe utilize thestatusasakindofhedgeagainstuncertainty: desirethe parties tocontinueworking together. Othercompanies “probationary themtoemployeesif period,”andthentoconvert retain workersasindependentcontractorsakindof arrangement provides. Somecompaniesprefer toprovisionally number ofreasons tiedtotheperceived flexibilitysuchan services ofindependentcontractorsratherthanemployeesfora Early-stage companieshistoricallyhavebeenprone toengagethe Employee orIndependentContractor? laws. overtime of employeesasexemptfrom federalandstateminimumwage contractors (ratherthanemployees),and(b)themisclassification areas of risk are (a) the misclassification of workers as independent to appropriate classificationsofnewhires. Themostsignificant In manyemerging companies,managementisnotattentiveenough 3 Misclassification Issues Five Common Employment Law Hazards for Start-Ups 11 to assist employers in understanding whether they can to assist employers in understanding 1 n addition, In addition, laws. various discrimination and requirements) by health not covered are typically contractors independent of the costs plans, lowering employee benefit and other insurance for companies. these benefits about careful companies should be extremely But emerging contractors. Several years workers as independent classifying their this as the “Microsoft” to lawyers referred ago employment against Microsoft brought to a high-stakes case referring problem, misclassified, were workers of thousands that alleging 1990s the in this might Currently, in a $97 million settlement. ultimately resulting class in light of the well-publicized be called the “FedEx” problem, to its relating against FedEx Ground action cases filed nationwide of drivers as independent contractors. In alleged mis-classification that case, significant overtime may be due and other compensation claims. successful in their the drivers if they are 50-employee a with high as be to going not are stakes the Although significant under the multiple federal still are the risks company, an whether a person is considered and state laws that hinge on The Internal Revenue contractor. employee or an independent the “20-factor to as referred Service has issued what is commonly test” classify an individual service provider as an independent contractor. as an independent contractor. classify an individual service provider to which test, it focuses on the degree Also known as the “control” the worker with and control the right to direct the company retains and how the work is performed. This was to when, where respect the most basic issue: whether the company developed to address taxes. If the company gets that would have to withhold payroll it can be found liable for back taxes and penalties. wrong, 12 Five Common Employment Law Hazards for Start-Ups “ …not all salaried employees working in requirements of federal law.” an office exemptare from the overtime pay advisable toerronthesideofcaution.Employersare in betteroff tobefocusedontheissueearlyon,anditis It isimportant classified asindependentcontractorsare actuallymisclassified. Simply put,inmanyearly-stagecompanies,workerswhoare individuals are owedwagesunderstatewageandhourlaws. providers canfileforunemploymentbenefits,andwhether under worker’s compensationpolicies,whetherterminatedservice whetherindividualsoughttobecoveredtest. Theselawscanaffect Massachusetts —havelawsthatare more stringentthantheIRS many states—including,forexample,Californiaand not coverindividualswhoare independentcontractors.Inaddition, Employee Retirement IncomeSecurityAct(ERISA),allofwhichdo Employment Act),theFamilyandMedicalLeavect, (Title VII,AmericansW compensation),theemploymentdiscriminationlaws and overtime including theFairLaborStandards Act(concerningminimumwage A numberofotherfederallawsalsohingeonthisclassification, ith DisabilitiesAct,geiscriminationin Five Common Employment Law Hazards for Start-Ups 13 o be exempt from federal overtime (and minimum wage) law, an federal overtime (and minimum wage) law, o be exempt from many instances hiring the person, spelling out the terms and the the terms and spelling out the person, instances hiring many part-time provisional, employment (including of his or conditions avoiding the and arrangements), employment and temporary altogether. problem misclassification Exempt or Non-exempt? is the problem contractor/employee Akin to the independent law complying with federal companies are question whether tech many emerging n particular, I overtime pay. regarding that because their the mistake of assuming companies make paid a all of their employees are “white-collar” and are workforces not worry about overtime they need issues for any salary, working in an officeemployees. In fact, not all salaried employees of federal law. the overtime pay requirements exempt from are LSA) mandates that Act (F The federal Fair Labor Standards rate of pay to times the regular companies pay one and one-half in excess of 40 during a work week, employees for hours worked Many early-stage “exempt.” who are except for those employees FLSA based on the prevalent companies lose sight of the or applies to factory workers misconception that the FLSA out a timesheet or punch a clock, “blue-collar” workers who fill a highly-skilled, high-salary job. not white-collar workers in T and a duties test. employee must satisfy both a salary requirement is two-fold: that the employee be paid on The salary requirement $455 per a “salary basis,” and that the salary be a minimum of be paid at week (except that exempt computer employees may basis at a least $455 per week on a salary basis or on an hourly rate not less than $27.63 an hour). 14 Five Common Employment Law Hazards for Start-Ups requirements. Forexample,manyclerical,administrative and duties threshold to be considered exempt from overtime Simply put,manypositionswithinsmallcompanies donotmeetthe of Labor’s regulations. salary mustmeetalltherequirements oftheU.S.Department an exemptiontoapply, anemployee’s specificjobdutiesand descriptions) donotdetermineexemptstatus. Inorder for tests regarding theirjobduties. Jobtitles(andevenwrittenjob of theseexemptions,employeesgenerallymustmeetcertain “outside sales”and“computeremployees.”T as “professional,” “executive”or“administrative,”andforcertain exemption exists only for employees who properly can be classified requirement thatismostproblematic foremployers.Theovertime Moving pastthe“salarybasis”requirement, itisthe“duties” is notavailable. and abletowork,deductionsmaynotbemadefortimewhenwork exemptioncanbelost.Iftheemployeeisready,overtime willing an employee’s absence—the paybecauseofapartial-day from anemployee’s predetermined salary—forexample,docking hours worked.Iftheemployermakesimpermissibledeductions anywork,regardlessemployee performs ofthenumberdaysor employee mustreceive thefullsalaryforanyweekinwhich employee’s exceptions,anexempt work.Subjecttocertain be reduced becauseofvariationsinthequalityorquantity weekly, orlessfrequent, basis.Thepredetermined amountcannot a predetermined amountofcompensationeachpayperiodona Being paid on a “salary basis” means an employee regularly receives o qualifyforone Five Common Employment Law Hazards for Start-Ups 15 s the company grows and roles are more more are roles and grows company the s A hose damages can be doubled if the violation violation the if doubled be can damages hose T start-up should think about this issue not only as it hires hires it as only not issue this about think should start-up clearly differentiated, companies need to continue to reassess the reassess companies need to continue to clearly differentiated, particular individuals jobs within the company and determine whether purposes. overtime for classified being properly are roles those in start-ups issue both at hire should consider the exemption Ideally, as a (for particular jobs) and on a yearly basis (for the workforce planning and legal in which some proactive whole). This is an area legal trouble. analysis can avoid significant downstream employees, but as it expands its workforce and creates new roles. roles. new creates and workforce its expands it as but employees, employees who wearEarly on, many start-ups have one or more multiple performing (and tasks multiple in engaging hats, different basis. daily a on jobs) was willful and a prevailing party is entitled to attorneys’ fees. fees. attorneys’ to entitled is party prevailing a and willful was be difficult, situation can Rectifying a misclassification because they that going forward, must inform such workers management and eligible for overtime. as non-exempt going to be treated are in these situations, inherent Putting aside the morale issues and how to compensate these companies must decide whether “overtime” worked. employees for previous A technical employees do not satisfy the relevant tests. Companies Companies tests. relevant the satisfy not do employees technical for unpaid can be liable as exempt employees that misclassify hours for compensation half-time (additional compensation overtime or two a over week) work particular any during 40 of excess in period. three-year 16 Five Common Employment Law Hazards for Start-Ups personally liablefor failing topaywages. andevendirectorsstates, individualmanagers,officers, canbe attorneys’ feesforfailure totimelypaywages.Inaddition,insome be significant.Manystates’lawsimposemultipledamages and unenforceable under many states’ laws, and liability in this area can agree to defer their wages temporarily. sales-based revenue injectionmaywanttoasktheiremployees cash-poor companies waiting for the next round of financing or for a T not enforceable inmanystates. their rightsinthisarea, aswagedeferralagreements generallyare wage liability. Employeesgenerallycannotagree inadvancetowaive understand isthatthere islittleflexibilityinthearea ofstatutory like a technicality, getting it wrong is actionable. must be paid no less frequently than bi-weekly. monthly orevensemi-monthly(twicepermonth)basis,butrather I generally isnotgovernedbyfederallaw, widely. andstatelawsdiffer frequency andmannerofpaymentwagestoemployees.Thisarea companies shouldbeaware ofthevaryingstatelawsconcerning payment ofwagesandtheproblem ofwagedeferrals.Inparticular, Emerging companiesshouldbesensitiveabouttheissueoftimely n his issue is particularly a concern for emerging companies, as M 4 assachusetts, for example, hourly workers cannot be paid on a Wage PaymentLaws Failure toComplywith S uch agreements are W W hile this may seem hat is important to

Five Common Employment Law Hazards for Start-Ups 17

of Protection Inadequate Property Intellectual

5 walks out property intellectual that a company’s It has been said leave the building. The day when its employees the door every employees is its is entrusted to a company’s information that start-up companies do not do lifeblood. All too often, however, and customer intellectual property their own enough to protect Unfortunately, company. their employees leave the goodwill after to this crucial issue. some companies take a superficial approach offer letter and use a standardized companies Many emerging of focused on non-disclosure agreement, intellectual property inventions, and in some instances, information, assignment of As a starting restrictions. non-competition and non-solicitation necessary to point, this may suffice, vigilance are but planning and such enforce in an optimal position to that companies are ensure down the road. agreements that one size does not necessarily A starting point is to recognize fit all, particularly and non- when it comes to non-competition thought to give careful Companies should solicitation agreements. to particular employees or job agreements tailoring restrictive …companies should consider defining what they they what defining consider should …companies rather activity ‘competitive’ be to consider any joining from employees barring simply than company.” the with ‘competes’ that employer “ 18 Five Common Employment Law Hazards for Start-Ups “ confidential information.” program to protect trade secrets and other …companies should develop acomprehensive California salespersonitsstandard NewY such, aNewY State lawcanvarysignificantlywith respect tothesematters.As maximize thelikelihoodthatthisargument willbeaccepted. the former employee’s actions; agreements should be drafted to will be arguing that its confidential information is at risk based on attempting to enforce a restrictive agreement in court, the company developments, customer lists, business plans etc.” Ultimately, when boilerplateabout“inventionsand typical (andimportant) consider to be confidential, proprietary information, beyond the companies should give careful thought to defining what they joining any employer that “competes” with the company. “competitive” activity rather than simply barring employees from companies should consider defining what they consider to be agreement is more likely to be enforced in court. categories ofemployees,asamore focused,narrowly-tailored classes, rather than using a boilerplate agreement provided to many ork companycannotsimplygiveanewly-hired ork agreement andtell S imilarly, A nd Five Common Employment Law Hazards for Start-Ups 19 n California, In California, ork law. nc. has a new hire sign an offer letter stating that Inc. has a new hire idgetronics, her that she is going to be subject to New Y to be subject she is going her that California and unenforceable almost always are non-competes another choosing a provision courts not recognize generally will consider formulating companies must As a result, law. state’s they of the states in which to the specific laws tailored agreements have employees. by process about the need to be careful In addition, companies example hypothetical a is Here signed. are agreements these which by start-ups in this area: encountered of a major pitfall W the offer the company’s is conditional on the person signing the company fails However, non-competition agreement. standard a week after the individual to sign the non-compete until to require he starts defeat the work. In some states, this lapse may is supported by adequate agreement that the argument company’s the may undermine therefore legal consideration, and it non-compete. of the enforceability initial documentation process, Looking past the hiring and to protect program a comprehensive companies should develop doing Ultimately, and other confidential information. trade secrets when seeking prospects a company’s so will significantly improve of such covenants and/or claiming theft of restrictive enforcement information. This should include the development and regular education and training of dissemination of a confidentiality policy, access (via issues, restricting employees on intellectual property locks etc.) to sensitive information to those employees passwords, (both who need such access, and labeling confidential documents copy and electronic). hard 20 Five Common Employment Law Hazards for Start-Ups employee’s departure. chances ofprotecting itsintellectualproperty followingavalued T compliance withthosepromises. restrictive covenantsandthecompany’s expectationsabout about theexistenceandcontinuedapplicabilityofemployee’s communicating totheformeremployeeandhisnewemployer instances anappropriate IP-protection process willinvolve of theneedtopreserve evidenceofthatactivity. Finally, insome challenges involvedininvestigatingelectronic activityandbecause recovery maybeadvisable bothbecauseofthetechnical expert departure. Inmanyinstances,retention ofathird-party data the employee’s computer-related activitiespriortohisorher immediate considerationshouldbegiventoactuallyinvestigating about theoutgoingemployee’s conductand/orintentions, and hard copiesofdocuments.Ifthecompanyhasanysuspicions possessed, includinglaptops,PDAs,storagemedia(discs,drives) whatever companyproperty and informationthepersonhas ensure thatthecompanytakesstepstoobtainimmediately confidentiality policiesandagreements. Theexitprocess should document thatreminds workersoftheirobligationsunderexisting should betheconsistentuseofterminationchecklistorexit agreements andpolicies.Asignificantcomponentofthisprocess groundwork forthepossibilityoflaterenforcement ofexisting In addition,companiesshoulddevelopanexitprocess thatlaysthe aking allofthesestepswillsignificantly improve acompany’s Five Common Employment Law Hazards for Start-Ups 21 ith a deep understanding understanding deep a ith W ashington, and the the and ashington, W assachusetts join with a network of of network a with join assachusetts M altham, altham, W is a leading law firm in the areas of dispute resolution, resolution, dispute of areas the in firm law leading a is ome 250 lawyers located in Boston, Boston, in located lawyers 250 ome LLP S nterprise Center in in Center nterprise E undi law firms to provide global support for clients’ largest challenges and and challenges largest support global clients’ for provide to firms law undi M merging merging ex ex Michael L. Rosen 617 832 1231 m [email protected] Click the image below for a full biography. Click the image below for a full About the Author About Foley Hoag About Foley Hoag E of clients’ strategic priorities, operational imperatives, and marketplace marketplace and imperatives, operational priorities, strategic clients’ of energy technology, high biopharma, the in companies helps firm the realities, sectors gain competitive financial services and manufacturing technology, advantage. L information visit foleyhoag.com. opportunities. 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