Chapter 4: Hiring Employees
Recordkeeping, reporting, and notice obligations are the most important tasks for when you begin hiring employees. This chapter will provide you with an overview of the essential federal requirements when hiring employees. Since compliance with state law is also required, you will need to contact your state’s labor office to obtain additional information. Consulting with a knowledgeable employment attorney is the best route to ensure full compliance with state and federal law.
The scope of employment law when hiring employees is considerable. It includes wages, safety, citizenship, family and medical leave, whistle-blowing and many other areas. It applies to all employees, with additional protections given to those in certain groups. Protected classifications include race, religion, disability, age, gender, marital status, national origin, ancestry, pregnancy, sexual orientation, gender identification and a number of other classes. Employment requires legal compliance in areas too numerous to discuss in this limited space. Some of the more important areas to pay attention include the following:
- Hiring employees, retention, termination, and references
- At-Will Employees and Employee Contracts Independent Contractors
- Discrimination and harassment
- Family and Medical Leave Act (FMLA)
- Citizenship Wage Laws and Compensation (including stock options)
Hiring Employees, Retention, Termination, and References
Each year, thousands of claims are filed with the Equal Employment Opportunity Commission (EEOC) alleging discrimination in connection with hiring or firing decisions. The most important thing an employer can do is to meticulously document each step when it comes to hiring employees, retention or termination process.
This means taking detailed notes about relevant matters such as their professional demeanor, their job-related experience, and the ability to communicate effectively. These notes can protect you in the event you are later sued for some alleged discrimination. Developing protocols for hiring employees, retention, and termination that are employment law compliant will minimize your exposure to unnecessary litigation.
Occasionally an employer will need to terminate an employee who is not performing up to expectations or who creates a hostile work environment. For example, an employee who continually demonstrates bias against a coworker because of the coworker’s race, gender, religion, or sexual preference should be terminated.
When references are requested from a terminated employee’s potential future employer, responses should be provided only in writing to the specific requests. It is advisable to obtain legal counsel to guide you in drafting a reply.
Recruiting top talent is time consuming and costly. When you have finally identified the candidate who offers the most promise to your business in terms of skill, experience and overall good fit, the last thing you want to do is lose them to a competitor.
Onboarding is a vehicle that – when used effectively – can transport your new employee from a date prospect to a fully committed partner. In a nutshell, it is basically corporate acculturation. Once upon a time it was more commonly known as “orientation”.
But it is actually so much more: onboarding can be a company’s secret weapon when implemented properly.
Employee retention is almost invariably rooted in successful integration. When you invest time into thoughtfully blending hiring employees into the admixture of your company’s culture, you are creating a stronger corporate alloy.
For startups, onboarding can be perplexing since your culture is still embryonic. At its core, however, bringing on a new employee is about walking your talk and basic sensitivity. It means being authentic and verifying representations you made during the interview process about who you are and what you are about. If you told your recruit that ‘the team’ hangs out together for trivia Thursday at the local eatery, then follow through with an invitation.
Managers should be available almost on demand for the first month or so. Tools and resources needed for the job should be readily accessible. Including new employees in meetings – no matter how informal – and sharing important information with them is crucial to minimizing fractures. Building a cohesive organization that pulls together in the same direction not only builds trust and stimulates innovation, but also can serve as an inoculation when headhunters try to lure away your valuable employees.
When your new employee starts their first day, go beyond setting up their office space with the basic tools. Think about the extras: a personal welcome note, an invitation to lunch, a new coffee mug and some company swag, company tickets to an event – all these personal touches reinforce that your recruit made the right decision.
Of course you will need to move beyond that first day with consistent action. Creating a positive environment requires a regular effort. It can be as simple as expressing gratitude with a thank you note, company t-shirts for the employee’s kids, or simply getting a few minutes of face time to check in and recognize contributions and accomplishments.
The majority of states recognize at-will employment when businesses hire employees. This means that either the employer or employee is legally permitted to terminate employment at any time. Furthermore an employer is entitled to fire an employee for any reason that does not violate any laws or regulations. An employee who has a contract is an exception to the at-will rule. An employee who has a contract can only be fired for “good cause.” There are two types of contracts: actual and implied. An actual contract is a written contract. The contract may specify the reasons for which an employee can be terminated or it may simply state “only for good cause.”
- An employee handbook or manual that includes a statement about employees becoming permanent after a certain probationary period
- A statement made by a supervisor during the hiring or evaluation process that creates a promise or condition that the employee can be terminated only for good cause
The meaning of “good cause” is determined by the jurisdiction’s laws and the specific facts of the case. Generally it means that employment can be ended only because of business-related goals or needs.
Some Good Examples of This Clause:
- Violating company policies
- Revealing confidential information or trade secrets Criminal activity
- Poor job performance
- Creating a hostile workplace or harassing coworkers Endangering health or safety
Finally, employers who are bound to a contract are obligated to observe the duty of good faith and fair dealing. An employer’s breach of this duty requires extreme behavior such as falsifying a record of poor performance or terminating employment to avoid financial or legal obligations such as eligibility for health insurance or stock options.
Offers of Employment
An offer of employment letter can create a contract or simply be a vehicle for clearly communicating expectations when hiring employees. If you do not wish to to enter into a legally binding contract with a prospective employee, then that needs to be unequivocally communicated in the offer of employment.
Engaging an employment law attorney can help you avoid inadvertently creating a contractual relationship, while documenting the terms and conditions of employment. At a minimum, there should be a clear statement that the relationship will be deemed at-will, which allows either the employer or employee to terminate employment for any reason that is not illegal.
You will also want to avoid using any language that discusses “the future” or “job security.” Salary should be expressed in weekly or monthly increments, not in terms of an annual amount.
Specify that the employment is contingent upon compliance with state and federal law, as well as company policy. For example, documentation that proves eligibility to work in the United States is a legal requirement. For citizens it is likely completion of an I-9 form; for legal residents, it would be the appropriate work visa. Additionally, drug screening and background checks might also be required as a matter of law or company policy. Executing a nondisclosure agreement would be an example of policy.
The advantages of a company using employment agreements include attracting and retaining top talent for a relatively significant period of time. On the other hand, if the employee becomes less productive during the contract and actually winds up costing you money, you could back yourself into a corner where the only options are to suffer the loss or risk litigation as a result of termination.
An employment agreement is a legally binding contract between the employer and employee, usually reserved for senior level managers and executives. It could be in the form of an offer of employment letter, or a more formal contract document. What is most important to understand is that as with most contracts, there are advantages and disadvantages.
Accordingly, it is vital to ensure that you have a well-crafted employment agreement with reasonably limited contract terms. Two of the most critical components are duration and cause for termination.
Duration should be limited to one to two years, or defined by the completion of a specific project. Of course, circumstances could dictate a longer term, for instance when hiring a CEO or CFO. No matter what the term of employment is or how it is defined, responsibilities and performance goals should be as specific as possible.
Grounds for termination should also be carefully drafted to allow the employer adequate latitude to dismiss the employee if that becomes necessary. Reasons to terminate can include business need (e.g., there is no longer a need for the position and the costs of maintaining the employee on contract will be financially detrimental to the business); or, it can address the employee’s specific failure to satisfy the job requirements or meet performance objectives. Breach of loyalty, confidentiality and similar violations should also be grounds for termination.
Benefits should also be specified in detail. These include vacation, sick days, personal days; life, health and disability insurance; stock options, vesting and golden parachutes; retirement accounts; continuing education and any similar job perks.
Nondisclosure provisions should also be incorporated when hiring employees. These should address all confidential and proprietary information without limitation. Proprietary information includes intellectual property (patents, trademarks, copyrights), trade secrets, drawings, billing methods, client lists and virtually anything related to the core competencies of your company and its competitive advantages. It is imperative to include a clear statement that confidentiality and nondisclosure obligations survive the employment relationship. This limitation serves to protect your proprietary information and trade secrets even after an employee no longer works for your company.
Similarly, a clause that limits the employee’s post-termination ability to recruit employees from your company should also be incorporated. State law varies on restricting a former worker’s ability to solicit vendors or employees of a business, so you will want to obtain legal guidance from an employment lawyer on the language and enforceability of this type of provision.
Assignment clauses are crucial to ensure that the ownership of any work (e.g., intellectual property) that is generated by the employee is assigned to the business. For example, if the employee procures a trademark or patent during the employment term, the employee must agree to promptly assign all rights and ownership to the company.
Alternative dispute resolution should also be required. Arbitration or binding mediation are particularly effective at reducing cost and minimizing business disruption.
Since employment agreements do bring some risk to to employers, you will want to engage an employment law attorney to help you minimize exposure to liability. Rather than viewing this as a cost, think of it as a value added service that can protect your business from unnecessary litigation.
Employers need to pay particular attention to independent contractors. This is an especially thorny area that has resulted in confusion for many employers.
The challenge results from the substantially higher costs associated with maintaining traditional employees. An employer is required by law to pay for unemployment, Medicare, and social security taxes for each employee. On the other hand, independent contractors are not subject to these payroll taxes, which can become quite costly for employers.
Many employers decide to hire an “independent contractor” to test their abilities prior to hiring them as an employee. The mischaracterization – whether intentional or unintentional – often results in some expensive consequences including back wages and the application of payroll taxes with interest and penalties. Criminal sanctions are also a possibility.
Distinguishing between an independent contractor and an employee can be dicey even for the most well-intentioned employer when thinking about hiring employees. The following list represents just a few guidelines issued by the U.S. Supreme Court that are considered to be only some of the more weighty factors in determining employee status:
- The degree of control an employer has over the work – the more control an employer has over how a worker performs work will favor an “employee” designation
- The extent to which the worker can or does provide similar services to other businesses – working exclusively for one employer will lean in favor of “employee” status
- The permanence of the relationship – established relationships will suggest an “employee” designation
- Investment – the more tools (e.g., phones, computers, software) an employer provides to a worker will tilt in favor of “employee” status
Navigating through the murky waters of accurate employee classification can result in a shipwreck. Startups are, therefore, cautioned to work closely with an attorney to ensure proper classification of a worker as either an independent contractor or an employee.
Safety, Privacy & Discrimination: How to Keep Your Employees Safe
Employers are required to provide a safe work environment – whether in or outside the office. This requirement obligates employers to ensure that employees are outfitted with safety equipment where needed, and that they are well trained about how to properly use the equipment.
The Occupational Safety and Health Act (OSHA) is the federal agency charged with overseeing and enforcing workplace safety. Mandatory standards for specific industries and activities must be observed. The use of caustic or toxic substances in the workplace will trigger the employer’s obligation to complete material safety data sheets (MSDS).
Since OSHA is known to make unannounced inspections at all types of workplaces, it is vital that you know both OSHA and your state’s safety requirements. Make sure that you create and enforce written safety policies and that your employees are adequately trained.
This area captures a wide range of activities including drug and alcohol testing, internet and email monitoring, searches, and security cameras. Sometimes these actions are warranted by the nature of the business when hiring employees.
For instance, a small pharmaceutical research and development (R&D) company may be developing a proprietary treatment for a specific disease that could potentially displace competitors; or a high tech startup could be creating a unique technology that promises to transform digital mobility. Both of these types of businesses have proven to be vulnerable to corporate espionage.
If you are a high tech startup or any other business where R&D or the development of any new proprietary product or service is sensitive, you will need to protect your company and its valuable assets. Security cameras, monitoring, and searches are available options.
There are also many businesses that do not have the option when hiring employees: they are required by law to install surveillance equipment, monitor employees, and possibly even conduct routine testing and searches.
Fixed Discrimination and Harassment
Special attention is required here. Federal anti-discrimination laws apply to companies with 15 or more employees. However, state law varies considerably.
Since you are required to comply with both federal and state laws, you will need to learn state requirements as soon as you begin hiring employees. This is because some states’ discrimination and harassment laws apply to a business with just one employee.
Multiple states also provide employees with additional discrimination protections that are limited or even nonexistent at the federal level. It is therefore crucial to learn what your state’s discrimination laws are since state employee protections can often be greater than the federal safeguards.
Family and Medical Leave Act (FMLA)
This law entitles “eligible” employees of “covered” employers to take unpaid leave for legally specified reasons without losing their job or health insurance coverage.
For startups with fewer than 50 employees: good news – the law does not apply to you. There are two main exceptions to this rule. If you are deemed either a successor in interest or joint employer, you may be on the hook for FMLA compliance. This is not typically the case, but you should make certain by checking the requirements at both the federal and state levels.
For companies that have hit the 50 employee mark: federal and state compliance is mandatory. Unfortunately, this is another area where there can be a considerable difference between federal and state laws. The safest route for an employer to take here is to observe whichever one provides the employee with greater rights.
This can actually be tricky for companies just approaching or surpassing 50 employees. What happens when you are bouncing around that 50 employee mark as companies often do – e.g., when new hires put you above 50 but then you subsequently drop to 49 and just continue to hover over that threshold?
The FMLA’s answer is that the law applies if you have had at least 50 employees during 20 or more calendar workweeks in either the current or preceding year. It is important to note that the workweeks do not need to be consecutive, so special care is required here.
Like many other regulations, the FMLA is a skein of rules that requires an employer’s strict attention. As your company approaches 50 employees, you will want to obtain legal guidance to ensure your full compliance.
The Immigration Reform and Control Act (IRCA) prohibits employers of any size from discriminating based on citizenship or immigration status in connection with hiring, firing, or recruiting. Employers are therefore not permitted to ask whether an applicant is a citizen prior to offering employment.
At the same time, IRCA requires employers to verify an employee’s identity and employment eligibility. Specifically it requires that an I-9 form (Employment Eligibility Verification) be completed for each employee. These should be requested only after an individual is hired to preempt illegal discrimination claims. However it is completely legal to advise applicants of these requirements by including a statement on the employment application that all persons hired will be required by federal law to verify their employment eligibility.
IRCA also prohibits discrimination on the basis of national origin. This additional qualification applies to even small employers with as few as four employees.
Wage Laws: The Fair Labor Standards Act (FLSA)
The FLSA establishes the legal requirements for minimum wages, overtime pay, child labor, and recordkeeping. The standards apply to both full and part-time employees.
The Act exempts certain employees from minimum wage and overtime pay provisions, while it exempts others only from overtime requirements. For example, professional, executive, and administrative workers are exempt from both the overtime and minimum wage requirements, while commissioned employees in service industries are generally exempt only from overtime pay provisions.
Under the Act, employers must pay non-exempt employees a minimum wage of $7.25 per hour. However where state law provides for a minimum wage above $7.25 per hour, the Act requires the employer to pay the higher rate.
Employers are permitted to require an employee to work more than 40 hours a week, as long as non-exempt employees are paid one and one-half times their regular hourly wage for all hours worked beyond 40 hours. Exempt employees are not covered by this standard.
FLSA employers are legally required to conspicuously place FLSA posters where they can be conveniently read by employees. If you employ a person with a disability, then the Employee Rights for Workers with Disabilities/Special Minimum Wage poster is also required to be displayed in an easily accessible place.
Additional labor and employment posters may be required by both federal and state law. Again, it is imperative to speak with a qualified attorney about other postings you may need.
FLSA employers are required to maintain specific records for each exempt and nonexempt employee. While there is no required form, records must contain certain information about the employee, wages, hours, and other mandatory information including:
- The employee’s full name and social security or other identifying number
- Full address
- Date of birth
- Gender and occupation
- Time and day of week when employee’s workweek begins
- Hours worked each day and total workweek hours
- Basis on which wages are paid (hourly rate or weekly salary)
- Regular hourly pay rate
- Total weekly straight-time earnings
- Total weekly overtime earning
- All additions to or deductions from the wages
- Total wages paid each pay period
- Date of payment and pay period covered by the paycheck
To ensure full compliance with federal recordkeeping requirements, employers need to review the regulations, which can be found at www.dol.gov. Additionally, state laws and regulations will also need to be consulted in order to guarantee compliance.
Record retention requirements include maintaining payroll records and sales and purchase records for a minimum of three years. Wage computation records are required to be kept for two years. This includes wage rate tables, work and time schedules, time cards, and records of deductions from or additions to wages.
There are no specific reporting requirements under the FLSA. The only general obligation is to store the records either at the place of employment or central records office; and further to make the records open for inspection by designated government officials who may need access to the records.
Penalties and Sanctions
The enforcement mechanisms available to the Department of Labor have some sharp teeth, so meticulous compliance with FLSA standards is essential. Penalties for violations include payment of back wages, steep fines, and sometimes imprisonment.
Using Stock, Stock Options and Restricted Stock Units As Compensation
Using stock, stock options, or restricted stock units (RSUs) in lieu of or as a supplement to compensation is a common practice among bootstrapped startups. However, creating and administering a legally compliant options or RSU program is expensive. Additionally, minimum wage laws prohibit an employer from substituting stock and options for pay where wages fall below the minimum standard.
Defining Equity, Stock and Shares: The Ins and Outs of Sharing Ownership
There is no financial or legal distinction between stock and shares. Stock is a catchall term, used generally to refer to owning an unspecified number of shares in a company.
Shares is more specific, referring to how a company’s stock is divided. Owning stock in a corporation means you own a specific number of shares.
Equity is also often used to describe ownership in a company. Equity can mean stock or shares, although it is increasingly used to refer to stock options or RSUs as well.
Stock options give you the right to buy a certain number of shares at a certain price after a certain amount of time. They do not represent ownership, however, unless your right to buy them has vested. Until then, there’s no equity.
Equity is also used to refer to ownership outside the corporate business structure. For instance, you might own equity in your house, which is generally the difference between its value and what you owe. For non-corporate businesses (e.g., partnerships), equity is determined by subtracting liabilities from assets. For instance, if you and your business partner are 50/50 owners, and your business assets are $300,000 and your liabilities are $100,000, that leaves $200,000 of business equity, with each partner’s equity valued at $100,000.
Stock is a type of equity that’s commonly referred to as an equity investment. When you buy stock as an equity investment, you’re expecting its value to increase and to derive income from its dividends or the profit you make from its sale (capital gains).
Since the terms are nearly synonymous, you might think of equity as the umbrella term that means an ownership interest whether expressed as stock or not. Shares are one expression of equity, but not the only kind since you can own equity in a non-corporate business or investment property.
Creating an Options Program
If you are planning to offer employees any of these options, you need to work closely with legal counsel to avoid numerous pitfalls. For instance, tax consequences could be unintentionally triggered resulting in a costly impact to the recipient. Additionally, exercise prices for options must be determined in accordance with the intricacies required by IRS Code Section 409A. These programs further necessitate third-party valuations and legally compliant administration.
For all these reasons – and more – stock options and RSUs make the most economical sense only for more sophisticated startups with a developed staff. This means having an organization with both managerial and non-executive positions.
Stock Options vs. RSUs
Stock options essentially give you the right to buy shares at a certain price (the strike price) after a vesting period – typically, after your one year anniversary date. The key here is that you must purchase the options. The goal is for the stock to appreciate by the time the option can be exercised. If the value of the stock has eroded at the time of exercise, then it becomes worthless.
This does not happen with RSUs, a relatively new financial creature. Similar to options, there is a vesting period where the employee must satisfy certain conditions before the stock or its value is transferred (typically, there’s a period of time and other conditions – e.g., work performance). Unlike stock options, no purchase is required. Instead, a certain number of units are allocated – or granted – to the employee, but there’s no value or funding until after the employee has satisfied the vesting requirements.
After vesting, RSUs are transferrable if the employee accepts the grant. Therefore, these instruments always have a value, in contrast to options that can decline in value by the time of vesting. The value of RSUs is the closing market value of the stock price on the vesting date. That is also the point at which tax liability is triggered, requiring the payment of withholding and income tax on the amount received.
Using Stock, Options and RSUs As Compensation
The most important thing to know here is that stock, options, and RSUs are not considered compensation when determining minimum wage and FLSA compliance. As mentioned, the federal minimum wage is $7.25 per hour and higher in many cities and states.
If you are using stock or options in lieu of or as a supplement to compensation, there is a considerable risk that you are violating state and federal minimum wage laws. Since wage and hour litigation is skyrocketing, it is crucial that you properly classify and compensate your hiring employees.
Using stock, options, and RSUs is permissible as long as you are complying with federal, state, and local minimum wage laws. Obtaining sound legal guidance when hiring employees will help you avoid the inadvertent violation of minimum wage requirements that could capsize your business.
Protecting Confidential Information and Trade Secrets
Protecting your confidential and proprietary information and intellectual property (IP) is paramount for many startups, particularly when hiring employees in the high tech field. These valuable assets not only endow a business with competitive advantages, but also are considered property that can used as collateral for securing financing.
Noncompetes, nondisclosures, and confidentiality agreements are some of the most common tools employers use to protect their IP and proprietary information after hiring employees. However, some of these restrictive covenants have fallen out of legal favor in recent years.
For instance, noncompetes are increasingly invalidated by courts, usually on the grounds that their geographic scope and length of time are unreasonable. In some states – for example, California – noncompetes are legally invalid. Moreover, including a noncompete provision in a contract or other agreement could expose an employer to tort liability. Because of their general unenforceability, many employers are using alternative vehicles to address concerns about protecting confidential information.
Nondisclosure and confidentiality agreements can provide robust legally protection of a company’s trade secrets and IP. These contracts are actually the same type of agreement with different names. Other names that are used include Secrecy Agreement and Proprietary Information Agreement (PIA).
The most important feature of a reliable nondisclosure agreement (NDA) is describing what information is confidential. This can encompass patent applications and trademark registrations (both filed and not filed), financial information, directories, methodologies, vendor and customer lists, and business strategies.
NDA provisions must be narrowly tailored to serve the legitimate interests of a business. Overreaching can result in the agreement being invalidated, so skilled drafting is absolutely essential to ensuring a legally enforceable contract. State law varies widely on the mechanics and validity of NDAs. Using qualified legal counsel to help you draft your NDA is strongly advised.
Chapter 4 Checklist
In summary, we covered how to…