Employee & Consultant Considerations for Start Ups

The following is an excerpt from The Start-Ups & Emerging Companies Guidebook, a preliminary discussion on best practices and strategies for start-ups and emerging companies to easily leverage.

A founder’s success may hinge on selecting a group of like-minded and passionate individuals to join the business.  After all, as Steve Jobs reminds us, “a small team of A+ players can run circles around a giant team of B and C players”. The following is a summary of the steps customarily taken to memorialize the relationship between personnel and the company, and certain considerations that should be accounted for when hiring employees and engaging independent contractors and consultants.  

Memorializing the relationship

A company can engage its personnel as independent contractors or hire them as employees.  Whether an individual is an independent contractor, or an employee, is a state law issue, but generally, an independent contractor: (i) charges fees for the service provided, (ii) is engaged strictly for the term required to perform the specific service, (iii) retains control over how the work is performed, and (iv) is responsible for their own taxes and benefits.    

An employee, by contrast, is an individual who is subject to significant oversight by the company, meaning that the company can exercise control in the method and manner of how the work is performed. Additionally, an employee is: (i) paid wages and is eligible for company sponsored benefits, (ii) is employed for a continuous period of time, (iii) pays a large portion of their taxes through amounts withheld by the employer, and (iv) is protected by applicable federal, state, and local employment laws. A misclassification of independent contractors and employees can expose a company to significant liability.  

An employment relationship can be established through many forms including an offer letter or an employment agreement. Employment agreements are usually reserved for executives and management-level employees, while an offer letter is more commonly reserved for non-management employees who have more straight-forward employment terms. However, an offer letter can contain the same or similar terms to an employment agreement if so desired.

The engagement of an independent contractor is oftentimes established under the terms of a consulting agreement although an independent contractor arrangement may exist on invoice terms short of a full consulting agreement. While there may be some overlap between the terms of a consulting agreement and an employment agreement, a properly drafted consulting agreement will explicitly state that the independent contractor will not participate or be eligible to participate in a company’s employee benefit plans and that the independent contractor shall be responsible for the payment of their own taxes.

Employment Terms

Employment agreements address the following: (1) compensation and benefits, (2) title or position, duties, responsibilities, and authority, (3) restrictive covenants and intellectual property assignments, and (4) any other conditions and terms of employment particular to the relationship.  In most cases, employment will be “at will” as opposed to a guaranteed term of employment and should expressly state the same.

Compensation and Benefits

An employee’s agreement with a company in any form should clearly state the base salary or wages of the employee and may include a mechanism for adjustment of such pay during the term of employment. Compensation can also include a commission component, in which case a commission plan should be included or referenced in the agreement.  

If the employee is eligible for a bonus, the document should indicate the bonus entitlement and the conditions or objectives that need to be satisfied for any bonus to be paid (e.g., whether the bonus is discretionary, based on individual performance, based on company performance, or any combination of the foregoing).

In some cases, bonuses are offered pursuant to an existing bonus plan for similarly situated employees. A discretionary bonus allows the employer the most flexibility, while a performance-based bonus includes a more defined set of criteria (such as individual and company-wide KPIs or revenue targets).  In some cases, a bonus may be subject to claw-back if the employee fails to stay employed by the company for a minimum amount of time (i.e. a signing bonus) or subject to forfeiture if the employee is not employed on the date of payment (i.e. an annual bonus).               

Compensation can also include a grant of equity, in which case the offer package should include the amount and type of equity the employee is eligible to receive, the conditions to receipt or ownership of the equity (such as vesting), and that the grant of the equity is subject to the terms of any applicable equity plan and award agreement and the terms of any other documents governing the relationship among owners of the company.                    

Finally, the employment documents should recite the employee’s entitlement to participate in the company’s benefit plans. This can be accomplished by detailing each plan or, by generally stating that the employee is entitled to participate in the benefit plans offered to similarly situated employees.  Employees may identify certain fringe benefits or “perks” that they would like in addition to any standard benefit package clearly delineated.

Positions and Duties

The employment documents should include the employee’s official title and a description of their duties and responsibilities. Supervisory and reporting relationships can be addressed as well.                  

An employment agreement for a full-time employee will require the employee to devote all of their working time to the employer. However, sometimes an employee will need the flexibility to participate in activities outside of work, such as philanthropic activities, serving on the board of another company, or speaking at conferences. Addressing such permitted activities up front will reduce the likelihood of a dispute later in the employment relationship.  

Restrictive Covenants and Intellectual Property Assignment

Restrictive covenants can be included in an employment agreement or in a separate restrictive covenant agreement entered into at the time employment commences. Restrictive covenants address the non-disclosure of confidential information, non-competition, non-solicitation of clients and other employees, and non-disparagement.                 

A non-disclosure or confidentiality provision typically obligates the employee to maintain the confidentiality of, and not disclose, the employer’s trade secrets and confidential information. These provisions can last in perpetuity and frequently require the return of all of the employer’s information and property upon the termination of employment.

Non-compete provisions impose restrictions on the employee during the term of their employment, and for a period following the employee’s termination. These provisions are limited to prohibiting employment in a competing business generally or by a defined group of competitors, in each instance for a defined time-period and oftentimes in a defined geographic area. The breadth of a non-compete can be heavily negotiated and exceptions may be required based on an employee’s particular situation. Further, the reasonableness of the duration and scope of a non-compete agreement is something that courts are sensitive to when faced with disputes concerning the enforcement of a non-compete agreement. It is important to note that most states have restrictions, and some have outright prohibitions on the enforceability of non-compete agreements and others have taken this issue under consideration.            

Non-solicitation provisions generally prohibit an employee from seeking to hire, retain, or create a contractual relationship with any employee, customer, client or business partner of the employer. These provisions are intended to help an employer maintain its business and revenue and protect its confidential information and trade secrets, but can have the effect of being a non-compete and thus subject to challenge.                   

A non-disparagement provision generally restricts an employee from making negative statements about the employer and its officers, employees, customers, clients and business. These provisions typically last in perpetuity. Sometimes, a non-disparagement provision creates a mutual obligation on the employee and the employer from making any negative statement about the other.              

Overall, restrictive covenants are governed by state law and can pose challenges in enforcement.  Careful attention must be given to the scope and duration of the restriction to increase the likelihood (or the extent) of enforceability.   

Termination

At some point, the employment relationship may expire or terminate, and the employment documents should identify those circumstance.  Agreements can expire at the conclusion of a specified term, subject to any renewal options, or be terminated: (i) without cause by the employer, (ii) with cause by the employer, (iii) upon death or disability of an employee, (iv) upon an employee’s resignation without good reason, and (v) upon an employee’s resignation with good reason.  These are all negotiated concepts, especially the definition of cause and good reason, and often involve negotiated severance obligations. Additionally, certain states have laws imposing requirements on termination of employees.   

Intellectual Property Assignments

Intellectual property assignment agreements are an important document in the employment relationship and are covered in further detail in the Intellectual Property chapter of The Start-Ups & Emerging Companies Guidebook. As a brief overview, intellectual property assignment agreements are presented to service providers and provide that the service provider assigns to the company all relevant intellectual property rights that have been created or will be created in conjunction with their service to the company, so that the company is the rightful owner of the intellectual property necessary to operate the business. An intellectual property assignment provision can also be directly incorporated into the employment document itself. Intellectual property assignment agreements should be used in connection with both employees and independent contractors.

Employee Handbook

In addition to the documentation setting forth the terms of employment of an employee, many companies will, and sometimes are obligated by state law to, adopt an employee handbook.  An employee handbook is an internal document distributed to employees that provides, among other information, an overview of the company’s policies, procedures, benefits, and code of conduct for employees. Employee handbooks can include policies on a variety of topics applicable to all employees and the workplace, including without limitation: (i) equal employment opportunity policy, (ii) anti-harassment and anti-retaliation, (iii) disability accommodation, (iv) payroll and compensation, (v) expense reimbursement, (vi) dress code, (vii) code of conduct, (viii) attendance and remote work, (ix) social media, (x) internet use, (xi) vacation and paid time off, (xii) parental leave, and (xiii) Covid-19/communicable illness policies. States may vary on the minimum required components and policies that must be included in an employee handbook.

Continue reading more in The Start-Ups & Emerging Companies Guidebook.