Risky Business: Three Costly Employment Law Myths Among Startup Companies

Startup companies, whether early-stage or more mature, share several common myths about employment laws in California. These myths, if not debunked and corrected, can create potentially crippling consequences for these companies including expensive and time-consuming employee lawsuits, governmental audits resulting in stiff penalties, and failure to pass potential investors’ and/or acquirers’ due diligence processes. Here are three such myths and truth behind them.

Myth #1: We can classify all our non-full time workers as independent contractors.

In the startup world in particular, there is a belief that a worker is automatically an independent contractor if he/she works part-time, assists temporarily on a discrete project, or provides services on as-needed basis. However, the hours in the day or the frequency in which the services are performed are secondary factors that are not determinative of independent contractor classification.

In California, the most significant factor in determining classification is whether the employer/business retains the right to direct and control the manner and means in which the work is performed. Thus, even if a worker is brought on temporarily to help with a project, what is more important to the analysis is whether the startup trains and actively manages the worker, tells him/her when and where to work, and retains unilateral authority to end the working relationship.

There are also several other secondary factors that may be considered; these can include whether the worker is performing services that are integral to the company’s product or service; if the worker’s responsibilities are similar to or the same as those being performed by employees; and if he/she is working at the office utilizing the company’s equipment, electronic resources, and/or information systems.

There are significant financial repercussions for misclassification, including expensive lawsuits by workers, EDD and IRS audits resulting in payment of back taxes and significant penalties, and liability for medical care expenses for misclassified workers who were not covered by the company’s workers’ compensation insurance.

Myth #2: We can have our employees defer their compensation or pay them in equity alone.

Startups have been known to ask employees to defer their earned wages to a later date such as when a round of funding closes. Additionally, emerging companies have offered to pay employees exclusively in stock or stock options. Both of these alternative compensation scenarios are unlawful in California, and can subject employers to costly lawsuits for unpaid wages. Under California laws, employers must pay their employees at least minimum wage for work performed. Further, if employees work more than 8 hours a day or 40 hours a week, employers must then pay those employees overtime.

Myth #3: We can pay all our employees a salary.

In response to the overtime requirement, I often hear another common myth related to compensation: We will just pay our employees – regardless of position and responsibilities – a salary so we don’t have to worry about overtime. To receive a salary, an employee’s actual duties need to meet the criteria for exemption proscribed by law AND meet the minimum salary requirement.

There are three main exemption categories: executive, licensed professional, and administrative. There are also a few position-specific exemption categories such as computer software specialists and outside salespeople. Each category has its own multi-factor duties test that must be met in order to qualify for the exemption.

The administrative category is the most commonly misused exemption; it in fact does not apply to most administrative professionals. It is limited to those who perform office or non-manual work directly related to management policies or general business operations, customarily and regularly exercises discretion and independent judgment (a.k.a. has the authority to make independent choices, free from immediate direction or supervision and with respect to matters of significance), and assists an owner/executive or performs specialized tasks that require training and education or works on special assignments and tasks under only general supervision.

Even if one’s job duties fit the criteria for one of the exemptions, that employee must also meet the minimum salary requirement; the employee must earn a monthly fixed salary equivalent of no less than double the state minimum wage for full-time employment (approximately $37,440 currently and $41,600 by January 1, 2016). Just a few weeks ago, the computer software specialist exemption salary minimum was raised to $87,185.14 effective January 1, 2016.

Thus, if an employee’s actual duties AND wages do not qualify him/her for an exemption, then that employee cannot be paid a fixed salary; instead he/she is a non-exempt employee who must earn an hourly wage for actual hours worked, is entitled to overtime compensation, and subject to other wage and hours laws (i.e. meal and rest breaks and recordkeeping for time worked).

Should you wish to discuss this article further or have legal questions about your startup company, please contact Shivani Sutaria at shivani@sutaria-law.com and 408/406-8208.