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Perspectives on issues affecting founders, startups and investors from Matt Bartus, a veteranstartup lawyer in Silicon Valley, CA

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How to avoid the top 10 employment mistakes made by

startups

On February 18, 2010, inEmployment,People issues, by Matt Bartus

The California business environment is highly employee-oriented and can be quite unforgiving

to the unwary new employer. Additionally, employment law compliance issues are notnecessarily intuitive by nature. The cost of even a single employment-related lawsuit can spell aquick end for most startup companies, so avoiding this type of liability is critical. Moreover, youmay feel very close to your employees, and may even believe that they are family, but dont

kid yourself into thinking that familymembers dont sue one another. Ever see Kramer vs.Kramer? Family members sue each other all the time, and todays family member istomorrows adverse party in litigation if they perceive that they have been wronged in a way that

can be made right through legal process. Accordingly, in an effort to avoid providing fodder to

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your local plaintiffs employment lawyer, below is a list of the top ten mistakes most commonly

made by startups.

10. Failure to document poor performers. I have three words for employers dealing withpoorly performing employees: document, document, document! Many startup employers

complain that they are too busy, too small, or to congenial a working environment to formallydocument poor performance. However, failure to document poor performance saddles startupemployers with one of two problems: either retaining a poor performer longer than necessary (inorder to develop the necessary documentation) or risking an expensive lawsuit upon terminatinga poor performer without sufficient documentation of the legitimate business reason for thetermination. If you want to keep a coaching session with one of your poor performers low key,but document it, too, then try having the low key coaching session and just follow up in an emailby saying something to the effect of, it was good talking with you today about [insert problemhere], and Im glad that we were able to identify that the best solution going forward is to [insert

expectation of conduct or performance here]. Let me know if I can be of further assistance inachieving that goal. Thus, what has the hallmarks of a congenial email actually puts a date/time

stamp on a document that identifies the problem and sets forth the expectation of the employeessolution to implement. It has the added benefit of demonstrating the senders willingness to workwith the employee to achieve improvement.

9. Failure to properly train employees and managers. Startup entrepreneurs typically tell methat they lack the time and resources to train employees and managers. Accordingly, many well-intended and hardworking people get thrown into the deep end and are left to sink or swim on

their own. Given the time and resources that are devoted to hiring (headhunter fees, or, at thevery least, interview and ramp-up time, etc.), failing to follow through with training to set thenew-hire up for success is short-sighted and costly. Moreover, management skills are not genetic,they are learned. If you are not teaching your managers how to manage consistent with the lawand the culture you are developing at your startup, then you are not giving your managers thetools they need to lead and succeed. Simply put: entrepreneurs that are genuinely interested inbuilding companies with a lasting legacy understand the importance of training, even whenbudgets are tight and schedules are busy. Accordingly, set time and resources aside to insure thatyou are incorporating training and skills-building into your corporate culture.

8. Failure to pay unused but accrued vacation in an employees final paycheck. InCalifornia, when an employer decides to terminate an employees employment, the law requires

that the employer provide the terminated employee with their final paycheck on the day oftermination. That final paycheck must include all wages earned, including accrued, unusedvacation. Failure to pay the full final paycheck, including unused vacation, subjects the employerto waiting time penalties under the California Labor Code. Those penalties are equal to one

day of pay (at the employees regular rate) for every day the employee awaits their proper finalpaycheck after termination, up to 30 days. As a practical matter, that means that if an employermiscalculates or otherwise fails to pay even a single day of vacation that is owed in the finalpaycheck, they are liable for up to six weeks of regular pay to that employeeone days pay forevery day the employee waits to receive the proper final pay, for thirty days of pay (which iswhy it is six weeks of pay rather than one month). Since there is no work around, this is one of

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those things that companies just have to get right. So, double check at termination that you aregetting the final paycheck right, whether the termination is voluntary or involuntary.

7. Implementing overreaching restrictive covenants in employment agreements. One of themost common practices in Silicon Valley that gets companies in trouble is the use of offer letters

and confidentiality agreements obtained from a friend or, more likely, a prior employer, that arelegally outdated and have overreaching restrictive covenants. The types of restrictive covenants Iam referring to are provisions such as noncompetes, customer non-solicits, and employeenonsolicits. First, apart from a very few exceptions (such as the sale of a business), noncompeteagreements are void and unenforceable as against public policy in California. So, to begin with,for California employees, get rid of any noncompete provisions in your employment agreements.Second, customer non-solicits have recently been subject to a lot of judicial scrutiny and are onlypermissible where an employer can legitimately establish that their customer list rises to the levelof a trade secret (which is no easy standard). Thus, customer non-solicitation provisions must becarefully thought out and drafted, if incorporated at all. Third, employee non-solicits, whilepermissible, should not include no-hire provisions. There is a tremendous legal difference

between a prohibition on soliciting your employees and a prohibition on hiring your employees.If your employees reach out to the former employee and make first contact, then Californiaspublic policy in favor of employee mobility makes any purported no-hire agreementunenforceable. Finally, the fact that these types of provisions overreach means that they are notonly unenforceable, but that they can give rise to liability in the form of an unfair businesspractice claim. Thus, the risk is not merely that the agreement wont work, but that it will give anenterprising plaintiffs lawyer a legitimate basis to sue your startup. Therefore, get good legal

advice on how far to go with restrictive covenants in your employment agreements to avoidoverreaching.

6. Failure to investigate employee allegations of harassment and discrimination. Wheneveran employee makes even the most benign allegations of harassment or discrimination based ontheir membership in a legally protected class (e.g. race, sex, age, disability, religion, etc.),employers are obligated to promptly conduct investigations into those allegations and, whereappropriate, take corrective action. Most startups ignore this legal obligation, short-circuit theprocess, or fail to document the fact that they have conducted a prompt and thoroughinvestigation of the complaint (and any corrective action taken). Without intending to sound toodramatic, when an employee utters the words harassment or discrimination, startups should

perk up their collective ears and know that something potentially serious is happening thatrequires a speedy, but careful, response. If the use of those buzzwords is in relation to a legallyprotected classification, then promptly conduct an investigation: a) interview the complainant,any witnesses, and the alleged wrongdoer; b) review relevant policies and physical or electronicevidence in support of, or contradicting, the allegations; and, c) arrive at a conclusion (even ifthat conclusion is that the results are inconclusive) and take appropriate corrective action.

Finally, document the interviews and each step of the investigative process so that you candemonstrate compliance with this important legal obligation. If your startup does not have thebandwidth or expertise to conduct and document such an investigation, then bring in someone tohandle it. The cost of the third-party investigator pales in comparison to the cost of a lawsuit forfailure to investigate a claim of harassment or discrimination (or the evidentiary damage done in

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a discrimination/harassment lawsuit where the failure to investigate is the icing on the cake fromthe perspective of plaintiffs counsel).

5. Non-compliance with mandatory postings. One of the easiest and most often overlookedcompliance aspects of employment law are the state and federal posting requirements. It is a

misdemeanor punishable by fines and/or imprisonment if you fail to comply with postingrequirements. Compliance can be achieved simply and for less than $100 by going towww.calbizcentral.com and clicking on employment posters. While you are there, order your

compliance pamphlets that are a requirement of California law as well. It just doesnt get any

easier than this.

4. Misclassifying employees as salaried employees exempt from the overtime provisions

of the wage and hour laws. You know you are likely getting this wrong if all of the employeesat your startup are exempt, salaried employees. By default in California, all employees are non-exempt, hourly employees entitled to overtime pay for any hours worked over 8 in a day andover 40 in a week. Even if someone would qualify for an exemption from the overtime

provisions of the wage and hour laws, you cannot get in trouble for classifying them as non-exempt hourly workers and paying them overtime. However, the opposite is not true, and clientslarge and small struggle with the issue of who must be paid overtime and who can be exempt.While there are many more exemptions from federal and state wage and hour laws than can becovered here, the most widely used by far are the so-called white collar exemptions. Thesefour exemptions, often referred to as the executive, professional, computer-relatedprofessional and administrative exemptions, exist in both federal and California law (though

the requirements differ between the two) and are the four exemptions most commonly used bystartups. Some requirements are common to each of these white collar exemptions (e.g.

regularly exercises discretion and independent judgment ), whether under California or federallaw, but each is a fact-specific inquiry that must be thoughtfully applied prior to making aposition exempt from the overtime provisions of the wage and hour laws.

3. Failure to provide meal and rest break periods to non-exempt employees. Because startupemployers are operating on lean budgets and trying to be as productive as possible with everydollar and every hour, they commonly fail to provide meal and rest break periods to their non-exempt, hourly employees (including failing to provide these breaks because they havemisclassified the non-exempt, hourly employee as an exempt, salaried employee as set forthabove). In a typical 8 hour workday, California law requires that companies offer a minimum of2 ten-minute breaks and both federal and California law generally require a 30 minute mealbreak. Moreover these breaks need to be provided at appropriate intervals in the workday, ratherthan being combined and taken as one large chunk of non-work time during, or at the end of, theday. Penalties accrue for every day that the employer fails to provide these breaks, so it is criticalthat startup employers utilize an appropriate mechanism for capturing not only the hours worked,but additionally, when the meal break was taken, and an attestation that the meal and rest breakswere provided (signed by the employee). The best way to do this is with a thoughtfully craftedtimesheet that requires all of the meal and rest break data be included alongside the calculation ofthe employees hours worked.

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2. Improper classification of an employee as an independent contractor. Most businesspeople believe that all you need to do to effectively hire an independent contractor is enter into

a written agreement stating that the relationship is an independent contractor relationship (asopposed to an employer/employee relationship). Unfortunately, what seems like it should be asimple matter of contract is anything but! By law, virtually anyone providing services to a

company (with some exceptions for volunteers to 501(c)(3) charitable organizations) ispresumed an employee, thereby requiring that the employer pay payroll taxes for them, takenormal withholdings, and provide employee benefits to them insofar as they are qualified toparticipate under the companys health and welfare plans. During these tight budgetary times,state and federal regulators are scrutinizing these situations far more closely because of thepotential lost tax revenue associated with misclassifying an employee as an independentcontractor. While state and federal agencies approach the classification of workers asindependent contractors a bit differently from each other, the primary issue that usually drivesclassification is how much control does the company have over the worker in question? Themore control the company has, the more likely it is that the worker is an employee. If the workeris required to come to the office, use company equipment, and is supervised closely by a

company manager, dont kid yourself into thinking that they are an independent contractor.Another way clients misclassify employees as independent contractors, is when they want to tryit before they buy it. By that I mean, they want to bring a worker on as an independent

contractor for a few months and then convert them to an employee once they are satisfied that

the person is a good fit. Unfortunately, most companies that do this make no change to the jobthe converted employee is doing or to how they are doing it. So from a legal perspective, what isan employee post-conversion was likely always an employee, just a misclassified one.Unfortunately, the state and federal tests for establishing a true independent contractor have toomany factors to go into in this article, but if you are unsure whether someone is or isnt properlyclassified as an independent contractor, good legal advice can save you lots of money in the longrun.

1. Failure to pay the minimum wage.It is called the minimum wage for a reasonyou cantgo lower than that hourly rate for any employee, for any reason, no matter what. The obligationto pay the minimum wage is not waivable, and a claim for unpaid wages for failure to pay theminimum wage cannot even be released in a settlement agreement. Startups often think that theycan contract around the minimum wage by offering sweat equity in lieu of payment. However,such a contract is void and unenforceable under California and federal law, and there are aparade of horribles that arise from a failure to pay the minimum wage, including the accrual ofunpaid wages and penalties, failure to accrue from an accounting perspective for the mountingliability, and the enormous impediments to future transactions when due diligence reveals thatthis fundamental requirement has not been met. If you are still unconvinced, be warned: there arecriminal penalties for failure to properly pay wages. If you decide to risk the misdemeanorcriminal sanctions associated with not paying the minimum wage, at least accrue the wageliability so that it can be resolved later, and avoid the fraud claim with investors by disclosing thecorrectly accrued liability.

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This post was written by my partnerGary M. Gansle, who specializes in labor and

employment law. Prior to working at Dorsey & Whitney, Gary worked as a labor andemployment lawyer at Wilson Sonsini Goodrich & Rosati, where he counseled startup companies

extensively. Let me know if youd like to get in touch with Gary.

If you liked this post, please share it!

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