Employment Law Best Practices for Startups

Introduction

As your startup grows, building a strong team becomes essential to success. However, hiring employees comes with significant legal responsibilities and potential liabilities. Understanding and complying with employment laws from the start helps you avoid costly mistakes, reduce legal risks, and create a positive workplace culture.

This guide covers the essential employment law considerations for startups, providing practical advice on everything from hiring your first employee to managing terminations and everything in between.

Employee vs. Contractor Classification

One of the most critical decisions you'll make is whether to classify workers as employees or independent contractors. Misclassification can result in severe penalties, including back taxes, fines, and legal liability.

The determination depends on the degree of control you exercise over the worker and the nature of the relationship. Key factors include:

• Behavioural control: Do you control how, when, and where the work is performed?
• Financial control: Does the worker have an opportunity for profit or loss?
• Relationship: Is this an ongoing relationship or a specific project? Are benefits provided?

General guidelines:

• Employees: Work under your direction, use your equipment, work set hours, receive training, and are integral to your business
• Contractors: Control their own work methods, use their own equipment, work for multiple clients, and provide specialised services

When in doubt, err on the side of employee classification or consult with legal counsel. The IRS, Department of Labor, and state agencies are increasingly scrutinizing misclassification, especially in the tech sector.

Hiring Process Best Practices

A well-structured hiring process helps you find great talent while minimising legal risks. Follow these best practices throughout your recruitment efforts.

Equity Compensation and Stock Options

Equity compensation is a powerful tool for attracting talent when cash is limited. However, it must be structured carefully to avoid tax problems and legal issues.

Key considerations:

• Stock option plans: Establish a formal stock option plan approved by your board
• 409A valuations: Obtain independent valuations to set proper exercise prices and avoid tax penalties
• Vesting schedules: Implement vesting (typically 4 years with a 1-year cliff) to ensure employees stay and earn their equity
• Vesting acceleration: Decide whether to offer acceleration upon acquisition or termination without cause
• Exercise periods: Define how long employees have to exercise options after leaving (typically 90 days, though some startups extend this)
• Types of equity: Understand the differences between ISOs, NSOs, RSUs, and restricted stock

Always have employees sign stock option agreements that clearly explain their rights, restrictions, and tax implications.

Essential Workplace Policies

Clear workplace policies set expectations, ensure consistency, and demonstrate your commitment to compliance. Essential policies include:

• Anti-discrimination and harassment: Zero-tolerance policies with clear reporting procedures
• Equal employment opportunity: Commitment to fair treatment regardless of protected characteristics
• Accommodation: Procedures for requesting accommodations for disabilities or religious beliefs
• Leave policies: Vacation, sick leave, parental leave, and required statutory leaves (FMLA, state sick leave laws)
• Code of conduct: Expected professional behaviour and ethical standards
• Social media: Guidelines for personal social media use and company representation
• Data security: Protocols for handling confidential information and company data
• Workplace safety: Safety procedures and injury reporting requirements

Regulatory Compliance Requirements

Startups must comply with numerous federal, state, and local employment laws. Key requirements include:

• I-9 verification: Verify employment eligibility for all employees within 3 days of hire
• Tax withholding: Withhold and remit payroll taxes properly
• Wage and hour laws: Comply with minimum wage, overtime, and meal/rest break requirements
• Required posters: Display mandatory workplace posters in accessible locations
• Workers' compensation: Obtain coverage in most states once you have employees
• Unemployment insurance: Register and pay unemployment taxes
• New hire reporting: Report new hires to state agencies

Requirements vary by state and often depend on your company size. For example, the Family and Medical Leave Act (FMLA) applies only to companies with 50+ employees, while many anti-discrimination laws apply at lower thresholds.

IP Assignment and Confidentiality

Protecting your intellectual property is critical for startup success. Ensure every employee signs agreements covering:

• IP assignment: All work created during employment belongs to the company
• Confidentiality: Protection of trade secrets and proprietary information
• Non-solicitation: Restrictions on soliciting employees or customers after departure (if enforceable in your jurisdiction)

Note: Non-compete agreements are increasingly restricted or banned in many states. Focus on protecting legitimate business interests through confidentiality and non-solicitation provisions instead.

Have these agreements signed at the beginning of employment, not at termination when employees may be less willing to sign and consideration may be required.

Remote Work Considerations

Remote and hybrid work models introduce additional employment law complexities:

• Multi-state compliance: You may need to comply with employment laws in every state where you have remote employees
• Wage and hour: Ensure you're tracking hours and paying overtime correctly for remote workers
• Workers' comp: Coverage may be required in the employee's location, not just your headquarters
• Tax withholding: Withhold state income taxes based on where employees work, not where your company is located
• Equipment and expenses: Some states require reimbursement for work-related expenses, including home office costs

Consider using a Professional Employer Organisation (PEO) or Employer of Record (EOR) service to simplify multi-state compliance if you have remote workers across many locations.

Performance Management

Effective performance management protects your company while helping employees succeed:

• Regular feedback: Provide ongoing feedback through one-on-ones and formal reviews
• Documentation: Document performance issues and improvement plans in writing
• Consistency: Apply performance standards consistently across similar roles
• Clear expectations: Set measurable goals and objectives
• Progressive discipline: Use a progressive approach (verbal warning, written warning, PIP, termination) when appropriate

Good documentation is your best defence in wrongful termination claims. If you didn't document it, it may be hard to prove it happened.

Termination Procedures

Terminations are high-risk moments for employment litigation. Follow these best practices:

• Document thoroughly: Have clear, documented reasons for termination that align with prior feedback
• Consistency: Treat similar situations similarly to avoid discrimination claims
• Final pay: Understand state requirements for timing of final paychecks (some states require immediate payment)
• Benefits continuation: Provide COBRA notices and information about continuing benefits
• Return of property: Collect company property, disable access to systems immediately
• Severance: Consider offering severance in exchange for a release, especially for longer-tenured employees or sensitive situations
• Unemployment: Respond promptly to unemployment claims with accurate information

Never terminate an employee in anger or rush the process. Take time to consult with HR or legal counsel before significant terminations, especially for protected class members or situations that might be sensitive.

Conclusion

Employment law compliance may seem overwhelming for early-stage startups, but investing time and resources in getting it right pays dividends. Proper employment practices help you attract and retain top talent, minimise legal risks, and build a positive company culture.

Start with the basics: classify workers correctly, use written agreements, implement essential policies, and document everything. As you grow, continue building out your HR infrastructure and don't hesitate to seek professional guidance on complex issues.

Remember that employment law is highly jurisdiction-specific. This guide provides general principles, but you should consult with legal counsel familiar with the laws in your specific location and industry.