Startup Law A to Z: Employment Law

Your startup will not succeed unless you, the founder, build an exceptional team. Great teams are built on top of great culture. Yet any venture-backed startup founder will tell you, myself included, that developing a positive corporate culture is more art than science, requiring constant and creative recalibration as your company grows. What then does this have to do with employment law?

First, building an exceptional team means hiring great people; whether that involves W-9s for consultants, I-9s for employees, lengthy H-1B visa applications, or a new employee handbook, you need to hire the right people in the right way. Second, one bad employment-related legal dispute can have ripple effects throughout an organization, undermining employee morale and executive credibility in one fell swoop, with palpable culture fallout.

Fortunately, when working to promote healthy company culture, founders can look to employment law for some preventive medicine. In fact, transparency through written policies, clearly communicated in advance and followed in practice, can help create the trust and accountability which are foundational to positive company culture. Moreover, in the event employment disputes do arise, well-drafted employment policies actually provide valuable guidance through difficult to navigate situations, while limiting downside risks to the company, as well.

This article, the fourth in Extra Crunch’s exclusive five-part “Startup Law A to Z” series, follows previous articles on customer contracts,  intellectual property (IP) and corporate matters. This series is calculated to provide founders the information needed to assess legal risks in the areas common to most startups.

After reading this article, or other “Startup Law A to Z” articles, should you identify legal risks facing your startup, Extra Crunch resources can help. For example, the Verified Experts of Extra Crunch include some of the most experienced and skilled startup lawyers in practice today. So use these resources to identify attorneys focused on serving companies at your stage and then reach out for further guidance in the particular issues at hand.

The Employment Law checklist:

Employee vs. independent contractor classification

  • Payroll Taxes and Payroll Providers
  • Federal Classification: 21-Part Test
  • State Classification: Various tests, e.g., Dynamex in California
  • Intentional vs. Unintentional Misclassification and Penalties

Minimum wage and hour laws

  • Application to founders
  • Federal Fair Labor Standards Act (FLSA)
  • State Laws

Meal and rest breaks, vacation pay

  • Federal Fair Labor Standards Act (FLSA)
  • State Laws

Deferred compensation

  • Rule 409A
  • Founders
  • Employees

Sexual harassment, discrimination, and related claims

  • Federal:
    • Civil Rights Act of 1964
    • Age Discrimination in Employment Act of 1967 (ADEA)
    • Americans with Disabilities Act of 1990 (ADA)
    • Equal Pay Act of 1963
    • Genetic Information Nondiscrimination Act of 2008
  • State Laws
  • Employee Handbook
  • Documentation and Investigation

Work authorization / immigration

  • Form I-9 (Employees) and W-9 (Independent Contractors)
  • For Temporary Workers:
    • Visa Waiver Program
    • B-1
  • Employee Visas:
    • H1-B
    • L-1
    • O-1
  • Students:
    • F-1 with OPT STEM Extension
  • Other Visas:
    • EB-5
    • E Visas (E-1, E-2, E3)


Employee vs. independent contractor classification

One of the biggest employment law issues that startups get wrong, often willingly, is “employee” versus “independent contractor” classification. For employees, a startup must withhold and pay federal, state, and local income taxes, state disability, and payments under the Federal Unemployment Tax Act and Federal Insurance Contribution Act (i.e. Social Security and Medicare), not to mention contributions for federal and state unemployment and workers compensation insurance. Given this complexity, startups should absolutely hire a payroll provider to help manage the process, such as ADP, Gusto, Paychex or Quickbooks.

Of course, all of this gets expensive. Instead, far too many early-stage startups simply hire “independent contractors” to avoid everything mentioned above, often misclassifying these workers in the process, whether under federal law, state law, or both.

Under federal law, the test for proper classification between “employee” and “independent contractor” is a complex 21-part inquiry which essentially comes down to who has the right of control (behavioral and financial) and the right to direct the work being performed. If this control is held by the employer, then the worker is likely an employee.

A similar inquiry is made under most state laws, but more recently, legal developments in some states will make it even more difficult for employers to classify workers as independent contractors. In California, for example, the 2018 case Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County has significantly narrowed who may rightly be considered an independent contractor through a new three-part “ABC” test. Specifically, workers are presumed employees unless the employer can prove that: (A) the worker is free from direction and control from the employer in how to perform the work; (B) the work performed is outside the usual course of work performed by the employer; and (C) the worker is engaged in an independently established occupation of the same nature of the work performed. It is quite likely that (B) and (C) will give many employers trouble. See more on the new California rule from Porter Simon.

The penalties for employee misclassification can depend on whether the misclassification is intentional or unintentional. If unintentional, the penalties will include at the federal level, at least: (1) $50 for each Form W-2 the employer failed to file; (2) penalties of 1.5% of wages plus 40% of the FICA taxes that were not withheld from the employee and 100% of the matching FICA taxes the employer should have paid, plus interest accruing from the date these amounts should have been deposited; and (3) a “failure to pay taxes” penalty equal to 0.5% of the unpaid tax liability for each month up to 25% of the total tax liability.

If, however, intentional misclassification is suspected (e.g. through a pattern of classifying employees as independent contractors), then additional fines and penalties may be imposed, including 20% of all wages paid plus 100% of the FICA taxes (both the employee’s and the employer’s share), as well as criminal penalties of up to $1,000 per misclassified worker and prison sentence of one year. On top of that, the person otherwise responsible for withholding the appropriate taxes could be held personally liable for the uncollected tax amounts. More on misclassification issues from the U.S. Department of Labor.

Penalties at the state level vary, but again taking California as an example, it is a misdemeanor to fail to withhold state income tax from an employee’s paycheck, carrying a fine of up to $1,000 and/or a one-year prison term. In addition, the California Labor Code authorizes civil penalties of between $5,000 and $15,000 for each misclassification. If there is a pattern of misclassification, or willful misclassification, the civil penalties may increase up to between $10,000 and $25,000 per violation. Add to that a 10% penalty (plus interest) on unpaid unemployment and disability insurance withholdings from the period in question and it becomes quite clear that penalties for misclassification can be severe.

Minimum wage and hour laws

This is an area most startups encounter less often than employee classification issues, perhaps because (though I hope otherwise) startups have improperly classified employees as independent contractors, or because it is not particularly difficult to look up the applicable state minimum wage rate and ensure that workers are being paid at least that amount. In any case, it is worth noting that technically even founders are not exempt from state minimum wage and hour laws; in fact, an early founder who initially works without pay (based upon her equity in the business) would likely have a valid wage and hour claim against her own startup!

At the federal level, overlapping with state wage and hour laws, the Fair Labor Standards Act (“FLSA”) recognizes that employees can be either “exempt” or “nonexempt” from its requirements.  “Exempt” employees by definition perform executive, professional or administrative duties (hence termed the “white collar exemption”) and must be paid in salary, at least $455 per week, or $23,660 per year. “Nonexempt” employees, on the other hand, are generally subject to more specific requirements; they must be paid at least the federal minimum wage ($7.25 per hour) and must receive overtime pay of 1.5x for hours worked in excess of 40 hours in a given week.

State laws make a similar distinction between “exempt” or “non-exempt” employees, again generally imposing more stringent requirements with respect to non-exempt employees and sometimes imposing requirements more strict than the FLSA itself. Taking just two examples from California, the minimum salary required for “exempt” employees is generally $49,920 (as compared to $23,660 at the federal level). However, California also maintains certain profession-specific salary thresholds; for example, in order to be considered an “exempt” employee in California, a computer-software employee must receive at least $45.41 per hour, $7,883.62 per month, or $94,603.25 per year. More detail on the various state laws here from Bloomberg and a specific look at California law in these areas via Work Lawyers here. Note also, some cities may impose additional requirements above and beyond what is required at the state level, such as San Francisco in California and New York City in New York.

Meal and rest breaks, vacation pay

Like minimum wage and hours laws, both federal and state laws may apply. At the federal level, employers are not actually required to provide meal, lunch, or break periods of any kind. However, should an employer actually decide to grant such periods, then certain rules do apply. If an employer decides to grant rest breaks (e.g., 20 minutes or less), then the breaks must be paid. If an employer decides to grant meal / lunch breaks (e.g., 30 minutes or more), then these breaks need not be paid, provided that the employee is free to do as they wish while on break. There are no federal laws concerning vacation pay or paid-time-off (“PTO”), leaving the matter entirely to state law.

At the state level, rules for meal periods and rest breaks vary widely, but generally, meal periods and rest breaks for non-exempt employees are mandatory. Given the variety of state law here, no simple summary will suffice, though the links above provide state-specific information. Again taking California just as an example, employers must provide paid ten-minute rest breaks for every four hours (or major fraction) worked, plus a 30-minute meal break once an employee has worked five hours in a day; beyond that, additional requirements and exceptions also apply, see more from Nolo.

For PTO, given the immense variety in state law (summarized here by Thomson Reuters), it is perhaps worth noting here just one specific approach to PTO, both popular and problematic, which has recently gained more traction, namely, the “unlimited vacation” policy. Taken literally, the proposition sounds merely absurd to some, but from a legal standpoint it creates genuine risk, for it remains an open question in many states whether such a policy is actually compliant with applicable law.

In California, for example, though employers are not required to provide PTO, should an employer decide to offer it at all, then employees are actually entitled to retain their earned PTO indefinitely (i.e., no “use-it-or-lose-it rule”), though employers can limit the total amount of vacation time employees may accumulate. California employees are further entitled to be paid in full for all earned PTO upon termination of the employment relationship. This raises the question: if an employee is entitled to unlimited PTO and it is practically impossible to pay out “unlimited” or unquantified PTO when the employment relationship ends, then is “unlimited vacation” really just a “use-it-or-lose-it” policy in disguise? If so, this violates California law; for one affirmative take on this question, see this well-researched article from attorney Sebastian Miller.

While founders must decide for themselves whether the ability to truly say “yes, we offer unlimited vacation” is worth the legal uncertainty, there is an easier, less-risky option too: simply adopt standard (or even better-than-market) vacation policies and then communicate to current and potential employees your willingness to accommodate all reasonable requests for paid-time-off. While this may not have the same appeal as “unlimited vacation” it is likely more accurate, more in-line with applicable law, and certainly the less risky approach, at least until such time as the issue is actually litigated and courts provide more clarity.

Deferred compensation

Outside of equity grants, deferred compensation issues most often come up in one of two ways: first, with respect to founders, allowing themselves to believe their salaries will be “deferred” until later VC money is raised (something rarely realized in practice); and second, the all-too-common situation wherein a startup is burning through cash too quickly and incorrectly asks employees to “defer” their salaries, rather than simply imposing temporary salary reductions – perhaps eventually offset with discretionary bonus payments later in the year.

In fact, deferred compensation implicates Internal Revenue Code Section 409A, which imposes strict rules on the manner in which compensation may be deferred. In short, IRC 409A requires that: (1) any election to defer compensation be made by December 31st in the year before deferred compensation is earned; and (2) there must be an explicit written plan or arrangement which details when the compensation will actually be paid, which cannot be accelerated, based upon one of six permissible triggering events, which may include a specific future date, separation from service (such as retirement), a change in ownership or control of the company, disability, death or an unforeseen emergency. Due to these complexities, no deferred compensation plan created without the advice of counsel is likely to qualify under Section 409A and the penalties for non-compliance are severe.

Thus, if you are approaching a situation where you may not have enough cash to make payroll (which is not altogether uncommon for startups), then before you announce a “deferred salary program” to employees, be sure to consult with an employment lawyer to structure an approach that will minimize legal risks for the company while also providing maximum assurances to employees. Again, this may involve temporary salary reductions, followed by some later bonus structure, but in any case, it should not involve “deferred compensation” in any literal sense and certainly should be done with the help of an employment lawyer.

Sexual Harassment, Discrimination, and Related Claims. Both federal and state laws protect employees from harassment and discrimination. Companies must work to well understand and handle these issues appropriately.

At the federal level, Harassment is a form of employment discrimination that may violate the Civil Rights Act of 1964, the Age Discrimination in Employment Act of 1967 (ADEA), the Americans with Disabilities Act of 1990 (ADA), the Equal Pay Act of 1963, and/or the Genetic Information Nondiscrimination Act of 2008.

Harassment is unwelcome conduct based on race, color, religion, sex (including pregnancy), national origin, age (40 or older), disability, or genetic information; it violates federal law when: (1) enduring the offensive conduct becomes a condition of continued employment; or (2) the conduct is severe or pervasive enough to create a work environment that a reasonable person would consider intimidating, hostile, or abusive.

Additionally, anti-discrimination laws prohibit harassment against individuals in retaliation for filing a discrimination action or participating in any way in a proceeding or lawsuit that relates to such matters, and more generally, for opposing any employment practice reasonably believed to be discriminatory. Note also that many of these federal laws apply only to employers above a certain size, e.g., 15 or more employees under the Civil Rights Act and the ADA, or 20 employees under the ADEA, etc. For more, see this summary from Sullivan Benefits.

At the state level, many states have gone further than federal law to provide protections to other protected classes of individuals, including protections based on gender identity, sexual orientation, and other traits. For example, California’s Fair Employment and Housing Act, administered by the Department of Fair Housing and Employment, protects California employees from discrimination based on many different factors, including race, religion, gender, disability, sexual orientation, veteran status, and age (if the employee is over 40). State laws may also apply to smaller companies relative to federal laws – in California, as few a 5 employees.

Note also that your startup may automatically be liable in certain situations involving harassment. For example, if harassment by a supervising employee results in a negative employment action (e.g. termination, failure to promote or hire, or lost wages). Also, if harassment by a supervisor has created a hostile working environment, the company can avoid liability only if it can prove that: (1) it reasonably tried to prevent and promptly correct the harassing behavior; and (2) the employee unreasonably failed to take advantage of preventive or corrective opportunities provided by the employer.

A company will also be liable for harassment by non-supervisory employees and independent contractors (or even customers) over whom the company has control if the company knew, or should have known, about the harassment and failed to take prompt and appropriate corrective action.

For these reasons, it is critical that your startup adopt a well-drafted Employee Handbook as early as possible, which all employees must sign when joining the company. Some states allow employers to require acceptance of mandatory binding arbitration provisions and class action waivers from employees as well. You should then carefully review your Employee Handbook and take care to follow all of the policies and procedures outlined in it – including periodic anti-harassment and non-discrimination training.

Furthermore, when carrying out the policies and procedures outlined in your Employee Handbook, it is critical to properly document all investigations and any findings reached. In the event of a lawsuit, this documentation will be used as evidence, so it should be taken quite seriously. Similarly, where formal discipline is warranted, it is important to take corrective actions in a consistent manner (that is, to treat like cases alike) without “playing favorites” with respect to high value, or well-regarded employees, for example. Remember, failure to take appropriate action and/or failure to properly investigate could itself give rise to separate causes of action in support of a new lawsuit.

That said, a well-drafted Employee Handbook, carefully followed in practice, is one of the cheapest insurance policies you can buy to protect your startup from liability under discrimination and harassment claims; it is a sound investment for any founding team.

Work Authorization and Immigration. In order to work in the United States, a worker must have appropriate work authorization. For U.S. citizens, this is typically proven with a Social Security card and state Driver’s License, or U.S. Passport.

Form I-9 and W-9

After the Immigration Reform and Control Act of 1986, all companies must complete a Form I-9 employment verification for each employee in a timely manner (usually within three days of hire), through which the employer verifies that the new employee holds the necessary documents for employment authorization.

For independent contractors, you will want to request a Form W-9 instead, which will provide the information you need to prepare and send Form 1099-Misc to your contractors at the beginning of the following year (required for any contractor paid more than $600 in a given calendar year). Make sure to do this before your contractors are paid in full, as it is much easier to get paperwork completed when payment is outstanding.

For non-U.S. citizens, founders will need to look into available visa options – some of the most useful for startups include the following:

For Temporary Workers

  • Visa Waiver Program: The Department of Homeland Security allows eligible citizens or nationals of designated countries (currently 38 in total) to travel to the U.S. for tourism or business stays of 90 days or less without first obtaining a visa, including for example Australia, France, Germany, Italy, Japan, Korea, Spain, Sweden, and the UK.
  • B-1 Visa: Allows an entrepreneur to work in the U.S. generally for up to six months to take meetings, events, contract signings, closing sales, or closing estates, etc., but not to remain and work in the country.

Employee Visas

  • H1-B Visa: Probably the most well known visa in tech, the H1-B is a temporary work visa for those holding at least a bachelor’s degree, which the employer must apply for on behalf of the employee, meaning also that the employer must pay all associated fees (a few thousand dollars in total). Each year there are 65,000 visas available for individuals with a bachelor’s degree and an additional 20,000 for individuals with a master’s degree from a U.S. university. The visa lasts for five years and can be renewed for a maximum of six years. For a more detailed checklist on H1-B applications, see this summary from MintzEdge.
  • L-1: Enables a U.S. employer to transfer an executive or manager from one of its affiliated foreign offices to one of its offices in the U.S., or allows a foreign company which does not yet have an affiliated U.S. office to send an executive or manager to the United States with the purpose of establishing one.
  • O-1: Available only to individuals who possesses extraordinary ability in the sciences, arts, in education, business, or athletics, or who have a demonstrated record of extraordinary achievement in the motion picture or television industry and have been recognized nationally or internationally for those achievements – not particularly common, as you can imagine.


  • F-1 with OPT STEM Extension: New startups often look to hire individuals completing their undergraduate or graduate studies on the F-1 student visa, especially if they are pursuing a technical degree. Eligible F-1 students with STEM degrees who finish their program of study and participate in an initial period of regular post-completion OPT (often for 12 months) have the option to apply for a STEM OPT extension as well. The STEM OPT extension is a 24-month period of temporary training that directly relates to the F-1 student’s program of study in an approved STEM field. After this 24-month extension period, employers will usually attempt to secure the H1-B visa mentioned above. One helpful tip: most universities will have a “Career Services Offices” or similar department which can be quite helpful to founders needing guidance in this area, since they are responsible for helping their own students in the same task.

Other Visas

  • EB-5: Those with significant capital to invest can apply for permanent residency status (along with their spouse and children under 21 years of age) through the EB-5 Visa classification. The minimum qualifying investment in the U.S. is generally $1 million, but for rural regions or areas with high unemployment the amount is only $500,000. The investment must create a new enterprise, or turn around a troubled one, and must create within two years at least 10 full-time, permanent jobs for U.S. workers.
  • E Visas (E-1, E-2, E3):  This category is designed for foreign nationals (both workers and investors), coming to the U.S. under the provisions of a “treaty of commerce and navigation” between the U.S. and the foreign national’s own country, such as Australian specialty occupation workers for example. Before entering the United States, these individuals must apply and receive an E-1, E-2, or E-3 visa from a U.S. consulate or embassy overseas, though a U.S. company may also request a change of status to E-1, E-2, or E-3 for a nonimmigrant already in the U.S. (though this can actually be less straightforward). The list of available treaty countries is available here.


As a founder, you owe it to your team to get the basics of employment law right. Beyond that, developing clear written policies, communicated in advance and followed in practice, can help create the trust and accountability foundational to a positive company culture. Moreover, well-drafted employment policies are an extremely cheap form of insurance, providing an objective roadmap for navigating difficult employment disputes and protecting your startup from certain downside risks. This article provides the overview, so use it alongside included links and additional Extra Crunch resources to build your dream team.

Daniel T. McKenzie, Esq., manages the Law Office of Daniel McKenzie, specializing in the representation of startups and startup founders. Prior to establishing his law office, Daniel McKenzie co-founded and served as lead in-house counsel for Reelio, Inc., backed by eVentures, and acquired in 2018 by Fullscreen (a subsidiary of Otter Media and AT&T).

Thank you to Christopher Petersen, Senior Counsel at Akin Gump for providing comments on this article.

DISCLAIMER: This post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. TechCrunch, the author and any acknowledged parties, including their respective law firms, expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.