Many Startups Are (Unintentionally) Breaking These Wage Laws
Since most startups don’t have a large reserve of cash during their early days, it is common for startups to compensate founders and early employees solely with equity. While this allows startups to conserve what little cash they have, this practice could ultimately be very costly for the company if it runs afoul of wage laws. In today’s post, we discuss various ways that startups may expose themselves (and in some cases their founders, directors, and officers) to liability for violating wage laws, and some steps companies can take to limit that liability.
While the attorneys in our firm do not practice employment law specifically, we come across these issues frequently when working with startups and think it is something founders should not overlook.
Minimum wage requirements
The Fair Labor Standards Act (FLSA) establishes minimum wage and overtime pay requirements for employees. In Washington State, the current minimum wage is $11.00 per hour. In Seattle, the minimum wage (for companies with less than 500 employees, which would include every startup) is $11.00 per hour, and the minimum wage increases each January and rises to $15 per hour by 2021. If employers fail to comply with these minimum wage requirements and do not fall within any statutory exemption from paying minimum wage, the company could be subject to legal action to recover unpaid wages to those individuals that were not paid at least minimum wage. Issues related to wage claims typically don’t come about until there is some sort of falling out between the company and the employee. However, they can be significant when they do arise. For example, Washington provides for double damages for any wages unlawfully withheld and attorney’s fees and costs associated with the wage claim. Importantly, giving equity does not count as wage in the context of the minimum wage statutes, so you can’t get around the wage requirements by giving out equity in lieu of wages.
Founders are corporate officers and therefore employees
Just like other employees, the company has an obligation to compensate its founders. The IRS includes a list of “statutory employees,” and included in that list are corporate officers. This makes it extremely difficult (if not impossible) to avoid classifying a founder that is an officer as anything other than an employee. And if they are an employee, then you must meet the minimum wage requirements—unless they fall under an exemption, which I’ll discuss below. If the relationship between the company and a founder breaks down, and the company failed to pay that founder at least minimum wage, there’s a chance that former founder will pursue a wage claim against the company (and wage claims can be messy!).
Most founders move forward under the assumption that majority founders are probably not going to sue the company, because they’d be essentially suing themselves. In the early days of the company, this usually ends up being the case. However, as the company grows and looks to bring on investors, those investors will want representations related to any outstanding claims or potential claims, including employment-related claims.
Also, where this assumption becomes problematic (even during the early days) is with minority founders. Minority co-founders have less of an incentive not to sue the company based on unpaid wages and, therefore, the potential risk of failing to comply with wage regulations is higher with minority co-founders.
Exemptions for certain employees
At the federal level, employees that are primarily providing executive, administrative, professional, or outside sales services may be exempt from minimum wage and overtime pay requirements. The U.S. Dept. of Labor outlines specific factors that must be met in order to qualify for these exemptions. Even if these employees meet the requirements for this exemption, the company is still required to pay the employee a minimum amount of compensation—for example, an executive must still be compensated a minimum of $455 per week.
The exemption above is a federal exemption. Washington state has adopted its own policies on this exemption, including its own requirements for who qualifies as an “executive” employee. Washington’s policy dictates that an employer should follow both state and federal regulations. Where there are discrepancies between the state and federal regulations, employers should follow whichever of the two policies is more favorable to the employee. Under Washington’s rules, an employee must meet three criteria to qualify for the minimum wage and overtime pay exemption. The employee must make a minimum salary of $250 per week, the employee’s primary duty must be managing the company, and the employee must customarily and regularly direct the work of two or more employees.
Exemptions for owners
The FLSA has an exemption for 20% or greater equity owners. Many founders fall into this category of exemption at the federal level. The problem is that Washington state law does not have a similar exemption, and for Seattle startups this means that you can’t rely on the federal exemption, and instead have to comply with Washington’s and Seattle’s wage laws.
Tips for avoiding complications for your startup
Review and understand wage laws and the rules surrounding the classification of employees and contractors. And if possible, try to hire contractors for as long as is reasonable during the early stages of the company.
Before you hire your first employee, review and understand the company’s obligations as an employer. Specifically, figure out what the minimum wage laws are and make sure you set up payroll to pay your employee at least that minimum wage. Also, be sure to submit the appropriate tax withholdings to the IRS, and file any necessary employment tax returns with the IRS. Don’t forget that founders are often “employees” in the eyes of the IRS and state regulators, so it’s important to be aware of the company’s obligation to comply with employment regulations even if the founders are the only employees.
And always get the terms of the relationship between the company and the employee in writing! Avoid handshake deals and informal, verbal agreements whenever possible, as ambiguity with respect to wage law claims almost always will be construed against the company.
If you’d like to learn more about how wage laws might affect your startup, please contact us today.