The High-touch Legal Services® Blog • For Startup/Early-stage Companies

Four months ago, I wrote about a Wall Street Journal report that the Internal Revenue Service planned to audit 6,000 randomly-selected U.S. companies to determine the extent to which companies misclassify employees as independent contractors (The “Independent Contractor” Trap Becomes More Dangerous).

Today The New York Times reported that both federal and state officials are cracking down on misclassification (U.S. Cracks Down on ‘Contractors’ as a Tax Dodge). The incentive: To reduce record budget deficits.

By misclassifying personnel, companies avoid paying Social Security, Medicare and unemployment insurance taxes. The article goes on to say that, on average, misclassified personnel do not report 30% of their income. The 2010 federal budget projects that the crackdown will net at least $7 billion over ten years.

Implication for companies of all sizes: If you have been lax in classifying workers, now would be a good time to start doing things correctly. Avoiding the “Independent Contractor” Trap may help you determine how to improve your classification procedures.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

I recently learned that one of my LinkedIn answers in Employment and Labor Law was selected as the Best Answer. The question and my answer are reproduced below.

Question: Which state law matters for employment contract questions (for the CEO of a firm), the law of the state of incorporation or the law of the state where the headquarters are located?

Answer: Please note that you actually have asked two different questions: (1) Which state’s law governs? (2) Where can / must the lawsuit be brought?

Answer to Q1: Most employment agreements will specify the applicable law. For agreements that do not, the court will need to make a “choice of law” decision. Assuming that the employee resides and works in the state where the company is headquartered, that state’s law probably will be chosen.

Answer to Q2: If the agreement has a mandatory jurisdiction and venue provision (stating where the suit *must* be filed), then that provision will apply – even if the law of a different state is to be applied. Otherwise, it is conceivable that multiple states could satisfy venue and jurisdiction requirements, though, again, the state where both parties are located would be most likely.

Getting to what may be the heart of your questions: In an employment-contract lawsuit, where the company is incorporated is not likely to matter.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

A few months ago, I posted Does your Employee Handbook address social media? This post discusses a specific social-media issue that is of great importance to every employer: Online endorsements of products or services by employees.

The Federal Trade Commission has published Guides Concerning the Use of Endorsements and Testimonials in Advertising. Actions that are inconsistent with the Guides may result in an FTC enforcement action.

Section 255.5 of the Guides states:

When there exists a connection between the endorser and the seller of the advertised product that might materially affect the weight or credibility of the endorsement (i.e., the connection is not reasonably expected by the audience), such connection must be fully disclosed.

So, if an employee touts your product or service on your company’s blog, no disclosure is required, because a company is expected to promote its own products or services. But if an employee touts your product or service on someone else’s blog, the employee should clearly and conspicuously disclose the employment relationship to readers of the blog.

Every employer should make employees aware of this requirement and should address this issue in its Employee Handbook.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

As I write this post, I am in the process of helping an early-stage client develop a stock-based compensation plan for a key officer. The principal choice was between a stock option and restricted stock.

A stock option is the right to purchase a specified number of shares at a specified price at some point in the future. The option typically “vests” over a period of years – the longer the individual stays with the company, the greater the portion of the option s/he has the right to exercise. At the end of the vesting period, the individual has the right to purchase all of the shares specified in the option.

With restricted stock, shares are granted to the individual immediately but are subject to “reverse vesting”: If the individual leaves the company, a specified portion of the stock is forfeited to the company (if the individual paid nothing for the shares) or is subject to repurchase by the company at the price the individual paid. The portion that is subject to forfeiture or repurchase declines to zero over a specified number of years.

Many companies are choosing restricted stock over stock options, and that was the choice my client made. Here’s why:

• The company has so few employees that it sees little reason to incur the costs of implementing a tax-qualified stock option plan.
• The officer’s input as a shareholder will be valued by the company. (A holder of restricted shares generally is accorded rights of a shareholder, including the right to vote; a holder of a stock option does not have any shareholder rights until the option is exercised, i.e., when the shares are purchased.)
• Restricted shares are likely to be perceived as more valuable. If the price of restricted shares decreases over time, the shares still can have some value to the recipient. On the other hand, if the price of the company’s shares decreases below the option holder’s exercise price, the option becomes worthless.

Whatever form of stock-based compensation is selected, both the company and the individual should consult with their tax advisors before the grant takes place.

Photo credit:  Michelle Meiklejohn

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

Most startups and early-stage companies have limited cash. As a result, they often are eager to use stock as a major component of  compensation. They need to make sure, however, that personnel stick around long enough to make the contributions for which they are being compensated.

In some instances, the corporation creates a tax-qualified incentive stock option plan. Employees are granted options to purchase stock, and they do not have to pay any tax on the stock (actually, on profits from their sale of the stock) until they exercise the option (purchase the stock, presumably, at a low price) and, later, sell the stock. (Tax law is less favorable to independent contractors.)

A prudent company will make sure that the options are subject to vesting – the longer the employee stays on board, the greater the number of shares s/he gains the right to purchase. For example, options on one-fourth of the shares  might vest after one year, with 1/48 of the total vesting each month thereafter, so that the entire option grant is vested after four years. (I am, though at this point probably should not be, surprised when employees of a company tell me that they were not aware that options typically are subject to vesting.)

In another scenario, founders or key executives might be granted stock, rather than options, for business and tax reasons. To keep these personnel around, the shares are subject to reverse vesting, i.e., the company’s right to buy the shares back, at a low price and in diminishing amounts, over time. So, as the mirror image of the preceding example, the company could have the right to buy back all of the shares during the first year, at the end of which only three-fourths could be bought back. Thereafter, the amount subject to buy-back is reduced by 1/48 of the total each month, so that after four years the reverse vesting is complete.

The essential point: Stock is valuable. If you are going to give some of it away as compensation, use vesting or reverse vesting to make sure that the personnel you are compensating earn their compensation.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.