📄 Employment Law Pitfalls

🎉 Happy Friday, funds family!

Hiring people quickly is one of the defining needs (features) of a growing startup. It’s an important topic for the companies and the investors who back them, because treating an employee as a contractor, relying on an unenforceable restrictive covenant, or overlooking the rules where someone actually works can create liabilities that surface during a financing or acquisition, long after the original hiring decision.

The short answer is: employment compliance follows the actual working relationship and the applicable law, not the label in an 📄 offer letter. Substance over form. Contractor status, overtime exemptions, and restrictive covenants are separate questions. For companies, the goal is to classify people correctly and use agreements tailored to their locations. For investors, the task is to test those decisions rather than assume signed paperwork resolves them.

➡️ What makes someone an employee rather than a contractor?

Generally, a contractor agreement and a Form 1099 do not determine worker status. Federal wage-and-hour law examines economic dependence, while federal employment-tax law emphasizes common-law control. State tests can be different (and sometimes stricter). Passing one test does not establish compliance with every other regime. The practical question is whether the person is genuinely running a separate business, not whether both sides prefer contractor treatment. Review the arrangement again as responsibilities change: a short advisory project can develop into an ongoing operating role without anyone updating the paperwork.

Common patterns that warrant closer review:

• A full-time developer labeled a contractor who works indefinitely on the company’s core product under a manager’s supervision.

• A consultant whose hours, methods, and assignments are controlled by the company and who has little opportunity to operate an independent business.

• A worker classified using an old template despite moving to a state with different classification rules.

➡️ Is contractor status the same as being exempt from overtime?

Generally, no. Employee status comes first; overtime exemption is a separate analysis for employees. Common mistakes include:

• Assuming a salary makes an employee exempt.

• Treating a senior title or equity ownership as a substitute for reviewing what the employee actually does in reality.

• Reviewing federal requirements without checking the state wage-and-hour rules that may provide additional protections.

Misclassification can mean unpaid wages and overtime, liquidated damages, tax exposure, and potential legal fees.

➡️ How do non-competes differ by state?

There is no single agreement that works everywhere. Representative approaches include:

• California: employment non-competes are generally void, with statutory exceptions including qualifying business sales; narrow “wording” alone does not save them.

• Federal developments: the FTC’s nationwide non-compete rule was set aside and removed; companies should not treat it as an operative blanket ban.

Confidentiality and non-solicitation provisions need their own review. They are not automatically enforceable simply because the document avoids the word “non-compete,” particularly where their practical effect restricts a person’s ability to work.

➡️ What should companies and investors check before a financing?

Review, for example, contractor dependence, employee duties, and signed confidentiality and invention-assignment documents. Ask whether threatened claims, unpaid compensation, or restrictive-covenant disputes exist. A chosen governing law does not necessarily override protections where an employee lives and works, and a business-sale covenant is not interchangeable with an ordinary employment restriction. Companies should also avoid assuming a founder’s prior employment restrictions are irrelevant. Recruiting someone who brings confidential materials or remains subject to a potentially enforceable covenant can create a separate dispute even when the new company’s own agreements are sound.

➡️ The practical takeaway

For the company:

1. Review contractor classifications against actual working arrangements before the workforce grows, rather than relying on labels.

2. Check overtime exemptions independently from contractor status and keep appropriate payroll and time records.

3. Tailor restrictive covenants to employee locations; reassess them when people relocate or state rules change.

4. Protect confidential information and secure invention assignments without assuming a broad non-compete is enforceable.

For the investor:

1. Check whether contractor-heavy core functions and exemption practices instead of accepting management’s characterization without testing it.

2. Assess unresolved employment claims and potential historical liabilities before agreeing to valuation and closing terms.

3. Confirm that key employee relationships and intellectual property protections survive scrutiny under the applicable state rules.

Thanks for reading, everyone!

Have a great weekend! 🙌

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This may be considered attorney advertising.