When should startups have to start paying employees?

[siegel]

When do you think the law should require a startup to comply with minimum wage and similar laws? I ask this question because I see far too many companies run into serious problems for not complying with these laws and being devastated by the consequences. It’s pretty overwhelmingly the case that at the earliest stages of a startup, the founders typically pay themselves nothing. They are working for equity. The same is often true for the earliest “employees.” Often time they are treated as independent contractors, even though that’s not technically legal. The law probably requires that they be paid at least minimum wage, but the company doesn’t have the money for that. Instead, again, the work for equity. It seems so unfair when a disgruntled early employee or even co-founder has a lawyer write a demand letter seeking $100,000 in unpaid wages and penalties. Everyone made an informed decision to work for equity. Everyone knew what they were doing. But the law doesn’t care. And, worse, in California, certain people in a management capacity (like directors) can have personal liability for unpaid wages. The usual response I hear to this is that the law is screwed up and way too employee friendly. These laws should be ditched and let people enter into whatever employment relationships they want. We’re all adults. I see this as a cop out. If you look more broadly at the world of employer-employee relations, there is a long, dark history of ruthless employers using the uneven power dynamic to cheat employees. I don’t think most people here would like the stories that are likely to come out if you ditched basic labor laws. The problem is it doesn’t “feel” like these laws should really apply to early-stage startups. My question is where one draws the line? And I’m curious what people think.

[corecoder]

When should any company pay employees? Always and with no exception!

There is a name for people in a company who share the risk of running a company, and that name is owners.

There are also names for people who want all the gains for themselves and all the risks and losses for their employees, and they are not flattering names.

[siegel]

I see two broad (but fuzzy) lines that can be drawn: 1) The requirement to pay at least minimum wage (i.e. not pay people in equity) should apply to anyone who is functioning in a traditional “non-exempt employee” capacity. This shouldn’t be all that controversial. People in these positions most typically earn less and for good reason have been the most protected under labor laws. Most founders and early employees are fulfilling roles that, with proper pay, would be considered exempt under labor laws. 2) Some sort of revenue or asset test. If you could pay your employees, but are not doing so, I have less sympathy for you. Investors are willing to put money into a company that will pay for reasonable salaries. So, even if your only assets come from investment (i.e. you don’t have enough revenue coming in), that’s not an excuse not to pay people.

But this doesn’t seem to be enough, does it? These two factors would say that any company that can’t afford employees can simply not pay anyone who would otherwise be an exempt employee. I don’t see that as sufficient. There could be other criteria: 3) In addition to #1 and #2, the “employee” would have to own at least X% of the equity of the company 4) Or maybe just X% of the voting power of the company (even if not the economic ownership)?

Those are just examples. Or maybe part of the solution is protection in terms of a liquidity preference of sorts. If a company has a less-than-stellar M&A exit, preferred shareholders (investors) typically have a liquidation preference that ensures they get their money back before anyone else shares in the merger proceeds. This seems sensible as a matter of investor protection – they put in $X million and understandably want to recoup their investment before other shareholders get a windfall. This might mean, however, that an early employee who didn’t get paid in cash and only has common stock, might get nothing while an investor who put in a bunch of money is made whole. What is the rationale for the investor being made whole, but an employee who worked for free getting nothing? The law could, for example, require that upon liquidation, employees who worked for free get a certain amount of money. (The law already provides a preference for wages in the bankruptcy context, but this is different. I’m imagining a situation where companies would be able to lawfully hire certain people for payment only in equity, rather than cash.) I’m curious to hear your ideas. How do you change the law to match the reality that startups can’t usually pay employees at the earliest stages, while not ending up in a situation where unscrupulous employers can take advantage of employees?

[gus_massa]

What about not hiring someone if you can pay him/her properly?

[siegel → gus_massa]

Well, let's say there are two co-founders who start a company they are bootstrapping. They don't pay themselves for the first 3, 6, 9 months or maybe even a year. Isn't that typical?

Then let's say they have a dispute, with one having to leave after a year working together. The departed co-founder files a claim against the company for unpaid "wages."

Now, the two co-founders had knowingly worked together for that year for equity - they were bootstrapping. But the departed co-founder has a slam-dunk case against the company for unpaid wages and probably waiting time and other penalties (as well as attorneys' fees).

I think most people on here would think that's absurd. But that's the reality.

And in California, not only is the company liable, but the remaining founder may be personally liable, as well.

I sympathize with the idea that you shouldn't hire anyone until you can pay. But does the co-founder situation I described make clear the problem?