Startup founders tend to see themselves, and their businesses, as the exception to some established rule. That mindset of exceptionalism can yield big benefits, but it can also create blind spots—particularly when it comes to legal and regulatory issues.
One area where this shows up is with employee compensation. Many Washington startup founders assume (incorrectly) they can issue equity in lieu of paying wages to employees, including themselves, in the early stages of the business. But in fact there is no exemption for startups to pay employees solely in equity, rather than paying a minimum wage or salary.
Related: A Short Guide To Issuing Stock Options
Let’s start by clarifying that most founders of startups are employees, whether they like it or not. Assuming the startup was formed as a C corporation, as most startups are (at least ones planning to raise venture capital), then the founders are most likely corporate officers. And corporate officers are considered by the IRS to be employees. Even if a founder isn’t an officer, the founder is probably still properly classified as an employee. If the founders are employees, state and federal wage and hour laws will apply to them. So founders should be paid at least minimum wage to stay on the right side of these laws.
Related: Washington State Employment Law FAQs
It’s at this point that startup founders inevitably ask, “what happens if we don’t?”
In Washington, if a startup fails to pay an employee minimum wage, the employee could sue not just the company but also the officers and other agents of the company personally for twice the amount of unlawfully withheld wages. So the founders need to understand and appreciate that they could be personally on the hook for wage claims.
Related: The Limits Of Limited Liability
Tip: Not only do employees need to be paid at least minimum wages, these wages need to be paid on a timely basis. That means no deferred wages. In Washington, employees must be paid their wages at least once a month.
Founders may rationalize at this point that it’s unlikely that the founders themselves will sue the company or the other founders for unlawfully withheld wages, and so there’s little problem with not paying founders minimum wage. While this may be true for majority owners, it is not necessarily the case for founders or early stage employees with minority ownership stakes in the startup, especially if they’re forced out before some or all of their stock vests.
Related: 4 Options For Documenting Founder Employment
The best way to minimize risk for startups is to comply with wage and hour laws from the start. But with the knowledge that not all startups will do this, there are some common risk mitigation strategies that cash-strapped startups use, including classifying workers as contractors, rather than employees, as well as paying minority stockholders (if not majority stockholders) minimum wage. These risk mitigation strategies can carry with them other risks, though. For instance, classifying workers as contractors when they are actually functioning as employees may lead to regulatory consequences for worker misclassification.
Related: Independent Contractors vs. Employees In Washington State
Employee compensation is something that too many early stage startups handle carelessly. The fact that some startups manage to avoid serious consequences does not excuse this carelessness. If you’re going to take risks here, the risks should at least be calculated, though of course the better option is to avoid the issue altogether by complying with wage and hour laws from the start.
Finally, as a reminder, no matter how your startup decides how to deal with this issue, always document your arrangements. That means using employment or independent contractor agreements, as appropriate.