Background:

Startups often choose to hire a worker as an independent contractor rather than as an employee.  The independent contractor relationship may be advantageous for both the worker and the company:  the worker may desire to retain autonomy and flexibility; the company may seek certain expertise possessed by the worker that its employees do not have.  Often, however, a business engages a worker as an independent contractor rather than as an Employee because the business expects to avoid the costs and responsibilities associated with the typical employer-employee relationship, most notably, unemployment taxes, workers’ compensation insurance, and wage withholding responsibilities.  Businesses also save from not having to provide independent contractors with health benefits, which are a significant burden on small businesses.

A business cannot, of course, simply classify all workers as independent contractors. Doing so just might simplify the complicated administrative processes of running a business to the point where one might be able to focus on the business itself and not the administration. Humor aside, classifying everyone as an independent contractor would deprive the system of tax revenue and thwart labor laws meant to protect employees.  As a result, the improper classification of a worker can have serious legal consequences for a business.  Again:  the failure to properly classify workers can financially destroy your business. If a business makes an error in classifying workers, the business will be liable for employment taxes, interest, and penalties, and may also be subject to claims for violating state and federal labor laws.

Enter the IRS:

The key factor in determining whether a worker should be classified as an employee or an independent contractor is control:  who has control over how the worker accomplishes the work.  Because this determination is sometimes unclear, the Internal Revenue Service has developed a set of factors that employers should use to determine whether a worker is an employee or independent contractor.  These factors are grouped into three categories:  Behavioral Control (http://www.irs.gov/businesses/small/article/0,,id=179111,00.html), Financial Control (http://www.irs.gov/businesses/small/article/0,,id=179113,00.html), and Type of Relationship (http://www.irs.gov/businesses/small/article/0,,id=179116,00.html).  The IRS will determine the classification for you if you are still uncertain (use IRS Form SS-8 (http://www.irs.gov/pub/irs-pdf/fss8.pdf)), but be forewarned that the IRS’s determination may take up to six months.

Your trusted attorney should be able to advise you regarding the employee/independent contractor distinction, and, if necessary, prepare an Independent Contractor Agreement that outlines the terms of the engagement and further documents the nature of the worker’s relationship with your company.

Volunteers and Interns

Can businesses control costs by using volunteers or interns?  Free labor always seems good, right?  Not so fast.  If you intend to engage volunteers or interns, then your company will subject itself to both legal and financial perils, namely the same federal and state labor and tax laws relevant to traditional employees.  Using unpaid volunteers in a for-profit enterprise is inherently suspicious, and using unpaid interns must comply with a very limited exception under federal and state wage and hour laws.  Consider the following:  could your business withstand claims for unpaid wages and benefits from volunteers and/or interns, whose relationship with your company has soured?  Suddenly, the savings derived from using inexpensive labor is no more, and your business may in fact have incurred additional costs and penalties.

As businesses look for creative ways to control expenses and survive during challenging economic times, independent contractors, volunteers, and interns are seemingly practicable options for reducing labor costs.  Because of the significant legal and financial consequences of improperly classifying workers, however, business owners and managers should take care to properly designate workers in order to avoid unanticipated and debilitating financial penalties.

eBay had purchased Skype for billions but, for some unspoken business reason, did not acquire absolute rights to a core component of the intellectual property behind the Skype technology, which was retained by the Skype founders and licensed to eBay.  Subsequently, when eBay tried to sell the Skype business to a group of investors, the Skype founders, who had initially stayed on with Skype after the sale to eBay but eventually left the company, sued eBay for violating the terms of their licensing agreement.  Although eBay and the Skype founders ultimately settled their disagreement, the legal embroilment resulted in costly litigation and nearly obstructed eBay’s sale of Skype.

The eBay/Skype anecdote illustrates an important lesson.

Companies often assume that the company owns the intellectual property created by founders, employees, and independent contractors.  However, unless the intellectual property developed by these individuals has actually been contributed to the company through an assignment or similar legal agreement, the individual, rather than the company, retains ownership (in the case of an employee, the transfer may be imposed by law depending on the nature of the intellectual property created; nonetheless, it is customary for employees to assign their rights to the company through written agreement).

Small business, albeit on a lesser dollar scale relative to the eBay/Skype incident, frequently encounter similar situations.  Who owns the company software?  Logo? Business name? Customer lists?  Website design and source files?  Content?  These examples are typical scenarios where a company would be wise to clear up any uncertainties over intellectual property ownership.

Why does it matter?

First, hostage situations (this is only an example!):  would your company be affected if your webmaster shut your website down and demanded that you immediately pay $10,000 if you ever wanted to see the website code or applications again?  If yes, then work out who owns what before that unlikely plot develops.

Next, clarifying the appropriate ownership of company intellectual property is a big deal to potential investors and buyers, who do not want the value of their asset to be subject to the later actions or claims of a third-party owner of IP.  As seen in the eBay/Skype scenario, the Skype founders created significant leverage for themselves — at the detriment to eBay — by retaining ownership of a piece of the Skype technology.  While the Skype founders likely walked away with a handsome financial premium, the potential Skype buyer surely contemplated walking away from the deal with eBay altogether.

For the inventor/author/creator:  Because there may be situations when a blanket assignment is not appropriate, you must ensure that the assignment that you sign is appropriately limited in scope so as not to include intellectual property that you do not intend to contribute to the company.  For instance, you may be developing intellectual property on your own time and with your own resources that should not be the property of the company.

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