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.

Whether these services are worthwhile depends on a person’s budget, the stage of his/her company’s development, and the type of service needed.

For example, if you need to set up a company in a vanilla fashion (no special provisions in the incorporation or formation documents), then using a legal document service could be an economical alternative to hiring a lawyer.  (You should be aware however that most state corporation divisions provide easily accessible forms and straightforward processes by which you can set up a company on your own without using an attorney or a legal document service.)

Likewise, if you have already been through the trademark registration process with your attorney, and are comfortable with registering a new mark on your own, a flat-fee trademark registration service might be suitable for you.

So, when should you not use online legal document services?

When you need legal advice.  Simple — but true.

Review the fine print:  Your use of an online service may be subject to a disclaimer that states that the online service provider is not acting as your attorney or providing legal advice.  The disclaimer may even recommend that you consult an actual attorney.   I do not knock these services, since the administrative solutions that they provide for certain complicated forms may be just what you seek.   But you should know what you are receiving for your fees, so that you are not surprised if you later discover that you did not get what you wanted (or needed).

Anticipate future circumstances:  if you envision offering stock options, or foresee raising money from venture capitalists, for example, then you should consider consulting with an attorney, who can draft appropriate provisions to include in your formation documents in order to prepare for these events (well, forget the VC bit, as VC’s will insist on changing whatever provisions you initially include, regardless!).

The point is that legal document services are sometimes, but not always, helpful for the budget-conscious, do-it-yourself individual.  Certain matters are more complex, and really should be addressed with the advice of experienced counsel, who will be conversant about your business and its goals (and who will have professional liability insurance).

What do I say about the cost disparity between a legal document service and a real attorney?  When you pay for a service, then later have to pay to correct an oversight or error relating to that service, have you really saved any money?

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.

]]> http://www.floridasmallbusinesslaw.com/2010/01/employees/small-business-and-intellectual-property/feed/ 0 http://www.floridasmallbusinesslaw.com/2010/01/transaction-fees/looking-for-the-best-deal/ http://www.floridasmallbusinesslaw.com/2010/01/transaction-fees/looking-for-the-best-deal/#comments Fri, 08 Jan 2010 16:56:36 +0000 Shannon DeRouselle http://www.floridasmallbusinesslaw.com/?p=159 Most of us, at some point, are frugal in our spending.  This is particularly true for a startup or emerging company, where being lean is likely a necessity for survival.  The concept of “frugality,” however, describes a wide range of thrift — from prudent and economical, on one end, to unwise and cheap, on the other (not that I personally have ever been alerted to this by a significant other, of course!).

When discussing the estimated transaction costs for a particular deal with a client, I, as a matter of course, encounter  the “breather,” or the short moment of silence that conveys the client’s surprise after receiving the estimate.  I’ve seen service providers handle the “breather” period in different ways, from staring down the client old-west style, to attempting to distract the client by changing the subject at an auctioneer’s pace.

Negotiating transaction fees is perfectly acceptable.  Clients should be mindful, however, that most good attorneys recognize the potential complexity of a deal, and, based on experience, are proficient at estimating the time and fees required to close the deal and accomplish the client’s goal.  Some deals are very complex, irrespective of size; further, a client’s own expectations and negotiating style often influence the total transaction costs.

Surely, there are attorneys out there who will claim to be able to do the job for less.  But cutting corners or the lack of true competence carries significant risk to a business.  The best advice for a client seeking to manage transaction costs is to work with an attorney advisor who is experienced in working with early-stage companies.  When the opposing side’s attorney has similar expertise, the transaction will run much more smoothly, and total costs will reflect the increased efficiency.

Businesses often encounter similar issues in a different context: should scarce resources be used for a lawyer, when legal pitfalls appear unlikely?  Likewise, should management heed the attorney’s advice on a particular contract issue, when the company wants  badly to land an account with a large customer?   The value of a transaction to a company often controls such decisions. While some business owners loathe the idea of legal fees, others integrate legal advisors into their regular decision-making process.

Which is the right course?

A business does not need a lawyer at every instance. Business owners and executives know best how to run their enterprise. Still, however, certain stages of company development warrant legal expertise due to the nature and importance of the underlying event or transaction. On these occasions, obtaining legal counsel is a valuable tool and a prudent investment toward company growth.

The following situations are fairly common in the lifecycle of a startup company and are ripe for advice from experienced legal counsel: legal structure of initial entity (liability, governance, tax, financing, securities law issues); jurisdiction of formation (governance, liability, tax, financing, securities law, contract interpretation issues); shareholder agreements (governance, tax, securities law issues); raising capital/selling securities (governance, liability, tax, financing, securities law issues); compensation/options (tax, securities law issues); intellectual property (registration, protection issues); licensing (intellectual property protection issues); strategic ventures/transactions (legal structure, jurisdiction, securities laws, liability issues); employees (intellectual property, labor and employment laws issues); independent contractor engagements (intellectual property protection, confidentiality, labor and employment laws issues). Of course, a single contract can incorporate several legal issues. An experienced attorney-advisor will walk a client through these events, highlighting what is needed to avoid pitfalls that typically result from poor planning and to implement the client’s business plan with out undue interruption.

Having the advice of experienced legal counsel is like riding with a mechanic in the passenger seat. An advisor can guide a company away from potential hazards, provide tune-up advice along the journey, and repair unexpected issues when they arise with precision. If a breakdown could result in the loss of an owner’s investment, then legal counsel is certainly worth the expense.