How to Classify Your Employees Right from the Start

Herd mentality is almost never a good thing. As social creatures, perhaps it’s only human to want to be included and be part of something bigger. When applied to business, the herd mentality often leads to less stellar decisions, against better judgment, because “everyone else is doing it,” so why not? For many startups, the hiring model to follow would appear obvious, with gig economy powerhouses like Uber, Handy and TaskRabbit hiring tens of thousands of independent contractors. Classifying employees as independent contractors delivers a cheaper workforce for employers, while touting freedom and flexibility for workers. But we all know what’s happened to their story since.

If your startup is looking to hire, even if it’s just one new person, then employee classification should be on your radar. It can be a smooth or a bumpy ride, depending on how you proceed.

Read on to find out what one startup did, why it matters, and how your business can stay on the right side of the law.

Related: Why Your Employees Are Your Best Marketing Asset

Full-time employees: A worthy investment for one startup

Freelancers now make up 35 percent of the U.S. workforce. When Dan Teran was starting his business in 2014, the gig economy’s independent contractor model was all the rage. That pitch centered on having a company with no inventory and no employees.

But Teran had just finished Zeynep Ton’s book, “The Good Jobs Strategy.” A professor at MIT Sloan School and retail industry researcher, Ton wrote about companies like Zappos and Trader Joe’s investing in their workforce, and how this has boosted their bottom line in the long run. This really resonated with Teran, having grown up in middle-class America where benefits were invaluable.

So when Teran launched Managed by Q, a technology platform that connects clients to facilities service providers, he decided to do something most startups would consider unthinkable: he offered health insurance, a 401K program with matching contributions, and paid family leave to full-time employees. These benefits were also applied to employees of Q Services, Q’s profitable, in-house network of cleaners, office managers, and handymen. Two years later, Q announced a stock option for all employees, regardless of their role.

Intent is everything

As an entrepreneur, you know best what your business needs and what you can afford. Scalability is the power to change in size. In a perfect world, businesses want a workforce that is scaled for growth, yet dependent on demand. But we don’t live a perfect world.

According to Maria O. Hart, an attorney specializing in employment law and business litigation, employee misclassification is not a new problem, and savvy business owners have always been aware of its existence. While it’s perfectly reasonable to hire independent contractors because the business is seasonal, it’s illegal to deliberately misclassify employees to free oneself of administrative and financial burdens, while depriving the workers of the legal protections they deserve.

Differentiating an employee and a contractor

According to Hart, the ultimate test in determining whether you have an employee or an independent contractor boils down to one primary factor: control. If the worker is dependent on the employer financially, has no say their schedule, and uses only employer-provided software, tools, or equipment, they are most likely a full-time employee.

An independent contractor is free to come and go once the job is done, can have multiple clients at the same time, can perform the work remotely in some cases, and can hire subcontractors or additional help to complete the task. Independent contractors with access to proprietary information can be required to sign confidentiality or non-disclosure agreements, but not non-compete contracts.

But sometimes, roles change. The independent contractor you hired during the early days of your startup may evolve into something more over time. This is not illegal. What is illegal, however, is a lack of self-auditing processes. The intentional failure to initiate the conversation to convert the contract worker into a full-time employee ultimately denies this employee the benefits and compensation he or she is owed.

$3 billion less to go around

The IRS estimated that about 15 percent of employers misclassified their employees as independent contractors, costing nearly $3 billion each year in income, payroll and federal unemployment taxes, with 10 to 20 percent of employers classifying at least one worker incorrectly.

States are reporting equally staggering figures in lost revenue annually due to misclassified employees. That revenue would otherwise go into education, transportation, or health coverage for low-income families, to build strong communities and contribute to the nation’s economic vitality, of which startups are part of.

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Running a business is a balancing act

There’s no denying that business owners are between a rock and hard place. They need to be profitable and competitive and keep employees and investors happy — and these factors aren’t necessarily mutually exclusive. However, having to juggle these factors is not an excuse to flout the law.

Classifying your next hire correctly is essential for both the business and the entrepreneur. Building a profitable organization may start with the entrepreneur, but its success is ensured by its employees; so start by taking care of yours.

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