Legally operational: Employees and equity
This is the second article in a 4 part legal series by Lucy Luo, a tech lawyer at Simmonds Stewart. Part 1 covered what founders should think about when starting a company, and this second article discusses what to think about when considering hiring. We welcome questions from readers throughout the series – please email firstname.lastname@example.org if you have something you would like to ask.
One of the most frequent questions I get asked by my much cooler start-uppy friends is what to do about employing people. How can we make sure they don’t tell anyone about our secret sauce? How can we even entice someone to join our start-up?
Firstly, good on you for reaching a stage where your company is growing, and you actually need to take on more people. It is an exciting position to be in. For some founders, their start-up is their baby – and employing someone can seem like welcoming a new person to the family. This article outlines some things you might want to think about, to ensure your baby will be in good care.
1. Do you want an employee or a contractor?
Maybe you’ve got an overload of work that needs more hands on deck, or you’re missing a skillset from the current team. Contractors may be more suitable for discrete pieces of work, whereas employees become part of your company (and hopefully add value) in an indefinite way. If you are in a position to choose from suitable and keen people, the main difference is that you will have more obligations to an employee than you would to a contractor. An independent contractor invoices your start-up for services provided and pays their own tax, and you can terminate the contract subject to its terms of notice.
Having said that, if you’re concerned about risky hires – New Zealand law permits employers to offer a 90 day trial period for new employees. Trial periods are voluntary, and must be agreed in writing and negotiated in good faith as part of the employment agreement. Anyone dismissed under the 90 day trial period cannot claim a personal grievance on the grounds of unjustified dismissal.
For more information on employees and contractors, the Department of Labour has put out a lot of useful guidance here.
Keep in mind that as a start-up becomes more attractive and you are thinking about seeking investment or exit options – investors or buyers will want to see that your key people are committed to the business (i.e. that they are buying into something that won’t fall apart if you’re no longer in the picture).
2. Protecting your baby and its future
When bringing new people into your start-up family, there are two things you want to protect upfront. The first is the intellectual property created while working for the company. Whether someone is helping you casually, or you’re signing up a permanent employee, or even a new co-founder – you will want to ensure that any IP produced is solely owned by the company, or transferred into the company’s ownership. This is particularly important to potential investors who want to be assured that there won’t be any future disputes about the company’s IP. Transferring or clarifying ownership of IP can be easily done using a standard clause in the employment agreement, or a separate deed of assignment of IP.
Secondly, you’re likely to have confidential information you wish to protect. Confidentiality can also be addressed using a standard clause in the employment agreement, or if the company has engaged a third party for a defined piece of work, you can also ask third parties to sign a non-disclosure agreement. Basically it would prevent the recipient of the information from disclosing any information they found out by virtue of working on your company, or the specific project.
For examples on how to protect IP and confidential information, have a look at our template individual employment agreement, deed of assignment of IP, and mutual non-disclosure agreement.
3. Attracting and incentivising employees
The tech scene in New Zealand continues to grow, and while this is fantastic for the overall industry, it can make it challenging to attract good talent to join your start-up. You may have an awesome product and team – but when you’re competing with big names like Xero, Orion Health, or Vend on massive hiring sprees, what can a young start-up offer a potential employee? One way to attract talent is to give employees an opportunity to participate financially in the growth of your company.
In tech hotspots such as Silicon Valley, employee share schemes are commonly used in high-growth companies to incentivise talented people. The dream endgame is the Facebook or Google scenario, in which many multimillionaires were created from early or even mid-stage employees who were granted share options early on.
Recent favourable changes in New Zealand’s legislation have made it easier for private companies to offer similar schemes here (perhaps this explains the employee share scheme discussions trending around town). There are a few ways to offer equity participation for your employees – the simplest for a tech start-up is to offer employee share options.
4. Employee share options
Share options give employees an option, but not an obligation, to buy shares in the company at some time in the future, at a price agreed now. This can be appealing to employees who may not want to buy the shares now, maybe due to cash constraints and the risks involved in start-up investing. If a share option scheme sounds relevant for your start-up, then there are two pieces of information you need to work out now.
Firstly, the options will be issued at a price – and so you need to figure out what the value of your company is today. This may be difficult to do, and more often than not there is very little science involved in valuing a start-up. In my future article on raising capital, I will talk more about valuation.
Secondly, if your purpose is not only to attract staff, but also to retain them – then you need to design the rules so that staff have to stay for a certain period of time before they can exercise their rights to buy shares. This is called ‘vesting’. I have seen vesting work to the benefit of the company in situations where three co-founders start something together in uncertain circumstances, and one soon had to leave the start-up. Instead of taking a third of the company with him, all co-founders held shares subject to vesting, and so the departing co-founder only got the percentage of the company he was entitled to, based on how long he had worked on the start-up.
As part of our free online resources, Simmonds Stewart has a set of template documents for offering employee share options. Under such a scheme, the options must be offered in connection with employment, raising funds must not be the primary purpose of the offer, and the company can only offer up to a total of 10% of its shares in any 12 month period.
Although share options are relatively simple to implement, employees will be taxed on any gains made when they exercise their options. Some companies implement share purchase schemes (instead of share option schemes), which are intended to minimise the employee’s tax bill, but are more complex and require expert professional advice.
5. Get some professional help
Employees and equity is a very fact-specific area of the law, and this article is largely oriented towards tech start-ups. While we want to inform you and suggest arrangements that may be beneficial – what is suitable for your start-up depends a lot on your situation and objectives. If you are thinking about setting something up, we recommend you talk with a professional legal and/or accounting advisor (especially as there are often tax effects).
BIO: Lucy is a lawyer at Simmonds Stewart – a law firm passionate about technology and growing businesses. Our clients range from start-ups raising seed funding to some of New Zealand’s largest IT companies, as well as high net worth and private equity investors. We understand technology, and we also understand how hard it is to start a company – which is why we open-sourced our legal templates to help you to get started with your legal documentation. Most recently, we have been helping with raising capital for three of the start-ups coming out of Lightning Lab 2014. Follow us on Twitter @techlawnz for updates, or get in touch email@example.com.