Team Building Done Right (Part 2): Accidental Employees, Owners, and Accidental Owners

Elena Volkova, Esq. on January 7, 2016

In the first part of the article on team building, I covered independent contractors, free labor and formal employees.

In this second part of the article, we’ll go over:

  • Accidental Employees
  • Owners
  • Accidental Owners

(Yes, there is such a thing as “accidental” employees and owners. Read on to find out more!)

Accidental Employees

If I could have a penny for every time someone mistakenly tells me, “I have independent contractors working for me,” I would be rich.

It is a very common misperception and a myth.

Just because you and your contractor called him or her an “independent contractor” does not mean the IRS or the departments of labor will view him or her as such.

If the so-called “independent contractor” does not have its own business, then it will be characterized by the regulators as a statutory employee, for whom an employer needs to withhold payroll taxes, issue W-2, pay unemployment and workers’ compensation premiums, and provide paid time off (if you are an NYC-based business).

The real test of an employment relationship is fairly complex. It has up to 16 factors the government weighs.

Yikes.

The rule of thumb is that if the person you are hiring has his or her own business, you’ll be ok.

What happens if you mis-classify an employee as “independent contractor”?

If you accidentally hired somebody who does not have their own business, the risk is that person may turn around and file for unemployment insurance when their project with you ends.

Once the government receives the claim, they’ll contact you for “unpaid” unemployment insurance premiums and fines. You’ll start getting unpleasant letters and potentially appear in front of an administrative hearing.

(It’s a huge distraction from running a business, and I’ve seen a few small business owners being crippled by this kind of unintended outcome.)

In addition, there may be tax penalties and workers’ compensation penalties assessed against your business.

That’s why I strongly, strongly, strongly recommend you don’t hire anyone who is not a business owner without processing them on W-2.

Are there any solutions?

Yes, if you really need part-time, hourly help from somebody and you’re not ready to put that person on payroll, then try using a placement agency or staffing agency. I have relationships with a few of them, and I’ve always been happy with the experience, especially because they do all preliminary vetting and screening.

And most importantly, they process all the paperwork, including confidentiality and non-compete agreements. It really does help to deal with the professionals when it comes to hiring.

Owners

So, now that we’ve established you cannot hire people for free, and hiring W-2s is hard and expensive, what can a small business owner do to grow a team?

Because you can’t do it alone for too long without burning out and starting to hate the business. There are only 24 hours in a day. Money is always tight. Yet, orders need to be filled, and marketing, sales, bookkeeping, and admin all have to be done.

How are you going to pay for all of that?

Short of making a personal loan to the business (separate article on that to follow), you may need to look into giving away equity (i.e. sharing ownership in the business).

The best way to do that is to negotiate an equity award, and for that you really do need a lawyer to get it done right.

At minimum, you need to consider all the tax consequences and the buy-sell rights. (This is one of my favorite services that I offer to small business owners who are planning to bring in a co-owner.)

Some people call buy-sell agreements “business pre-nups,” and that’s really what they are. They address what happens if there is a disagreement, death or disability among the owners.

It costs a couple of thousand dollars to prepare, but is infinitely worth it in the long run, as it will save you tens of thousands of dollars in future ownership disputes.

But sharing ownership has its drawbacks.

Yes, it is cheap – you can give shares to the co-owner for free, or even ask the person to pay you for them (called “capital contribution”).

However, you can’t fire a co-owner.

You have to buy him or her out.

And if the company is worth a lot of money, it’s not always easy to find the money to buy out the other side. Many businesses run into this problem, most famously Arizona Iced tea co-founders. Years and years of litigation, and millions of dollars in legal fees. Not to mention a beautiful friendship gone to pieces.

Firing employees on the other hand is very easy in this country. It does not even have to be for cause.

There are, of course, best practices that you need to have to protect yourself from future lawsuits, but overall the law strongly favors employers. (Which reminds me that we’ll need to write another article on this topic.)

Accidental Owners

This brings me to my last warning regarding building a team. That is having an accidental owners in your business.

This happens when you start a business project with someone, you share expenses and ideas, and do work together… but you never discuss who owns what and what would happen if the project does not work out.

That’s what we call an “unincorporated business partnership,” and I’ve written extensively on all the dangers it presents in my Joint Ventures series.

When you have a business partnership with someone (especially if you’re not incorporated or have no written agreement with the person upfront), then you basically are at their mercy to file a claim against you…

  • to share profits
  • to pay a salary (unpaid wages claims are the worst)
  • or for breach of implied contract.

Any way you look at it, you’re on the hook for thousands of dollars in legal fees, a monumental waste of time away from your business, aggravation, and a lot of other problems.

Thus, before you bring someone into your business, I strongly suggest to have a conversation with an attorney to determine what is going to be the status of the person:

Are they going to be a W-2 employee?

Or an independent contractor?

Are they going to be an owner?

Or are they going to be a lender?

You have to label the relationship.

Because if you don’t know what the legal label for the relationship is, you’re exposing yourself to unnecessary risk.

This material may be viewed as attorney advertising and does not constitute legal advice. This information does not create an attorney-client relationship between you and the author. This article strictly represents the personal views of the author on the date it was written and such views are subject to change without notice.

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