Unless your new business is a one-person shop, you will need to hire others to perform services for your business.
Hire.
Unless your new business is a one-person shop, you will need to hire others to perform services for your business.
Overview
Hiring Employees
When you hire employees for your business, you must comply with a host of applicable federal, state, and local laws and regulations. For example, you will need to obtain a federal level Employer Identification Number (EIN) and certain state level identification numbers. You will need to report the hiring of your employees to the state in which they work, and you will need to complete and maintain various forms and records in connection with the hiring process, including tax withholding forms and verification of work authorization.
Most states require employers to obtain workers' compensation and contribute to unemployment insurance schemes. Consider engaging a small business payroll provider or Professional Employer Organization ("PEO") to handle tax withholding, insurance, HR, and related matters.
You should strongly consider having employees sign an offer letter and a form of confidentiality/IP assignment agreement that, in some cases, could contain nonsolicitation and noncompetition covenants, depending on the level of employee and state law. Depending on headcount, the type of workforce, and the jurisdiction, entering into a mutual arbitration agreement with employees can be beneficial to mitigate legal risks.
You should keep in mind that various laws governing minimum wage, timely payment of wages, antidiscrimination, pay equity and transparency, restrictions on asking about past salary, and background checks, among other topics, may apply to applicants and new hires, depending on the jurisdiction.
Please note that, in general, employers must still comply with minimum wage laws even if offering stock-based compensation. In other words, typically, an employee cannot only be paid in stock-based compensation. Similarly, employees cannot agree to be paid below minimum wage (e.g., an employee typically cannot accept a salary of $1 per year). There are some exceptions to these rules for certain business owners, but they are not recognized in all states.
The fact that different states have different employment laws is something you should keep in mind when hiring employees in multiple states, including remote employees. Generally, the law of where the employee works governs, not the law of incorporation or headquarters. Most states require employers to register as a foreign corporation conducting business in the state. Because compliance with state and local laws requires a clear understanding of the jurisdiction in which the employee lives and works, consider limiting remote employees from relocating without your approval.
Equity Incentives
Many start-up companies use equity incentives to compensate, recruit and retain executives and employees. Equity compensation, typically in the form of restricted stock or stock options, serves to align the interests of employees and stockholders, as it incents employees to contribute to the long-term growth of a company without depleting a company's cash resources.
Employees or Independent Contractors
When a person is retained by your company to perform services, the person must be classified as an employee or an independent contractor. Whether a worker is an employee or independent contractor is a legal determination. It is safest to classify workers as employees. Treating a worker as an independent contractor can carry real risks if the person is not properly classified under the law, as an employer can be liable for back taxes, wages, benefits, and other liability for improper contractor classification. The determination of whether someone providing services to your business is an employee or an independent contractor can be complex. Both federal and state laws apply, and the laws are not necessarily the same. In fact, there are circumstances where a person could be an independent contractor for federal tax law purposes, but an employee for state law purposes. (In that case, you should treat the worker as an employee.)
Federal Determination
At the federal level, the Internal Revenue Service has historically applied a 20-factor test to determine whether an employer has a "right to control" the person in question, but more recently has condensed the analysis into three categories: behavioral control, financial control, and the type of relationship of the parties. The federal Department of Labor has developed a different standard for federal wage and hour purposes. The IRS test and other federal standards, however, do not control for state law purposes.
Determine whether the individuals providing services are employees or independent contractors: Visit the IRS website to get started
State Determination
States often have their own methods for determining whether a person qualifies as an employee or independent contractor. A number of states, including, but not limited to California and Massachusetts have independent contractor tests that are more stringent than federal law. Both California and Massachusetts (along with several other states) apply a three-prong test known as the "ABC test," where one of the prongs requires that the service performed cannot be of the usual course of the company’s business. The California and Massachusetts laws create a presumption that a person retained to perform services is an employee unless a company can prove otherwise by satisfying all three prongs of the ABC test.
Hiring contract workers through staffing agencies should not result in violations under the Massachusetts Independent Contractor Law or similar state laws so long as the staffing agency itself complies with the applicable state employment laws.
Learn more about the Massachusetts law: Visit the Massachusetts website
Learn more about the California ABC test here.
Consequences of Improper Classification
Improper classifications of persons as independent contractors rather than employees can have serious consequences, including penalties and possible violations under federal and state employment and tax laws, such as wage payment laws, pay stub laws, minimum wage laws, overtime laws, laws governing social security and unemployment insurance, and laws governing tax withholding, each of which carry their own civil and sometimes criminal penalties.
Contractor misclassification cases have been a particular focus of legal action in recent years. Due to the complex nature of the analysis and the risk of exposure to significant criminal and civil liability and penalties, you are urged to tread carefully when classifying workers as independent contractors.
Stock Based Compensation
Start-up companies frequently use stock-based compensation (such as stock options) to incentivize their executives, employees, and other service providers.
Stock-based compensation provides executives and employees the opportunity to share in the growth of the company and, if structured properly, can align their interests with the interests of the company’s shareholders and investors, without burning the company’s cash on hand. The use of stock-based compensation, however, must take into account a myriad of laws and requirements, including securities law considerations (such as registration issues), tax considerations (tax treatment and deductibility), accounting considerations (expense charges, dilution, etc.), corporate law considerations (fiduciary duty, conflict-of-interest) and investor relations (dilution, excessive compensation, option repricing). In light of these requirements, the company’s accounting and payroll teams will be instrumental to ensuring the proper administration of stock-based compensation.
The types of stock-based compensation most frequently used by private companies include stock options (both incentive and non-qualified) and restricted stock. Other common forms include stock appreciation rights, restricted stock units and profits interests (for partnerships and LLCs taxed as partnerships only). Each form of stock-based compensation will have its own unique advantages and disadvantages.
Stock Options
A stock option is a right to buy stock in the future at a fixed price (i.e., the fair market value of the stock on the grant date). Stock options are generally subject to satisfaction of vesting conditions, such as continued employment and/or achievement of performance goals, before they may be exercisable, and need to be formally approved by the company’s board of directors.
There are two kinds of stock options, incentive stock options, or "ISOs," and non-qualified stock options, or "NQOs." ISOs are a creation of the tax code, and, if several statutory requirements are met, the optionee will receive favorable tax treatment.
Because of this favorable tax treatment, the availability of ISOs is limited. NQOs do not provide special tax treatment to the recipient. NQOs may be granted to employees, directors and consultants, while ISOs may only be granted to employees and not to consultants or non-employee directors.
Generally, there is no tax effect to the optionee at the time of grant or vesting of either type of option. Regardless of whether an option is an ISO or an NQO, it is very important that an option's exercise price be set at not less than 100% of the fair market value (110% in the case of an ISO to a 10% stockholder) of the underlying stock on the date of the grant in order to avoid negative tax consequences.
Upon exercise of an ISO, the optionee will not recognize any income, and if certain statutory holding periods are met, the optionee will receive long-term capital gains treatment upon the sale of the stock. However, upon exercise, the optionee may be subject to the alternative minimum tax on the "spread" (i.e., the difference between the fair market value of the stock at the time of exercise and the exercise price of the option).
At the time of exercise of an NQO, the optionee will have compensation income, subject to tax withholding (if the optionee is an employee), equal to the option's "spread" and taxable at ordinary income rates. When the stock is sold, the optionee will receive capital gain or loss treatment based on any change in the stock price since exercise.
409A Valuation
Private companies often need to make decisions with respect to stock-based compensation that require determining the fair market value of the company’s common stock. Independent, third-party valuations may be provided by a reputable valuation firm. These valuations, often referred to simply as 409A valuations (in reference to Section 409A of the tax code), are particularly important to granting and administering stock option awards, which require the exercise price be set at not less than 100% of the fair market value of the underlying stock on the date of the grant. A private company should typically obtain a 409A valuation before making stock option grants for the first time and obtain a new valuation no less frequently than every 12 months thereafter. Additionally, new 409A valuations will need to be obtained after any material events, like an equity financing, regardless of such 12-month cadence.
Restricted Stock
Restricted stock is stock sold (or issued as payment for services) that is subject to vesting and is forfeited if the vesting is not satisfied. Restricted stock may be granted to employees, directors or consultants. The recipient is typically required to fulfill vesting conditions that may be based on continuing employment over a period of years and/or achievement of pre-established performance goals. During the vesting period, the stock is considered outstanding, and the recipient can receive dividends and exercise voting rights.
A recipient of restricted stock is taxed at ordinary income tax rates, subject to tax withholding (if applicable), on the value of the stock (less any amounts paid for the stock) at the time of vesting. Alternatively, the recipient may make a tax code section 83(b) election with the IRS within 30 days of grant to include the entire value of the restricted stock at the time of grant and immediately begin the capital gains holding period.
This 83(b) election can be a useful tool for start-up company executives, because the stock will generally have a lower valuation at the time of initial grant as compared to the value on future vesting dates.
Other Stock-Based Compensation Considerations
Vesting: It is important to consider vesting schedules and the incentives caused by such schedules before implementing any stock-based compensation program. Companies may elect to vest awards over time (such as in monthly, quarterly, or annual installments), heavier weighting in the beginning or towards the end, based on achievement of pre-established performance goals, or based on some mix of time and performance conditions. Typically, vesting schedules will span three to four years, with the first vesting date occurring no earlier than the first anniversary of the date of grant for initial grants.
Change in Control: Companies should also be particularly mindful of how awards will be treated in connection with a change in control of the company (e.g., when the company is sold). Most broad-based equity compensation plans should give the board of directors significant flexibility in this regard, including discretion to accelerate vesting (fully or partially), roll over awards into awards of acquirer's stock or simply terminate awards at the time of the transaction.
Employer Protections: There are a number of protection provisions that a company will want to consider including in their employee equity documentation.
Limited Window to Exercise Stock Options Post-Termination: If the employment is terminated for cause, stock options should provide that the option terminates immediately and is no longer exercisable. Similarly, with respect to restricted stock, vesting should cease and a repurchase right should arise. In all other cases, the option agreement should specify the post-termination exercise period. Typically, post-termination periods are 12 months in the case of death or disability, and 3 months in the case of termination without cause or voluntary termination.
Repurchase Rights: With respect to restricted stock, private companies should always consider having repurchase rights for unvested as well as vested stock. Unvested stock (and vested stock in the event of a termination for cause) should always be subject to repurchase either at cost, or the lower of cost or fair market value. Careful consideration should be given to the period of time that the company has to repurchase such shares following an employee’s termination.
Right of First Refusal: Private companies often have a right of first refusal or first offer with respect to any proposed transfers by stockholders. Generally, these provide that prior to transferring securities to an unaffiliated third party, a stockholder must first offer the securities for sale to the company-issuer and/or perhaps other shareholders of the company on the same terms as offered to the unaffiliated third party.
Drag Along Rights: Private companies should also consider having a so-called "drag-along" right, which generally provides that a holder of the company's stock will be contractually required to go along with major corporate transactions such as a sale of the company, regardless of the structure, so long as the holders of a stated percentage of the employer's stock is in favor of the deal.
Amendments and Corrections: If an equity award needs to be amended or an issue with an award needs to be corrected after it is granted, such actions often can be taken but may require the grantee’s consent in addition to structuring such action to comply with any applicable legal rules. Strong corporate governance processes are key to preventing issues from arising in the first place.
83(b) Election: Tax Consequences of Restricted Stock Purchases
If the taxpayer decides to make the election, the taxpayer must complete an "Election to Include in Gross Income in Year of Transfer of Property Pursuant to Section 83(b) of the Internal Revenue Code" form, sign and date it, and file it with the Internal Revenue Service. If filing electronically, the taxpayer will need to create an account on the Internal Revenue Service’s website and follow the instructions for making an online Section 83(b) Election. As of June 2026, the online portal for filing a Section 83(b) Election has only recently been made available and may not accept Section 83(b) Elections for Equity with certain characteristics (for example, a very large number of shares or units or a very low purchase price per share or unit). The taxpayer should consult a tax advisor to ensure an electronic filing is properly made. If filing by paper, the taxpayer should file the Section 83(b) Election with the Internal Revenue Service Office where the taxpayer files its annual tax returns. The taxpayer should consult a tax advisor to obtain and prepare the form. In addition, the taxpayer should make two copies of the completed form and (i) provide one copy for the records of the Company and (ii) retain the other copy for the taxpayer’s records.
To be effective, the election form must be filed with the Internal Revenue Service within thirty (30) days after the acquisition of the equity in the company.
Please note that the determination of the fair market value of the Equity should be made in consultation with the Company and the taxpayer's tax advisor. The fair market value which the taxpayer indicates on the Section 83(b) Election form must be as of the date of transfer—which in this case is the date the taxpayer acquires the Equity.