Worker Classification 101 and Why it Matters for Your Startup

Misclassifying a worker is a common mistake made by startups. As a founder, you’ll need to pay attention to whether your employees are full-time, part-time, contract, seasonal, salaried, or hourly, and whether they are exempt or non-exempt from overtime. And whether they’re located in the US or globally. 

This sounds like a lot! Let’s break it down and explain why you should care.

Why does worker classification matter? 

These distinctions matter because how you classify your workers affects how your startup complies with national and local labor regulations. Failure to comply with labor laws can lead to penalties and back pay in the future. 

Many startups overlook worker classification and get stuck with unexpected fines, which can impact their cash runway. As the founder and CEO, pay attention to this small but important issue.

Here’s a quick 101 on worker classification

Employee vs independent contractor 

Many startups often make mistakes in worker classification when distinguishing between employees and independent contractors. 

For example, is your new hire an employee (who requires a W-2 Tax Form) or an independent contractor (who needs a 1099 Tax Form)? It’s essential to make sure you classify this correctly, as it has implications for taxes, benefits, and other labor laws. 

When classifying a worker as a full-time employee versus a contractor, key considerations to think about are:

• Degree of control over work - Are you telling the person when to work and what to work on?
• Provision of tools and materials - Are you providing them with a laptop and other equipment?
• Permanency of relationship - Is the contract finite or indefinite?
• Integration into core business operations - Do they have to attend company meetings, regular standups, and do key training?

Resource: Here’s a worksheet by the California Employment Development Department to determine if a worker should be classified as an employee or independent contractor.   

Exempt vs non-exempt worker

This classification is related to an employee's eligibility for overtime pay under the Fair Labor Standards Act (FLSA). 

• Exempt workers are typically paid an annual salary (above a certain minimum amount) and don't receive overtime pay, regardless of the number of hours they work per week. 
• In contrast, non-exempt workers are typically paid an hourly wage or salary, usually at the minimum wage, and are entitled to overtime pay if they work more than 40 hours per week. 
• Startups must comply with FLSA as soon as they make $500,000 in annual sales and have at least two employees. 
• Moreover, the FLSA is the primary federal law that governs minimum wage requirements, compensation, frequency of pay, breaks, and other related matters. 

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Resource: See more information on the Fair Labor Standards Act (FLSA) here.

Here are some typical startup mistakes you’ll want to avoid:

• Treating a contractor like a full-time employee 
• Offering equity in exchange for work, which means you aren’t meeting minimum wage laws
• Not paying interns but giving them free pizza every day 
• Assuming that if you offer a salary, they are automatically classified as “exempt” and you don’t have to pay overtime.

You’ll also want to review worker classification over time. For example, someone might start as a contractor but then gradually act like a full-time employee as they take on more work and naturally become more integrated with the business. Don’t let this sneak up on you; make sure you review and update your employees’ status as needed. 

These mistakes can be expensive and can significantly hamstring a startup before you’ve even had a chance to grow, so do your homework and get worker classification right from the start.