Three Ways Your First Employees Can Kill Your Startup

by: Clint Costa

There may be no greater objective credibility for a startup than hiring employees.  Putting new people on the payroll not only makes the Friday foosball tournaments more enjoyable, but exudes economic patriotism in this post-Great Recession world.

Employees can help a startup scale and gain real traction, but they also present real risks.  When your startup begins hiring, keep these three risks in mind:

1. Hell Hath No Fury Like an Employee Scorned

Most of us have experienced a bad break-up, typically involving some manner of public humiliation or property damage.  The same dynamics exist with employee relationships.  When early hires are terminated or leave with hard feelings, the Business Software Alliance is there to offer consolation and the ability to get even.

The BSA is a non-profit organization funded by the largest software companies in the world.  Its job: to find companies that use software without buying a license, threaten to sue them and then extract as much money as possible.  The BSA pays informants who alert it to software piracy and most reports come from disgruntled ex-employees.

Possible Recommendation: Don’t use pirated software (of course) and/or consider paying a severance to terminated employees (even if it’s a small amount) conditioned upon signing a confidentiality agreement.  Most employers are surprised at how effective even a small severance and related legal restrictions are to give ex-employees an incentive to move on without causing problems.

2. Coffee is for Closers

Good sales employees are worth their weight in gold, but they can sink a startup like a lead weight if they leave with valuable information like pricing, customer lists, and leads.  Without confidentiality and non-solicitation restrictions in place before these folks are fired or quit, there is no obligation keeping them from setting up the equivalent of the Michael Scott Paper Company and attacking your startup’s bottom line.

Possible Recommendation: Workers who don’t start out with an employment contract can generally be held to confidentiality and non-solicitation covenants later.  Startups that don’t begin with these agreements in place should assess their employee rosters and determine which ones should be required to sign.

3. Beware the Trust Fund. 

Social Security and Medicare taxes are also referred to as “trust fund taxes,” because at some point (perhaps when hobbits roamed middle earth) Congress refused to tap funds earmarked for those programs to operate the government.  Employers [are supposed to] pay 7.65% of each employee’s wages to IRS for these taxes (along with employees paying the same amount).  Sometimes employers become a little cash-strapped and, in order to keep the lights on, skip these payments. Very. Bad. Idea.

The Trust Fund Recovery Penalty is a tool the IRS has at its disposal to make the owners and some top management at startups pay dearly when these trust fund taxes go unpaid.  Simply put, the IRS can assess unpaid Social Security and Medicare taxes against owners and some management personally.  Yes, personally—without regard to whether or not the business operates as an entity with limited liability.

Possible Recommendations: Of course, it’s easy to say “pay your taxes.”  But, really, if you’re going to miss paying any taxes, don’t miss paying Trust Fund taxes.  If you have to, then do whatever it takes to pay those taxes later.  If all else fails, be proactive and take the IRS up on alternative payment arrangements sooner than later.

About the author Clint Costa @LawGuy60606
Clint Costa is an attorney and CPA with the Chicago law firm of Duggan Bertsch, LLC. Clint represents startups, entrepreneurs, established businesses and high net worth individuals (rich people) on all manner of official sounding legal and tax matters. Clint teaches "Law School for Entrepreneurs" through the Chicago start-up, Dabble.co and his writings can also be found on TechCocktail. Feel free to get in touch with Clint via email.

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