In the early stages of your startup, it will likely just be yourself and your co-founders working in the business. As the business grows, you will bring on board other people, and it’s important that you do this correctly from the outset. Almost all startups grapple with limited cash flows. This means that it can’t always pay market salaries to those who contribute to your startup’s growth. What a startup can offer, however, is an equity stake in what one day might be a very valuable company. But is this enough?
Employee vs. Contractor
While founders who are directors of the company are not legally obliged to pay themselves directors fees, when hiring new team members, you should be aware of your employment law obligations. The first thing you need to consider is whether they are an employee or contractor.
| Factor | Employee | Contractor |
|---|---|---|
| Control | The startup directs and controls the worker’s work. | The worker has a high level of control over the work they complete. |
| Hours | You set the hours that they work, whether that be a full-time, part-time or casual workload. | The worker has agreed to the hours needed to complete a certain job. |
| Task | You have given the worker a job description, and they perform a variety of tasks to fulfil this. | The worker has been asked to complete a specific task or work on a specific project. |
| Equipment | You have provided the majority of equipment that the worker needs. | The worker brings their own equipment. |
| Risk | You have insurance which covers the worker. | The worker has their own insurance and manages their own risk. |
Importantly, you can’t call a worker a contractor while treating them as an employee (also known as sham contracting). The Australian Tax Office (ATO) frowns upon businesses that mischaracterise workers to avoid their employment law obligations. If you are unsure, use the employee/contractor decision tool on the ATO’s website to determine whether your team member is an employee or a contractor.
Employee Pay and Entitlements
Under the Fair Work Act 2009, an employer must pay an employee at least minimum wage. The minimum wage may differ depending on the type of employee and if they are covered by an award.
The Fair Work Ombudsman may investigate and enforce suspected contraventions of the minimum wage and financial penalties apply. Importantly, even if the employee and the employer agree, an employer cannot pay the employee below minimum wage. This means that if you are not paying your employee at least minimum wage, your employee can later sue you for unpaid wages and entitlements. Fair Work may also fine your startup.
In addition to minimum wage, you also have to ensure that you provide your employee with the appropriate leave entitlements, deduct income tax from their wage and pay the superannuation contribution.
Contractor Pay and Entitlements
Unlike employees, there is no requirement to pay contractors minimum wage. Contractors are considered to run their own business and therefore negotiate their pay as part of their contract. A contractor will typically provide the business with an invoice for the work completed. Contractors arrange their own tax deductions and pay GST and superannuation themselves.
Using Shares to Pay Employees and Contractors
As employees must be paid minimum wage, there is no room for startups to substitute this with equity. However, as there is no such regulation with contractors, a contractor may agree to be paid for their services in shares.
A startup which is unable to pay market salary to an employee or fairly compensate a contractor for their services may offer shares or options via an employee share scheme (ESS).
Under an ESS, an eligible startup will offer an employee or contractor shares or options to purchase shares in the business. Startups often use an ESS to reward and retain key staff or to ‘top up’ team members’ salaries.
Key Takeaways
If you are engaging a contractor, you may be able to come to an agreement pay them via shares or options. However, this is very risky from the contractor’s perspective and potentially detrimental to founders who will accept a dilution of their shareholding.
But if all you have to offer an employee is equity, this is not enough under the law, and you will have to postpone the hire until your business in financially ready. Once you can pay your employees a fair salary which is at least minimum wage, you may want to look into an ESS to supplement their salary and help ensure you hire the best person for the job,
If you have any questions about hiring for your startup or need assistance drafting an ESS, get in touch with our specialist startup lawyers on 1300 544 755.
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