LEGAL
Employment & Advisory Contracts
Employee vs Contractor — What Founders Must Know
Misclassifying employees as contractors can lead to serious tax and legal consequences. Founders need to understand the criteria regulators use to distinguish between the two and ensure compliance from the start.
Why it Matters
Misclassifying a worker as a contractor when they should be an employee can lead to IRS penalties, back taxes, and even investor red flags.
Know the difference before you hire — especially if they're full-time or core to your product.
Founders Checklist
Use the IRS and Dept. of Labor criteria to classify each hire
Use contractor agreements with clear scope and deliverables
Set up payroll and benefits for employees
Avoid treating contractors like employees (don’t set hours, tools, or locations)
Reevaluate classification when roles change over time
Founder Fails
Hired full-time “contractors” working 40 hrs/week on Slack
Got flagged during diligence for misclassification
Promised equity to contractors without formal agreements
When to ask for Help
Before hiring your first team members
If unsure how to classify a part-time or project-based worker
When using international or remote workers
If switching someone from contractor to employee
Before signing contracts with unclear role definitions
Frequently Asked Questions
Q: What’s the legal difference between an employee and a contractor?
A: It comes down to control and independence. Employees work under your supervision with set hours and tools. Contractors work independently on defined projects.
Q: Why do startups love contractors?
A: Flexibility, speed, and no payroll tax or benefits. But abuse the model, and you’ll pay for it later — with interest.
Q: What if I hire someone internationally?
A: Use a contractor agreement if no local entity. But consult counsel — missteps in foreign jurisdictions can be expensive.
Q: What if I want to convert a contractor to a full-time employee later?
A: That’s fine — but make sure their original contract doesn’t imply employment terms like vesting or benefits.