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Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other practice members. Our Band 1 ranked London TCG team closed over 320 growth financings and tech M&A deals totalling US$9.76bn in 2022 and has dominated the European venture capital tech market for 7 years in a row (PitchBook, FY 2022). Our first instalment provided guidance to founders on the process of setting up a private limited company.
When setting up and growing your company, one of the first priorities will be hiring your first employees and building your core team – a requisite for long-term strategic growth. In the second instalment of Orrick's Founder Series, our London Employment team offer top tips to help UK startups navigate this key stage in their lifecycle.
Employee, worker, or consultant?
1. Correctly classify your staff. In the UK, there are three employment status categories: an employee, a worker, and a self-employed consultant. The category a person fits into is dependent on specific facts and circumstances (including the amount of control the company has over the individual, whether the individual is free to work/provide services to others, whether the individual has a right of substitution and whether the individual is obliged to accept work and the company is obliged to provide it), rather than how the parties decide to document the relationship. This is significant because it will impact their access to certain legal rights such as paid holiday, sick pay, payment of minimum wage, protection from termination and controls on working time. There are also differences in tax treatment and if an individual is incorrectly classified as a consultant when they are, in reality, an employee or worker, the "employer" may be liable for income tax ("PAYE") and National Insurance contributions in respect of that employee, including interest and a potential fine.
Employing your first employee
2. The practical considerations. You will need to: (i) set up a UK bank account from which to pay salaries or other benefits to your workforce, (ii) deduct employment taxes at source (you do not need to operate your own payroll in-house, but can instruct an external payroll provider to operate payroll on your behalf), and (iii) register with HMRC to ensure employment and other taxes are paid, which can be done online here.
3. Register as a data controller with the ICO. As UK employees are subject to the UK General Data Protection Regulations and Data Protection Act 2018, it is likely an employer will process data in relation to these UK individuals. As such, the employer will need to register with the Information Commissioner's Office (ICO) and pay a registration fee, unless exempt. You can carry out a registration self-assessment here to determine whether you need to pay a data protection fee to the ICO, and can complete your registration with the ICO here.
4. Consider insured benefits and pension auto enrolment. The insured benefits which may typically be provided to a senior employee are:
If benefits are not set up at the outset, appropriate wording can still be included in any employment agreements, which allows for them to be put in place in the future without creating any obligation on the company. This will ensure that the protective conditions for the company are in place regardless.
Auto enrolment legislation requires that qualifying employees must be enrolled in a qualifying workplace pension scheme automatically – such requirement can be postponed for up to three months from the employee's start date.
Statutory employment rights
Statutory particulars of employment must be provided to employees on or before their start date. They are usually provided in the form of a more detailed employment contract. All employees, including founders, should be asked to sign employment contracts (or service agreements) at the earliest opportunity, to ensure that the company is adequately protected.
5. Basic employee entitlements. Employees in the UK: (i) are entitled to a minimum of 5.6 weeks (28 days) of holiday each year (which can include public holidays), (ii) must be paid at least the minimum wage (different rates apply to different age groups and the rates are updated annually), and (iii) are not permitted to work more than an average of 48 hours per week and are entitled to minimum rest breaks (which an employer must monitor or an employee must opt out of).
6. Employees' day one rights. The following are examples of key rights which the employee will automatically have with no minimum service requirement:
7. Rights accrued by the employee. Employees will accrue unfair dismissal rights after two years of service. An employee can bring an unfair dismissal claim if: (i) their dismissal does not fall under one of the five "fair" reasons (capability or qualifications, conduct, redundancy, breach of a statutory duty or restriction, or "some other substantial reason"), or (ii) a fair process was not followed (there are prescribed steps which the employer should follow) in relation to their dismissal and the employer cannot show that they have acted reasonably.
Giving equity to your co-founders and first employees
8. Co-founders and first employees. As discussed in our last article, there is a temptation for co-founders to put in place Founder Agreements to govern their relationship and what happens to those all-important founder shares if a co-founder were to leave the company. However, we often see these agreements replaced by the full shareholders’ agreement and articles of association put in place during the first priced round. Putting a Founder Agreement in place might therefore not be worth the time and costs required and there are often better strategies / mechanisms to achieve more appropriate protections.
In the current competitive market for talent, equity also becomes an important question in respect of your first employees. We will explore the dilemma of shares versus options in our next article.
Founder Service Agreements – are they necessary and what are the key considerations?
Founder Service Agreements are a more comprehensive form of employment contract, which usually contain director-specific wording to ensure the company is properly protected.
9. Protect your intellectual property (IP) and confidential information. It is best practice to have written contracts in place for founders that (amongst other things) make specific provision for the transfer of IP from them to the company and protect the company’s confidential information. Under English law, there is a presumption of ownership on the creation of IP from employees to their employers, but this is not the case for contractors and freelancers. A company's IP is often its most valuable asset, and investors will be very interested in these provisions. An employee is also subject to an implied duty of confidentiality during their employment, but including express provisions can ensure that all relevant confidential information is protected and that this protection continues after employment has ended.
10. Consider including post-termination restrictions to protect the business. The Service Agreement should also include post-termination restrictions (also known as restrictive covenants), which help to protect the business and its confidential information for a defined period after employment has ended – and investors generally expect these to be in place for founders. These can encompass, for example, non-compete, non-solicitation of employees and business, and non-dealing restrictions. Without these restrictions, the employee would be free to set up business in competition with the company or recruit the company's employees immediately after leaving employment. However, such restrictions must also be carefully drafted and tailored to an individual's position and go no further than necessary to protect the employer's legitimate business interests, to ensure that they are enforceable. If post-termination restrictions are not included from the outset, it can be more difficult to introduce these at a later date and separate consideration will need to be provided to the employee for them to be enforceable.
Our London Employment team are here to advise you on the topics raised above and provide other general UK employment law advice. The team regularly advise early-stage companies on all aspects of employment law, from guidance on recruiting a company's first employees, to growing a team and beyond. We can also assist with drafting service agreements, employment contracts, consultancy agreements and a range of policies, as required. As a company grows, we can advise on issues that arise during the employment relationship, as well as termination of employment.
If you would like more details on any of the issues above, please contact Nicola Whiteley ([email protected]).