Startups often rely on both employees and independent contractors. But these are legally distinct relationships - and using the wrong type of agreement can create serious legal and financial risks. Misclassification can lead to tax penalties, lawsuits, and regulatory violations, especially in strict states like California and New York.
Here’s what founders need to know.
Employee vs. Contractor: What’s the Difference?
The key distinction comes down to control and integration into your business.
- Employees: Work under your direction, often full-time, using your tools, and are central to your business. They’re covered by wage laws, tax withholding, and benefits.
- Contractors: Are independent, control how and when they work, typically serve multiple clients, and are not subject to the same laws or protections.
Misclassifying a contractor as an employee (or vice versa) can lead to tax penalties, lawsuits, and labor violations - especially in states like California or New York.
What Goes in an Employment Agreement
A strong employment agreement should include:
- Title and duties
- Compensation (base salary, bonus, equity)
- At-will clause (if applicable)
- IP assignment and confidentiality obligations
- Restrictive covenants (like non-solicitation)
- Severance or termination terms, if any
- Dispute resolution and governing law
This document is more robust than an offer letter and gives you a firmer legal foundation - especially for founders, executives, or key hires.
What Goes in a Contractor Agreement
A good independent contractor agreement should include:
- Scope of work: Clearly defined services and deliverables
- Payment terms: Flat rate, hourly, or per milestone
- Timeline or duration of the engagement
- Ownership of work product: Must include an IP assignment clause
- Confidentiality terms
- Termination rights for both sides
- Dispute resolution and governing law
Also include a clause affirming that the contractor is not an employee, and that they’re responsible for their own taxes and benefits.
Common Pitfalls to Avoid
- “Contractor” in name only: If someone works 40 hours a week under your direct supervision, they’re probably an employee - no matter what your agreement says.
- No IP assignment: Without a written assignment, the contractor - not your company - may own the work product.
- No written agreement at all: Even short-term gigs should have something in writing. Emails don’t cut it.
Final Thoughts
Clear, customized agreements are essential whether you’re hiring your first employee or your fifth freelancer. The type of agreement you use should match the nature of the relationship - and protect your company from day one.
Want help drafting a bulletproof employment or contractor agreement? We’re here for that.
Frequently Asked Questions
FAQs on Employment vs. Contractor Agreements
Can I decide whether someone is an employee or contractor?
Not entirely. The classification depends on how the work is structured. If you control when, how, and where they work, they’re likely an employee, even if the agreement calls them a contractor.
Do contractors get the same benefits as employees?
No. Independent contractors are responsible for their own benefits, insurance, and tax obligations unless you choose to offer additional perks in the contract.
What happens if I misclassify a worker?
You may face IRS penalties, back taxes, unpaid benefits, wage claims, and potential lawsuits. States like California impose strict penalties for misclassification.
Should startups use templates for these agreements?
Templates are a good starting point but rarely cover the specific needs of your business. Customized agreements reduce risk and ensure compliance with state and federal laws.
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