The Key Roles of Human Capital in eCommerce Business and Their Importance
This post is Part 6 of a series covering core legal issues for eCommerce and Internet-based businesses.
Human Capital in eCommerce and Internet-Based Businesses
Even in a technology-based business, a significant amount of enterprise value is created by and relies upon the creativity, energy, and efforts of people.
Human Capital in eCommerce Business
People serve as managers and executives, developers and creatives, marketing a sale, operations, fulfillment, installation, as well as repair and tech support. These people produce content, create and implement business strategies, and manage operations for eCommerce businesses. In doing so, they may be creating liabilities, sharing secrets, poaching clients, or doing all number of things – intentionally, as well as unintentionally – that can create liability or cause harm to ecommerce businesses.
So, even though people are often critical to the success of an eCommerce business, relationships between the eCommerce business and these people must be defined and covered by clear and enforceable legal agreements.
The people involved in a technology business typically fit into one or more of the following categories:
Service Providers (Contractors & Employees)
Owners, including Founders and Investors
Directors, Officers and Advisors
Because an individual may have multiple roles within the organization, it is important to know what role they are filling at any given time to appreciate their obligations to the company. Below is a discussion of each of these distinct roles, as well as some common challenges and pitfalls eCommerce businesses face in dealing with people in those roles.
Service Providers
Service providers create assets and other forms of value for ecommerce business. These services providers fit into one of two roles: they are either employees or contractors.
The respective rights of the eCommerce business and its contractors are defined solely by contact. However, because of the impact of various state and federal laws, the relationship between ecommerce businesses and its employees can be more complex. Therefore, it is critical that eCommerce businesses correctly identify who is who so that they can appropriately manage the relationship.
Independent Contractors
An independent contractor is a worker that is typically independent from your main, or core, business. Very often independent contractors include workers that do not have a permanent position, works only on special projects, or only works when needed. Further, any independent contractor in your business should have a written agreement in place that lays out the rights and responsibilities of the contractor.
Additionally, you must ensure that your relationship and agreement with the contractor does not involve too much control over the contractor, which could lead to the contractor being classified as an employee. An independent contractor will likely be in control of their schedule, will not have a set number of hours, will not have taxes deducted from their payment, and usually are not permitted fringe benefits of the company.
Further, your company should issue an IRS form-1099 to the contractor after each year for all payments made to the contractor during the prior year. Your company should also consider suggesting that your independent contractors obtain insurance to cover their actions as they will likely not be covered under your typical business insurance.
Pay to contractors is not salary and thus is not run through payroll. As such, eCommerce businesses are not required to collect and pay social security or income taxes on behalf of independent contractors. Moreover, independent contractors are not entitled to benefits such as health insurance and 401k plans that eCommerce businesses might provide to their employees.
eCommerce Employees
As a company, you will normally have more control over the actions and direction of the employee. The laws regarding employment vary significantly from state to state, and federal laws governing employees often depend on how many employees a company retains.
Generally speaking, “at-will” employees can be hired and fired for any reason – or no reason – other than something illegal like racial or sex discrimination.
However, a written employment agreement can change this basic rule. An employment agreement should cover the rights and responsibilities of the employee and company and any other special provisions for which you would like to bind the employee.
Employees will typically have a set schedule each week, will report for a certain number of hours, will have taxes deducted from their payment and are typically entitled to fringe benefits of the company. eCommerce businesses must collect and pay various taxes to state, local, and federal tax agencies in connection with their employees.
Furthermore, eCommerce businesses will likely need to invest in worker’s compensation insurance coverage for those employees or may opt-out. Worker’s compensation is handled differently in each state, and you should think about those laws before deciding on whether to bring on employees or independent contractors.
Employee or Contractor?
Because of the implication of employment laws as well as the costs associated with payroll, taxes, workers compensation, unemployment insurance, healthcare and other employee benefits, eCommerce businesses often will seek to define a service provider’s role with the company as an independent contractor rather than employee in an effort to save on administrative burdens and costs.
Regardless of the title given to a service provider, however, state and federal law ultimately will determine whether a given sole provider is an employee or a contractor. Misclassifying an employee as an independent contractor could subject an eCommerce business to significant fines and legal penalties, as well as civil lawsuits.
There are a number of legal factors that go into such an analysis, and no single factor is typically dispositive. The overarching consideration is how much control the eCommerce company exerts over the service provider. When in doubt, an eCommerce business should consult with expert employment counsel to determine whether a given service provider’s role constitutes an employer-employee relationship.
eCommerce Business Owners
Any person or entity owning equity interests in the company is an owner. Depending on the type of legal entity (e.g., LLC, corporation, LP, etc.) and the type of equity owned (e.g., common shares, preferred shares, etc.) will determine the rights and obligations the owners have.
The initial owners of most ecommerce businesses are the founders. Although founders will often contribute some capital and other assets (including IP assets) to an eCommerce business, their ownership rights are often driven by their service to the company.
In addition to the founders, other owners can acquire equity in an eCommerce company. Some may receive equity in exchange for services, while others may simply be providing capital to the company.
Also, where a founder or other person is receiving equity in exchange for services, it is important for eCommerce businesses to clearly define what services are expected as consideration for those services. Ideally, a vesting schedule can be used to grant additional equity to the founders once they complete certain benchmarks or years of service.
To avoid possible disputes, all issuances of equity should be governed by detailed and clear agreements between the eCommerce business and the owners. In addition, there are a number of state and federal laws which govern the sale of ownership interests (i.e., securities). eCommerce businesses should work with experienced legal counsel whenever they grant equity to anyone – including to founders.
It is important to note that an owner, including a founder, is not necessarily an officer or employee of an eCommerce business. Although in many instances they do serve in those roles, if they are only owners, they typically don’t owe any duties or obligations to an eCommerce business, including confidentiality, non-competition. Moreover, if they have created or will create intellectual property, it is possible that the creator – and not the company – will own the IP assets.
Thus, it is important that an eCommerce business ensures that anyone with access to proprietary materials – including founders and investors - has executed a confidentiality agreement, and anyone providing creative or development services for the company executes an agreement transferring all IP rights to the company.
Directors and Officers
Directors and officers are elected by the owners to make decisions and manage the operations of the eCommerce business. Although they ultimately answer to the shareholders, while in office they wield considerable power over the company’s operations.
Founders of eCommerce businesses often serve as officers and directors of these companies. In these roles, they act as fiduciaries of both the company, itself, as well as all other owners. Thus, a founder who is also a director or officer must be sure to act always in the company’s best interests, even at the cost of their own personal interests.
In addition, officers and directors of eCommerce businesses who are also involved with other businesses must be sure to avoid any conflicts of interest. This can create some special challenges where an officer or director is also a majority owner of the company. Because of their fiduciary obligations as officers, they must be sure to protect the interests of even the smallest shareholders or else they risk personal liability.
Board of Advisors
It can often be helpful for eCommerce businesses to seek outside advice from experienced business professionals, mentors, and other advisors. On some instances, they will recruit a few of these people to serve on a “Board of Advisors.”
It is important for eCommerce businesses to appreciate that a “Board of Advisors” is different than a “Board of Directors.”
For one thing, a Board of Advisors serves in an advisory capacity only. They do not have any voting power or direct control over the company or its operations. In contrast, as noted above, directors and officers make decisions and manage the operations of the eCommerce business.
While advisors can provide useful counsel, it is important for the eCommerce business to understand that because advisors are not directors or officers, and they do not owe automatically any fiduciary or other obligations to the company. To ensure that advisors do not release confidential information nor use information they receive to compete with the eCommerce business, the eCommerce business should ensure that all advisors execute an advisor agreement that includes confidentiality, non-compete, and other important provisions.
Finally, often an eCommerce business will want to compensate an advisor with equity in the company. As with all other issuances of equity for services, the eCommerce businesses should clearly define what services are expected of advisors, and how equity consideration is earned. In most instances, a vesting schedule can be used to grant additional equity to the founders once they complete a certain term of service. Even better would be to issue options to purchase equity at a discount, rather than equity, itself.
The Importance of Human Capital in eCommerce Businesses
eCommerce businesses rely on people to produce content, create and implement business strategies, and manage operations for eCommerce businesses. These people can create significant value for eCommerce business, as well as potential liabilities.
Depending on their role, these people will have certain rights and obligations, and as such the relationship between an eCommerce business and its human assets must be defined and covered by clear and enforceable legal agreements. This is particularly challenging when a person serves in more than one role for an eCommerce business.
It is critical, therefore, that eCommerce businesses work with expert eCommerce business legal counsel to manage their transactions and relationships with all the people involved with the company.
To view previous articles in this series:
Part 1: eCommerce Law for Internet-Based Businesses
Part 2: Privacy Law and Requirements for eCommerce Businesses
Part 3: Understanding and Protecting IP in eCommerce Business
Part 4: The Key Agreements Every eCommerce Business Should Have
Part 5: Legal Issues to Know for International eCommerce Businesses
ABOUT THE AUTHOR: Jim Chester is a 25-year technology business lawyer, professor and entrepreneur. He is a recognized authority in buying and selling technology businesses, global technology transactions, and providing strategic legal counsel for innovation-based companies. For more on Jim, visit his professional profile. You may email Jim at jim.chester@klemchuk.com.
For more information on eCommerce legal issues, see our Internet Law and eCommerce Legal Services and Industry Focused Legal Solutions pages.