Structuring employment contracts in early-stage start-ups

By Omoruyi Edoigiawerie, Esq

Many start-ups’ early years are characterized by rapid growth, resource constraints, and an all-hands-on-deck approach to building a viable business.

Founders often focus on securing funding, refining their products, and acquiring customers. In this whirlwind, one critical aspect frequently overlooked is the structuring of employment contracts.

From experience, I have seen first-hand how employment agreements, or the lack thereof, can shape a business’s trajectory. In some cases, well-drafted contracts have provided clarity and stability, allowing companies to scale seamlessly. In others, the absence of clear employment terms has led to disputes, financial liabilities, and even legal battles that threaten the start-up’s survival.

A well-structured employment contract is more than a formality; it is a strategic tool that safeguards a start-up’s intellectual property, mitigates risks, and sets the foundation for a productive work environment. This article explores the key components that should be carefully considered when structuring employment contracts in a start-up’s early years.

1. Defining the Employment Relationship

One of the most common pitfalls for start-ups is misclassifying employees. In the rush to bring talent on board, many founders engage workers informally, often under vague agreements. However, the distinction between employees, independent contractors, and interns has significant legal implications.

•             Employees: Under most labour laws, full-time employees are entitled to statutory benefits, including pensions, health insurance, and paid leave. Employers are also required to comply with tax and social security obligations.

•             Independent Contractors: Contractors are not entitled to employee benefits, but if a start-up incorrectly classifies an employee as a contractor, it risks legal claims for unpaid entitlements.

•             Interns: If an internship is unpaid, labour laws may restrict the scope of work the intern can perform to ensure they are not exploited as unpaid employees.

I once had to help rescue a start-up that had engaged several workers as “freelancers” without formal contracts. Initially, this wasn’t a concern, but as the business grew, it became a major issue. The company faced significant financial risks due to potential substantial payoffs, an outcome that could have been avoided with properly structured agreements from the outset.

2. Compensation and Equity Considerations

In the competitive start-up ecosystem, founders often rely on innovative compensation structures to attract and retain talent. While start-ups may not always be able to match larger companies’ salaries, they frequently offer equity, performance-based bonuses, or deferred compensation as incentives. However, these arrangements can lead to serious disputes if they are not clearly documented.

For example, a start-up founder verbally promised an early employee a percentage of the company’s equity. Years later, as the company scaled and raised funding, the employee insisted on receiving the full percentage without dilution, despite the founder’s original intent to grant the equity subject to a vesting schedule. The resulting dispute led to lengthy negotiations and an expensive buyout.

To avoid such scenarios, employment contracts should explicitly state:

•             Salary and benefits, including payment terms and any performance-linked incentives.

•             Equity agreements, including vesting schedules (e.g., four years with a one-year cliff) to prevent employees from departing with significant equity after a short tenure.

•             Bonus structures, clearly defining performance metrics and payout timelines.

A well-documented compensation plan not only aligns employee expectations but also provides clarity for investors conducting due diligence.

3. Intellectual Property (IP) Protection

A start-up’s most valuable asset is often its intellectual property, whether it is proprietary software, innovative designs, or unique business strategies. Without proper safeguards, employees can inadvertently or intentionally walk away with critical IP, leading to costly legal disputes or competitive disadvantages.

In many jurisdictions, an employer automatically owns intellectual property created by an employee during their work. However, this is not always guaranteed without an explicit contractual agreement. Start-ups should ensure that employment contracts include the following:

•             An IP assignment clause explicitly states that any work, invention, or innovation developed by employees during their duties belongs to the company.

•             Non-disclosure provisions preventing employees from sharing proprietary information with external parties.

I have worked with start-ups that faced significant challenges during fundraising due to gaps in their IP ownership structure. Investors flagged risks where key employees had not formally assigned their work to the company. Addressing such issues retrospectively can be complex, time-consuming, and expensive.

4. Confidentiality and Non-Compete Clauses

Confidentiality is crucial for start-ups, particularly in industries where competitive advantage depends on proprietary strategies, customer data, or technical know-how. A robust confidentiality clause should be included in employment contracts to restrict employees from disclosing or misusing company information during and after employment.

Additionally, start-ups may consider non-compete clauses, which prevent employees from joining direct competitors or launching rival businesses within a specific time frame. However, non-compete clauses are subject to legal limitations in many jurisdictions and must be carefully drafted to ensure enforceability. Courts often scrutinize such clauses to determine whether they impose unreasonable restrictions on an individual’s ability to earn a livelihood.

In practice, I have advised start-ups to take a balanced approach, limiting non-compete provisions to reasonable durations and geographic scopes while prioritizing strong confidentiality and non-solicitation clauses to protect business interests.

5. Termination and exit provisions

While hiring is often a priority for start-ups, employee exits are equally important to manage effectively. Founders sometimes assume that terminations can be handled informally, but disputes can arise over notice periods, severance entitlements, and post-employment obligations without clear contractual terms.

A well-structured employment contract should address:

•             Notice periods for resignation or termination, ensuring both parties clearly understand exit timelines.

•             Termination for cause, specifying conditions under which immediate dismissal is justified (e.g., fraud, misconduct, breach of contract).

•             Severance policies, if applicable, to provide clarity on financial obligations upon exit.

I have seen first-hand how messy things can get when improperly structured employment contracts are used. In one instance, a start-up dismissed an employee without a documented process. The employee sued for wrongful termination, demanding substantial compensation. With no proper termination clause in place, the company had no choice but to settle at a significant cost, which is exactly the kind of situation no start-up should find itself in.

Conclusion: Employment Contracts as a Strategic Asset

In a start-up’s fast-paced environment, employment contracts may seem like a secondary concern. However, experience has shown that well-drafted agreements are fundamental to preventing disputes, protecting intellectual property, and maintaining operational stability.

As a start-up grows, its workforce evolves, and so should its employment policies. Founders must proactively seek legal guidance early, ensuring that employment contracts are tailored to their specific needs and compliant with applicable labour laws.

Ultimately, employment contracts are not just legal formalities; they are strategic assets that contribute to a business’s long-term sustainability. By establishing clear agreements from the outset, start-ups can mitigate risks, foster a strong company culture, and position themselves for scalable success.

*Omoruyi Edoigiawerie is the Founder and Lead Partner at Edoigiawerie & Company LP (EandC Legal), a full-service law firm offering bespoke legal services with a focus on start-ups, established businesses and upscale private clients in Nigeria.  The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. His firm can be reached by email at [email protected]