Interns, Early Employees and Other Unpaid People

Any business, especially a pre-funded start-up, has an incentive to pay its agents as little as possible. Two issues here.

First, founders rarely think twice about working without pay, the idea being that everyone's compensation is represented by theoretical post-IPO pay out. However, all states, including California, have state minimum wage laws, which means problems might arise if, among other things, someone leaves the company prior to that pay-out (and the issue of his compensation is not contemporaneously resolved and documented).

Second, a start-up might be in a position to hire college students to work their little hearts out for free. This sounds convenient, but, like the decision to roll through a stop sign, requires some caution and forethought.

The legality of unpaid internships is a matter of both federal and state labor laws, which provide narrow exemptions for interns from minimum wage and overtime laws (state laws tend to pretty closely follow the Department of Labor (the "DoL") federal standard). The most recently promulgated federal standard (in the form of an April 2010 fact sheet on maintaining a compliant internship program) sets forth a six factor test for the exemption, which essentially requires:

1. The internship must provide some level of vocational or education-like training (think of an apprenticeship model) similar to the training given in a vocational school or academic institution.
2. The employer cannot derive "immediate advantage” from the intern’s activities. (This has been subject to a few different interpretations and the most reasonable standard of judgment (to the extent regulators' past practice and a 2002 decision by the Department of Labor’s Wage and Hour Division are indicative) seems to be whether the internship is, at the very least, mutually advantageous to both parties.)
3. The intern cannot be doing the same work as a regular employee (the "non-displacement" criterion). He should be doing intern stuff.FN1

As it turns out, this test may be almost impossible to satisfy. The acting director of the federal Labor Department’s Wage and Hour Division has stated, “There aren’t going to be many circumstances [where for-profit companies can have unpaid internships and] still be in compliance with the law.” That's a curiosity because unpaid internship programs are thriving and ubiquitous, at the highest level of business. So, on one hand, internship programs are unethical and illegal, and surely the cause of your ruin, FN 2 and on the other, you're a nit-wit if don't have one.

There are two alternative conclusions in light of this. The standard legal counsel is: pay the minimum wage. Don't roll through that stop sign! It's not invalid advice since a) the fact the DoL promulgated the fact sheet and 6 factor standard has people wondering if the DoL plans to more aggressively regulate; b) it might increase quality of your interns; and c) arguably, any company that can't benefit from a bright eager college kid at a minimum wage salary has problems.

As a matter of practice, however, based on the historical level and type of enforcement by the Department of Labor and their state regulator counterparts (as well as some of their published findings and commentary), the legal exposure from a well managed and properly instituted unpaid internship program is probably limited (depending on the circumstances) so long as you a) document the program and program processes FN3; b) limit interns to part-time work (to respect the DoL's non-displacement criterion) and c) most importantly, employ common sense and a generous spirit, which means the following:

-Hire carefully. FN4
-Be nice to your intern (free lunches, etc.).
-Don't treat him/her like just another employee.
-Don't make him/her hand sponge the bathrooms.
-Accept the fact that by giving your intern(s) meaningful assignments (to respect the DoL's "training" criterion), it's going to require a certain level of management effort, time and hassle.

FN1. The additional requirements include that the internship benefits from the training, you can't promise the intern a job after completion of the internship and he/she must appreciate no wages will be paid to him/her.

FN2. The liability for employers with misclassified unpaid interns includes unpaid wages, overtime and missed meal or rest periods, and certain waiting-time penalties as well as unpaid employment-related taxes owed to governmental agencies.

FN3. First and foremost, you should design and document a rudimentary "curriculum" (put together something) that the company plans to teach the intern. Additionally, you'll need to investigate whether there any state specific requirements (such as ensuring the intern receives academic credit from his school). More generally, you'll need to develop a wariness with respect to any written material (emails/agendas/plans) discussing tasks for which the intern(s) are responsible. Ideally, these materials should include language that reflects the tasks have some educational purpose.

FN4. Probabilistically, the trouble a company encounters in connection with an unpaid internship won't be caused by a random state or federal investigation. It will be caused by a disgruntled intern.