Investors are overlooking one thing when they throw money at ‘Uber for X’ startups

Homejoy is shutting down after blaming independent contractor lawsuits. Facebook/homejoyinc

While venture capitalists are looking for a market fit or scrutinizing metrics, they may be missing a key area that would lower their return on investment in so-called “Uber-for-X” startups: employment contracts.

The independent contractor debate claimed its first victim this week when on-demand cleaning company Homejoy announced it will be shutting down July 31.

It blames the lawsuits it was facing over 1099 workers as the “deciding factor” in the decision, its CEO Adora Cheung told Re/Code. Its finances were reportedly dismal, and it likely couldn’t afford to keep up the fight in courts.

Homejoy isn’t the only company to be fighting these battles, though. Many “Uber for X” startups, like Instacart and Washio, are also seeing litigation pile up at their door.

Venture capitalists are forgetting to do due diligence on the labour contract side, and it will ultimately end up lowering their returns in the long run, said Rich Reibstein, a lawyer at Pepper Hamilton and head of its independent contractor compliance group.

“They see that the IPO has a billion-dollar value to it, but they don’t realise that the structure of the business has a billion-dollar value to it too. When you see these decisions that are discussed in the media, finally then CEOs are telling their subordinates, ‘make sure we are good with our independent contractors. We don’t want to be the next Uber defendant,'” Reibstein said.

First, there’s the cost of fighting the legal battles themselves. Companies have to have the margins to handle the lawsuits and the time to put aside for it. Homejoy, a company that raised $US40 million, couldn’t afford to fight its lawsuits. And while many could be argued as frivolous or trivial, the lawsuits can’t be ignored or else it could be a further liability.

Washio Delivery
Washio is facing litigation from its workforce of ‘ninjas.’ Vimeo/Washio

There’s also the cost of if these companies lose —  it takes a lot of money to switch from independent contractors to employees, and that may lower some venture capitalists’ return on investments when the extra cash is gobbled up and margins are tightened.

Re/Code calculated that it could cost Uber $US209 million to reclassify its workers. A recent decision against FedEx forced the company to shell out $US228 million. Companies like Alfred and Munchery have told Business Insider that it costs them about 20 to 30 per cent more to employ workers than independent contractors — and each company decided to do so.

Many companies aren’t asking the right questions when they’re setting up their business in the beginning, Reibstein said. A lot of it is mimicking the “Uber for X” model, but not realising how hard independent contractor compliance actually is. The Department of Labour had to publish a 15-page guidance this week just to explain the test used.

“Startups need to spend more time making sure that their business structure and documentation is compliant with regulatory requirements. This is not always so easy because in the area of independent contractor compliance, it may be a matter of dotting your I’s and crossing your T’s, but where the I’s and the T’s are not so easy to understand,” Reibstein said.

However, many of the investors we talked to consider much of this debate a sideshow. A successful business should be able to absorb the cost, and once one company prevails in court, some investors think that the lawsuits will dwindle.

Homejoy, after all, was reportedly losing a lot of money despite the $US40 million it had raised. Fighting independent contractor compliance may have been the fatal blow, but not its root problem.

Still, even if independent contractor misclassification is viewed as a business risk, it’s one that can be marginalized if the company is structured in a compliant way — from the beginning.

“The same rigour is not given for something as important as the structure of the service provider, even though it’s a critical part of the business model,” Reibstein said. “It’s a question of misplaced resources.”

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