Why Some Gig Economy Startups Are Reclassifying Workers as Employees

While gig economy behemoths like Uber and Lyft are fighting tooth and nail to keep classifying their workers as independent contractors and not employees, a steady stream of prominent startups have made the switch from 1099 to W2.

The most recent company to begin employing its workers is Honor, a healthcare startup that sends caregivers to attend to elderly individuals at home.  In mid-January 2016, Honor announced its frustration with not being able to provide its “Care Pros” with training, benefits, promotions, and—in a rare move—equity in the company.

Honor follows a line of gig economy companies that have made similar moves, mostly within the last year: office management startup Eden, grocery-delivery provider Instacart (partly), on-demand valet service Luxe, courier and shipping startup Shyp, and meal-delivery services Munchery and Sprig—to name some of the best-known examples.

This string of switches raises the question: why are these startups doing this?  Analyzing their respective announcements provides some answers, with a big caveat that these are simply their publicly stated perspectives.  They do, however, prompt one further uncertainty: should all gig economy startups be pushing to reclassify their workers as employees?

Why Startups Say They Make the Switch

While these startups vary widely in terms of funding, scale, and services offered—from delivering groceries to providing in-home care—the stated reasons behind switching classification from contractor to employee are fairly consistent.

More training.  The foremost rationale behind making the switch was to be able to provide workers with substantive training.  Investing in workers made them more reliable, knowledgeable, and lowered churn.  Eden, for example, claims to put their workers through extensive training to not only make them effective, but also pleasant to be around.

More control.  Startups like Munchery noticed that, with total worker flexibility, they’d find themselves shorthanded on busy days.  Luxe, which offers an on-demand parking service, realized all their valets congregated in particular parts of their market cities and weren’t as spread as out as they’d like.  Switching to an employee model allowed these companies the control over their workers that was necessary to optimally run their businesses.

Customer satisfaction.  One particular subset of the additional training and control was a focus on customer satisfaction.  Honor and Eden, which were providing services in homes and in offices, respectively, wanted to make sure each interaction was as positive as possible.  Even delivery-focused startups realized that many of their customers were repeat players, and building a face-to-face relationship would be critical to their success.  The exception to this was Instacart, which decided last summer to offer its in-store shoppers and cashiers part-time employee status, leaving their customer-facing deliverers as independent contractors.

Goodwill.  These companies seem excited that the reclassification will allow them to confer benefits to their workers: healthcare, unemployment, worker’s compensation, and even (for Honor and Sprig) equity.  (Of course, at least some of these benefits could also be provided to independent contractors.)  In Shyp’s case, the company started covering its couriers’ vehicle expenses.

The “disintermediation” problem.  Companies sometimes experience being cut out completely as middlemen.  Contractors, once connected with users, would create their own relationships and agreements, obviating the need for a “platform.”  This issue seemed particular to startups like Honor, which originally referred skilled caregivers to customers.  It’s a bit unclear how switching to employee status fixes this, especially since non-compete and non-solicitation agreements are unenforceable in most of these companies’ home state of California.  Perhaps the combination of benefits with a more stable client base would ward workers away from striking their own agreements with customers.

Definitely not the Uber lawsuits?  Surprisingly, and perhaps suspiciously, companies did not raise the specter of Uber’s (or Homejoy’s or Postmates’ or Caviar’s or…) widely reported misclassification lawsuits.  Some went so far as to specifically deny them as a motivating factor.  It is notable, however, that most of these companies have made their own switch within the last year, when these lawsuits were on everyone’s minds.

Is Switching Right For Everyone?

Across the board, these diverse companies claim very similar reasons for reclassifying.  In exchange for providing benefits, startups gained additional and necessary control.  But one statistic appeared time and again among announcements: making the 1099-to-W2 switch tacks on an additional 20–30% to a company’s costs.

On one hand, not switching could be costly: in-home cleaning startup Homejoy faced four lawsuits over the misclassification of its workers as contractors, which were ultimately blamed for causing the company to shut down in July 2015.  (Other reasons for the company’s failure have been suggested too.)  On the other hand, virtual assistant startup Zirtual made the switch but could not survive after operating costs “skyrocketed,” as explained in an apologetic note by former CEO Maren Donovan.  The company was sold to Startups.co, which has reverted to hiring the virtual assistants as independent contractors.

These two scenarios, however, may not be as different as they seem.  In both Homejoy’s and Zirtual’s cases, confronting the classification issue was inevitable. And perhaps in both cases, the companies dealt with it too late.

Importantly, most companies highlighted above that made the switch had tens or hundreds of millions of dollars in funding.  The exceptions are Zirtual and Eden, with a few million dollars in seed funding each.  Zirtual, however, made the switch two years after its founding (and shuttered a year later); Eden decided to reclassify when it was just five months old (and is still growing fast).  By taking such action earlier on in their existence, startups like Eden have a lower inertial barrier to clear.

Changing from contractors to employees isn’t an easy—or cheap—feat.  Zirtual’s Donovan noted to Bloomberg after her company’s sale that the model of on-demand sharing economy companies built on using independent contractors “will be destroyed if they have to move contractors to employees”—companies like Uber may be too big to change.  Realistically though, flush with venture capital money, Uber may in fact be best equipped to deal with this switch.  The trend seems to show that companies make the switch most successfully when they have enough money to do so or when they do it early enough to adapt their business model around the change.

Some gig economy startups have gone a step further and chosen to classify their workers as employees from the beginning.  A poster child for this strategy is Managed by Q, an office cleaning service that offers part-time and full-time employment—it’s still on-demand and app-centered, but the company can “train and nurture” its workers.  As noted on the blog before, having employee status does not seem to take away any of the foundational flexibility of the gig economy.  Honor, Luxe, Sprig—they’ve all shown how part-time employees can work a few hours a week and still have significant input on when they do so.  The stories of these startups suggest that switching to W2 employees is within reason for a range of services, and the earlier it is done, the better.