Why VCs Care About the On Demand Contractor Debate

A lot of VC investors have chimed in to the debate about employment status of on-demand workers.  Why do they care?  I’ll look at a few popular reasons:

The Non-Monetary Argument:

One argument is that “it’s just not right” to squeeze every last cent out of an employee and “force” them to work as a contractor when they probably would prefer to have all of the benefits of an employee.  However, this isn’t why VCs care.  Sure, treating your labor force as true employees may have other long-term benefits to the company, but I don’t believe that this comes down to a moral argument.  Contractors are an important part of our workforce and contract labor isn’t a new phenomenon.  The NY Times recently gave some startups credit for “doing the right thing by employees”

The Risk Mitigation Argument:

This argument says that some companies will choke and die under the current regulatory framework and increasing risk of lawsuits.  Let’s call this the Homejoy Argument.  I believe that many VCs can (rightfully) look past these risks because the upside of catching a unicorn is so tempting (and part of their core business).  According to CB Insights Real-Time Unicorn Tracker, we have 118 active private unicorns.  By my count, sixteen of these companies were either illegal or accused of being illegal at some point during their life.  This is part of the business these days, so I don’t think many VCs are passing on companies because they’re too risky.  Uber and Airbnb have taught them not to do that.

Zombie Risk Argument:

I haven’t seen this one but I bet every investor in a contractor-based company is thinking something like this right now: “Oh shit, am I stuck in a potentially huge, marginally profitable business that will never exit?”  Many of these companies may reclassify workers and survive, just with far lower margins (and therefore less money to reinvest in growth).  It’s possible that we’re watching the biggest run of “lifestyle business” funding ever.

The Unit Economics and Venture Scale Argument:

This is where VCs’ bread is buttered.  Unit economics and scalability.  Insert a VC’s yardstick here:  “Can this company [be a 10x return] / [return my fund] / [be a billion dollar company]?”  Given the recent debate, many VCs are likely running models that sensitize cash in the bank and/or runway vs rising labor costs and/or one-time legal charges.

Next week I’ll post a simple model that shows the difference and why it matters.

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