Earlier this year, I hired a house cleaner. I wouldn't have done so normally, but my place was a mess, I was busy at work, and I saw an offer on Facebook that looked too good to be true — a San Francisco start-up called Homejoy was offering home cleanings in the Bay Area for $19. (Not $19 per room or $19 per hour. Just $19.) So I booked an appointment through Homejoy's website, and a day later, a young man showed up at my door.
As the cleaner laid out his tools, we made small talk, and I asked him where he lived. "Well, right now I'm staying in a shelter in Oakland," he said. I paused, unsure if I'd heard him right. A shelter? Was my house cleaner — the one I'd hired through a company that has raised $40 million in venture-capital funding from well-respected firms like Google Ventures, the one who was about to perform arduous manual labor in my house using potentially hazardous cleaning chemicals — homeless?
He was, as it turned out. And as I told this story to friends in the Bay Area, I heard something even more surprising: Several of their Homejoy cleaners had been homeless, too.
To explain why it's possible for a cash-flush tech start-up to have homeless workers, it helps to know that the man I hired through Homejoy wasn't a Homejoy employee at all. That's because Homejoy doesn't employ any cleaners — like many of its peer start-ups, it uses an army of contract workers to do its customers' bidding. To hear Homejoy tell it, it's simply the digital middleman that allows people seeking home-cleaning services to find people willing to do it. The worker dusting off a bookshelf might look like he works for Homejoy, when he's really the sole employee of John Smith, LLC. As the Washington Post wrote, "Homejoy is just organizing the masses of people who already offer their cleaning services independently."
With Uber valued at $18 billion, Airbnb valued at $10 billion, and new imitators popping up daily, Silicon Valley is clearly infatuated with the middleman model. A recent study by venture-capital firm SherpaVentures, which has invested in start-ups like Washio (Uber for laundry), BloomThat (Uber for flowers), and Shyp (Uber for packages), estimated that venture capitalists invested $1.6 billion in so-called "on-demand" start-ups in 2013 alone. SherpaVentures predicts that so-called "freelance marketplace" or "managed-service" labor models used by these companies are poised to transform industries like law, health care, and investment banking, and that fewer people have traditional full-time or part-time jobs as a result. This, in the firm's mind, is a good thing.
"Perpetual, hourly employment is often deeply inefficient for all parties involved," the report reads.
But increasingly, critics argue that the freelance model is being abused, with workers being treated as if they were on payroll without getting any of the benefits afforded to payrolled employees. Some Silicon Valley insiders are beginning to worry that start-ups' overreliance on contract workers could come back to haunt them if they run afoul of longstanding labor rules. If that happens, these high-flying disruptors could be facing serious disruption themselves.
One former Homejoy cleaner who asked to remain anonymous because he feared reprisal from his current employer told me that when he signed up for Homejoy, he was issued a cleaning kit and a uniform and given a training session at a Homejoy employee's house. The company, he said, let him make his own schedule, but encouraged him to work certain days rather than others. And although he gave Homejoy credit for letting him work without any prior professional cleaning experience, he now takes issue with the company's policy of not covering independent contractors if, for example, they get injured on the job.
"Quite frankly, I don't think that's fair," the former cleaner said. "At every organization I've worked for, I considered myself an employee."
Welcome to the 1099 economy
I first heard the term “1099 economy” at this year’s TechCrunch Disrupt conference, where it was uttered not as a pejorative, but as a way to praise the innovative labor practices of Silicon Valley start-ups. When you order a service from one of these companies, the people who get paid to perform it don't file W-2 tax forms because they’re not officially employed. Instead, they file the independent contractor form, the 1099-MISC. The most famous examples of 1099 companies are on-demand car providers like Uber and Lyft, but there are dozens of others: Homejoy, Handy, Postmates, Spoonrocket, TaskRabbit, DoorDash, Washio. All of these companies employ similar jargon to describe their labor model — if you hear the words platform, provider network, or Uber for ____, you’re likely talking to one.
Homejoy, one of the more successful start-ups to adopt the 1099 model, insists that its method is better for workers. "Our partners are free to create their own availability and scope of work," CEO Adora Cheung said in an email interview. "That flexibility is one of the main appeals of the platform." (As for the homeless cleaners, Homejoy says its Bay Area contractors earn, on average, between $17 and $20 an hour, well above minimum wage. "While we sympathize with anyone who is in an economically difficult situation, we don’t think that relating that to Homejoy’s website or its practices makes sense," Cheung says.)
For start-ups trying to make it in a competitive tech industry, the benefit of opting for 1099 contractors over W-2 wage-earners is obvious. Doing so lowers your costs dramatically, since you only have to pay contract workers for the time they spend providing services, and not for their lunch breaks, commutes, and vacation time. Contract workers aren’t eligible for health benefits, unemployment insurance, worker's compensation, or retirement plans. And contractors don’t have to be fired if they mess up, since they were never employed in the first place. Instead, they’re simply removed from the network, and life goes on.
In other words, the 1099 economy is almost perfectly calibrated to serve the needs of fast-moving start-ups — lower costs, less liability, the ability to grow and shrink the labor pool quickly — but is it good for the people doing the work?
That depends on whom you ask. Start-up workers generally "fit into three buckets,” explains Josh Felser, a venture investor at Freestyle Capital. “There’s the control-your-hours contractor. That group seems to be very happy with where things are. There’s the full-time employee. And then there’s the middle group — where they’re acting like full-time employees and being paid like contractors. That group is disenfranchised.”
What is a worker, anyway?
The question of where, exactly, “contractor” ends and “employee” begins is a matter of debate. The IRS has a 20-factor test to determine whether businesses are treating their service providers like contractors or employees. Most of the factors have to do with the degree of control the company exerts over a worker. Does the worker have a schedule set by the company? Does the company require the worker to wear a uniform, receive job training, or use tools provided by the company? If so, that 1099 worker might be properly classified as a W-2 employee — and the company might be on the hook for thousands of dollars in back payroll taxes. (Just how widespread is this practice of improperly substituting freelancers for payrolled employees? It’s hard to say, but a recent paper by the National Employment Law Project claims that “state and federal governments lose billions in revenues annually as a result” of worker misclassification.)
The marketing materials used by these companies can complicate things further. For example, the main page of Homejoy’s website offers “Trusted, Affordable, and Convenient Home Cleaning & Home Services,” but makes no mention of the fact that these services aren’t provided by Homejoy employees. (For that, you have to look at the bottom of the company’s “About” page for a disclaimer set in small type.) A Craigslist ad recently placed by the company to seek new cleaners didn’t mention the independent-contractor model either. “Join our team of Cleaning Professionals!” the ad read. No mention was made of the fact that people who responded to this ad would not, in fact, be invited to “join a team” at all, but would be self-employed contractors working on Homejoy's platform.
In some industries, the independent-contractor model makes sense — part of the appeal of being an UberX driver, for example, is that you get to pick your own hours. But when companies begin to control their contractors as if they were employees, trouble often follows. Recently, a group of New York–based Uber drivers threatened to quit the service if Uber continued to penalize them for declining lower-cost UberX fares in favor of black-car fares that would earn them more money. Eventually, Uber backed down, reversing its policy and letting its drivers keep their choice of fares.
“It’s a balancing of a lot of factors,” David Schwartz, a labor and employment lawyer at Skadden, Arps, says of the contractor/employee question. “But the things the regulators look at the most are: Where are the services performed? How much supervision are you getting? And how much time is devoted to the project?” Schwartz adds: “If the person is highly dependent on one company for work, it starts to look like an employment situation.”
At least one on-demand start-up, Handy.com, has a contingency plan for a possible change in the law. The company's terms of service states that "if Handy.com is found to be liable for any tax or withholding tax in connection with your use of Users' services, then you will immediately reimburse and pay to Handy.com an equivalent amount, including any interest or penalties thereon." In other words, if Handy.com is forced to reclassify its contract workers as employees, its customers – not the company itself – will be on the hook for any extra costs.
The two-way street of contract work
Spoonrocket, which offers 10-to-15-minute delivery of cheap meals in the Bay Area, is one of the companies whose growth will depend on existing rules staying in place. Its drivers, who are independent contractors, earn a flat fee each time they drop off a meal (the company estimates that most drivers end up making between $10 and $25 an hour). And although Spoonrocket used to pay its drivers hourly and lent them Spoonrocket-branded cars to use for delivering meals, it ultimately decided to switch to contractors using their own vehicles.
“For a certain amount of time we tested out W-2 drivers, but that’s when we provided equipment,” Steven Hsaio, Spoonrocket’s CEO, said in an interview. “It wasn’t the most financially sound decision.”
Like many start-ups, Spoonrocket could afford to bring contractors onto its payroll if it wanted to. (In May, the company announced it had raised $11 million in a funding round led by Foundation Capital.) But optimizing for growth means lowering costs, and lowering costs means constantly looking for new ways to squeeze out inefficiencies. Hsaio says that Spoonrocket may begin testing a new model, in which drivers will be paid commissions for deliveries based on how far they're willing to drive.
“I ultimately think it’s really good,” Hsaio says. “We can’t tell [drivers] what to do or how to do their job. They’re their own entrepreneurs.”
Billy Hasan, a former Spoonrocket contractor who drove for the company until June of this year, remembers the moment that the company switched from paying drivers hourly wages to paying them on a commission basis. Under the old system, Hasan says, he often made between $50 and $60 working a six-hour shift. Under the new one, it took him eight or nine hours to make the same amount.
"Before they made the switch, it felt like one big team working together," he says. "After, it kind of felt like, 'We don’t really care about you guys, we only care about the money coming in.'"
Could courts destroy the 1099 model?
In June, a group of Uber drivers joined a class-action lawsuit against the company in California and Massachusetts. The drivers, represented by Boston attorney Shannon Liss-Riordan, alleged that Uber misclassified them as independent contractors, thereby requiring them to bear upkeep and maintenance costs that normal employees wouldn't be liable for. (Uber, in a statement to the Boston Globe, said it would "vigorously defend the rights of riders to enjoy competition and choice, and for drivers to build their own small business.”)
Start-ups aren't the only companies being targeted for worker misclassification. But they are the most vulnerable to a change in the law. Require a 1099 start-up to reclassify its workers as W-2 employees, and you radically change its ability to lower prices and undercut the competition — which was, in many cases, a key reason investors were interested in the first place.
“If their drivers are classified as employees then that suddenly makes their business model untenable,” Denise Cheng, a research assistant at the MIT Center for Civic Media, told the Globe.
One warning shot for 1099-dependent start-ups came in an August ruling by a federal appeals court, which found that 2,300 FedEx delivery drivers in California were being misclassified as independent contractors, since FedEx exercised broad control over their schedules and methods. "The drivers must wear FedEx uniforms, drive FedEx-approved vehicles, and groom themselves according to FedEx's appearance standards," Judge William Fletcher said. The three-judge panel ultimately ruled that since the contractors were being treated like employees, they were entitled to employee benefits such as overtime pay and reimbursement of expenses.
The implicit threat to start-ups like Homejoy, Spoonrocket, and Uber couldn't have been clearer. If you want to use independent contractors, the judges told FedEx, you've got to give them real independence.
Is there a better way?
As some start-ups push the 1099 model even further and others are challenged in court, a small group of companies is trying to reverse the trend.
MyClean, a New York–based on-demand cleaning service, tried the 1099 model in its early days. But it found that customers weren't happy with cleaners who came from third-party agencies. ("Almost almost all of our 1-star Yelp reviews are from those days," a post on the company's blog says.) So MyClean CEO Michael Scharf and COO Ken Schultz decided to go in-house instead, hiring cleaners instead of bringing them in as contractors.
The result of switching to W-2 labor, Scharf says, was labor costs as much as 40 percent higher than the competition's. But it also resulted in better customer satisfaction and better performance as a company. MyClean now has around 200 employees and has grown to $8 million in annualized revenue in the past two years.
“We see [independent contractors] as a legal risk,” Scharf says. “We also want, for lack of a better word, control — the ability to manage, dispatch, train, have processes in place for what our end service looks like. We wanted MyClean to have one consistent level of service.”
Another company bucking the 1099 trend is Munchery, a San Francisco–based food-delivery start-up that has raised $32 million in venture-capital funding since launching in 2012. Unlike Spoonrocket, Munchery classifies its drivers as employees and gives them health benefits as long as they work at least 30 hours per week.
Munchery’s co-founder, Tri Tran, doesn’t mind adhering to a more expensive labor model. “We know that delivery drivers are the face of the company,” he says. “They’re the only human-to-human interactions customers face, and they have to represent us well. When you get contractors do to the work, we tend to get poor results. They don’t really care. And some time ago, we realized that’s not the way to go.”
Companies that use W-2 workers to deliver services — which include food-delivery start-up Sprig and personal-storage start-up MakeSpace — face steep challenges compared to their 1099-dependent rivals. In a pre-Uber world, if you wanted to hire a house cleaner, you'd have had the choice of either using a traditional maid service or finding an independent cleaner on your own. But start-ups like Homejoy have been able to combine these two models, wrapping solo practitioners in the banner of a well-funded parent company, such that many customers can't tell the difference.
The ability of certain start-ups to thread that needle has peeved their competitors.
“In a world without laws, it would be great to be able to hand someone supplies, train them, and give them 30 bucks under the table,” says Ken Schultz, MyClean’s chief operating officer. “But we’re compliant, and the result is employees who have rights. We’d like to have a level playing field.”
Can Silicon Valley learn to love the W-2?
In the end, lawsuits and organized efforts by contractors could force many 1099-reliant companies to overhaul their practices. But more likely is that Silicon Valley will self-correct first. If it's true, as Munchery and MyClean say, that workers who are employed directly provide better service than independent contractors, the market will reward those companies accordingly.
Already, there are signs that a sea change could be underway. At this year's TechCrunch Disrupt (the same place I first heard the term "1099 economy"), the winner of the start-up competition was Alfred, a personal-service start-up that sends helpers to customers' homes to stock their refrigerators, fold their laundry, and in all ways ease their burdens.
Like Homejoy, Alfred provides an intimate, personal service, the kind that requires implicit trust between customer and company. Unlike Homejoy, it offers its errand-runners regular employment — and benefits — once they work 20 hours a week or more. It's a model Alfred knows will be more expensive in the short-term, but that it hopes will pay dividends down the road in the form of happy employees and satisfied customers. And if it works, it may just convince the rest of Silicon Valley's 1099 start-ups to scale up their payrolls as well as their profits.