1099ers Exposing Startups, Private Equity Firms to Costly Liability

A recent online edition of New York Magazine's "Daily Intelligencer" includes a comprehensive article on how Silicon Valley startup tech companies using "the 1099 model" may be exposed to employment, tax and benefit law liabilities that could drive them out of business or cause them to change to a W-2 model. Kevin Roose's fine article is titled "Does Silicon Valley Have a Contract-Worker Problem?"

Roose predicts that venture capital funding sources that have invested in 1099-model startups may not have anticipated their potential exposure to the types of class action lawsuits where the contract workers allege that they are not really independent contractors but actually misclassified employees. The article examines companies that use the 1099 model — such as TaskRabbit (errand service), Homejoy (house cleaning), Uber (car service), BloomThat (flower delivery), Washio (laundry services) and Spoonrocket (meal delivery) — and concludes, "If their [freelance 1099ers] are classified as employees then that suddenly makes their business model untenable."

Three things seem to have prompted the article. The first was Roose's hiring of a house cleaner through a San Francisco startup called Homejoy, which was offering home cleanings in the Bay Area for $19. As Roose noted, that was not $19 per hour or $19 per room, but $19 for his entire home. Striking up a conversation with the cleaner, he found out that the worker was homeless and, to Roose's surprise, was not an employee of Homejoy but an independent contractor referred to Roose by Homejoy.

The second event was Roose learning that a federal appellate court had just ruled that FedEx Ground had misclassified 2,300 drivers in California that it had treated as independent contractors. The third was Roose hearing that Uber had been sued in Massachusetts and California in a class action lawsuit alleging that they were being misclassified as independent contractors. Roose asks: "Could courts destroy the 1099 model?" The answer to that question is below, but first we address investments by private equity firms in companies that use a business model built around independent contractors.

Hidden Due Diligence Risks

In our January 2013 blog post titled "Hidden Due Diligence Risk in Mergers, Acquisitions and Investments: Independent Contractor Misclassification Oftentimes Overlooked by Private Equity Firms, Hedge Funds and Other Investors," which was republished in the American Bar Association's Jan. 23, 2013...

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