Independent Contractors Serve a Vital Role in the U.S. Startup Ecosystem
TLDR: Hiring full-time talent is costly and difficult when a startup is in its early stages, but recent federal efforts have created even more uncertainty for nascent companies that rely upon independent contractors to help them innovate and grow. As Congress and the Biden administration take steps that could narrow the definition of an independent contractor, policymakers must be careful to examine how this push would impact workers, startups, and small businesses across the country.
What’s Happening This Week: The U.S. startup community is continuing to follow potential legislative and regulatory changes that would create uncertainty for nascent companies looking to make vital talent decisions.
Although a rule issued at the close of the previous administration would have clarified the distinction between independent contractors and employees, the Biden administration is moving forward this week to withdraw the effort. The Trump-era ruling from the Department of Labor (DOL) attempted to clarify independent contractor status under the Fair Labor and Standards Act, which would have provided clearer factors for startups and gig workers to consider when making hiring decisions or pursuing freelance work. While DOL has argued that rolling back the rule is not harmful because it has yet to go into effect, the administration’s proposal ignores entrepreneurs’ need for regulatory clarity. As Engine noted yesterday in comments to DOL, “the clarity the rule would have provided could have eased uncertainty in making talent decisions that startups may have difficulty shouldering—lessening a burden during the current economic climate.”
House lawmakers last month also passed legislation—known as the Protecting the Right to Organize (PRO) Act—that would, in part, limit who could qualify as an independent contractor by codifying language similar to the ABC test in California’s Assembly Bill 5 (AB 5). The state law expanded the definition of an employee, limiting startups’ ability to hire independent contractors, and placed the employment futures of gig workers and freelancers—many of whom pursue the work they do because they don’t want to be tied to an employer—in jeopardy. Under the ABC test, workers are considered employees unless: “A) the individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of service and in fact; (B) the service is performed outside the usual course of the business of the employer; and (C) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.”
Why it Matters to Startups: Launching a startup is complex and costly. While raising capital is paramount, deciding how and when to hire talent is a critical and complicated decision for early-stage companies. Legislative proposals and regulatory actions that limit startups’ access to talent and create uncertainty make it more difficult—if not nearly impossible—for nascent companies to rely on the independent contractors and freelancers they need to innovate, grow, and expand their operations. While the debate around the status of independent contractors frequently centers on the employment designation of gig workers for large Internet companies, independent contractors provide essential services for startups in their growth stages.
The average startup launches on a bootstrap budget with funds cobbled together through self funding, friends, family, and personal or business loans. With limited resources, founders might have to choose between a number of necessary factors—such as R&D, advertising, and employees—that all require significant resources and can stretch a limited budget. And startups in their nascent stages often require project-by-project assistance that does not necessarily necessitate full-time employees. Instead, startup founders often turn to contract workers to fulfill their talent needs before they are able to fully scale their businesses. These workers fill essential roles for nascent companies—including by providing product development, design and marketing services, legal advice, and accounting support. While larger companies are well situated to shoulder the costs associated with hiring full-time talent—including salaries and employee benefits—new businesses often lack the resources needed to hire full-time staff while they are still building their products and services.
In California, startups and support organizations feared the effect that AB 5 would have on the Golden State’s entrepreneurial community after the law’s passage. While some of those concerns were lessened after California voters amended the law via a ballot measure last year and after state lawmakers moved to exempt certain contractors—such as food delivery workers—from the application of AB 5, recent efforts by federal policymakers do not contain similar exceptions.
According to Laura Good, the co-founder of StartupSac—a Sacramento-based nonprofit focused on educating and connecting founders and innovators—not having an exemption for pre-revenue companies places the same standards on small startups and large corporations. Grant Leah, the co-founder of Woodland-based startup Nytch, explained in 2020 that the passage of AB 5 was particularly worrisome for early-stage companies that rely upon independent contractors to scale their operations. “The reality is that startups are so small and so lean that we can’t really hire employees,” Leah told us. “Founders are the ones who typically don’t take a salary. Without the ability to hire independent contractors to fill these voids, most startup ideas would never get off the ground.”
Without regulatory certainty, startups’ budgets will be stretched thin and their ability to scale may be restrained. Instead of limiting the ability for startups to access the talent they need—particularly amidst the uncertainty caused by the pandemic—policymakers should consider the circumstances and lifecycle of the American startup when legislating and regulating on the status of independent contractors.
On the Horizon.
The Senate Commerce Committee is holding a hearing at 10 a.m. tomorrow to discuss the Endless Frontier Act and efforts to strengthen the U.S. innovation ecosystem.
The Consumer Technology Association is holding a virtual innovation policy summit tomorrow and Thursday to discuss hot-button tech policy issues, including Section 230, digital trade, and connectivity.
The Brookings Institution is holding a virtual conversation with venture capitalist Bill Tai this Friday at noon to discuss investing in new technologies like non-fungible tokens.
The High Tech Inventors Alliance is hosting an event on the U.S. Patent System: Challenges and Opportunities in 2021 on Wednesday, April 21st at noon ET. Experts will discuss how the patent office reviews low-quality patents, an increase in forum shopping, and a rise in patent litigation, as well as what the government can do to fix problems in the system. Register here.
Join Engine next Thursday, April 22nd at noon ET for a virtual event to unveil our report with Startup Genome and the Charles Koch Institute on "The State of the Startup Ecosystem.” The report examines changes and trends in startup investment and exits over the last decade. The panel will discuss the report's findings as well as the importance of understanding the health of the U.S. startup ecosystem for sound policymaking. You can RSVP here.
