A maid enters a hotel room. Shutterstock The debate around how startups classify workers is heating up. On July 31, the same day that Uber - a pioneer in the independent contractor movement - hit a massive $51 billion valuation, Luxe Valet announced that it will join Shyp and Instacart in converting 1099 workers to employees. Since then, Sprig has announced it will do the same – while Zirtual said that it was shutting down, in part because it converted independent contractors to employees.



The issue may even become a political football. Democratic frontrunner Hillary Clinton said in her first major economic speech of the campaign that she would “crack down on bosses who exploit employees by misclassifying them as contractors or even steal their wages.” She called out the on-demand economy later, saying that it raises “hard questions about workplace protections and what a good job will look like in the future.” Alternatively, Republican hopeful Jeb Bush showed his support for the on-demand economy by Ubering during a trip to San Francisco.



But this showmanship masks the real truth: breaking an addiction to 1099 work is good for the entire startup ecosystem - filtering down from the employees’ satisfaction to customer demand and the startup’s growth to investors’ returns. And the fact that Zirtual didn't have a strong enough business model to support it meant that it was able to "fail fast" - instead of dragging investors, customers and employees along for additional months.



This is because reclassifying employees fundamentally challenges the “grow fast” model of building a startup. More upfront capital will be required to get businesses off the ground, and startups will have to strategically, and potentially less quickly, scale the business. However, the advantages of a full-time workforce - lower employee turnover, improved customer experience and reduced regulatory uncertainty - may more than make up for an initial increase in costs.



Almost by its nature, the on-demand economy employs a transient workforce. In a May 2015 study by Requests for Startups, nearly 28 percent of independent contractors at Uber, Postmates and Airbnb said that they expected to be employed at those companies for less than 12 months. Why? Mostly because the pay isn’t what it’s cracked up to be. Nearly 43 percent of those that had previously left an on-demand job said that it was due to “insufficient pay.”



Though good for some workers who want to fit a part-time job in between other work or school, transience also impacts the customer experience. IRS rules mandate that: “You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done)” [emphasis added]. To employ 1099 workers, the startup must relinquish control. It cannot train workers or set schedules – and therefore, it cannot control the service.



And though on-demand businesses are built on technology, to customers, the service matters more.



Case in point - Homejoy, which raised nearly $40 million before it shuttered at the end of July. The challenge at Homejoy and other startups using 1099 workers goes beyond the legal issues to the fact that no matter how the technology works, the company was synonymous with its end product.

People dressed in food-themed costumes give away donuts to people headed to the floor of the New York Stock Exchange to celebrate the IPO of GrubHub, in New York Thomson Reuters On the opposite front would be GrubHub*, which is the dominant platform for food delivery. Consumers aren’t confused about what GrubHub’s product is - it’s the technology that connects them to local restaurants. However, when a bad delivery experience happens, which we all were familiar with before GrubHub, GrubHub’s customer service is there to rectify the situation - often when the restaurant is not. By doing so, the company distinguishes itself.



So while 1099 startups may save upfront, costs eventually emerge on the back end – for constant recruitment of new workers, customer acquisition and retention and, as recent news has indicated, fending off lawsuits from workers who believe they should be compensated as employees. This trade-off is likely why Luxe Valet said that the financial impact of its move was not nearly as high as some might think.



For investors, upfront vs. long-term costs is a critical point as they adjust to a new reality. Startups were able to create a minimally viable product and scale quickly in a 1099 model, benefiting from trends that included a growing freelance population and an economy where many look for part-time work. Investors liked that – valuing growth over longer term clarity of business models and the consistency of user experience.



But the landscape is now mired with potential risks, from litigation to potential changes in legislation or regulatory scrutiny.



Eliminating these risks in a way that also improves customer satisfaction makes for good business - and a better long-term investment. Growth may be slower, but valuations shouldn’t take too big of a hit - the slower growth balanced out by substantially diminished legal risks and higher rates of repeat customers consistent with a better user experience. In the meantime, startups will be able to move from the flavor of the day to become sustainable, long-term businesses.



Tech startups and investors would be right to follow that path to prosperity.



*Disclosure: GrubHub Co-Founder Mike Evans is an investor and board member in Whittl.