Uber, Lyft, and the Sifting Sand of the Gig Economy’s Labor Model

Our Call: Capstone first wrote in July 2019 that the likely passage of California Assembly Bill 5—then-pending legislation in the state—posed sizable unappreciated risks to companies that rely on independent contractors. The law would rewrite the rules for the business models of Uber Technologies Inc. (UBER), Lyft Inc. (LYFT), and other “gig economy” firms. Both Uber and Lyft were just months past their respective IPO dates, with stock prices hovering near record highs.

Background: There has been a national debate over what constitutes an “employee”—a question with implications measured in the billions of dollars for companies and their workers. The push for AB 5, a California bill that would make it harder for companies to classify workers as independent contractors and skirt state and federal labor laws was at the nexus of the issue. AB 5 expanded on the California Supreme Court’s 2018 Dynamex Decision, which instructed businesses to use the “ABC test” to figure out whether a worker is an employee or independent contractor. The ABC test consists of three conditions that companies must demonstrate to classify workers as contractors and is much stricter than federal guidelines or the 11-point Borello test previously used in California. If passed, AB 5 would affect various industries that rely on independent contractors. Food delivery and ridesharing platforms would face the largest impact, as it may be difficult for these companies to demonstrate that drivers perform an independent service outside the “regular course” of the platform’s business.

Our Rationale: Momentum favored advocates of AB 5. If passed, the legislation would require gig economy companies to classify California workers as employees, a move that could cost Uber and Lyft hundreds of millions of dollars in associated costs. Moreover, the prospect of action from other states that also use the test, though strictly for determining eligibility for unemployment benefits, suggests a long regulatory road ahead for gig economy companies. Massachusetts, New Jersey, and Vermont already use the ABC test to assess employee classification across all labor-related laws.

Our Process: We conducted a rigorous review of the public record of existing and proposed regulation and legislation. We combined this research with targeted conversations with relevant regulators, policymakers, and other stakeholders to assess the risks and opportunities the companies face. We also conducted financial analysis to determine how exposed they were to the looming headwinds.

The Outcome: AB 5 was passed into law September 2019, despite massive opposition from Silicon Valley and tens of millions of dollars spent in a lobbying effort to defeat it. Since our note first published on July 25, 2019, until the law went into effect on January 1, 2020, Uber’s stock fell 30% while Lyft’s stock price dropped 33%. Both companies remain mired in last-ditch legal battles to roll back the bill. However, hundreds of thousands of independent contractors in California will become employees under AB 5, the change in designation will have a considerable impact on the bottom lines of Uber and Lyft.