Venture Bytes #56 - Startups for Startups

Startups for Startups

With the proliferation of venture capital funding in larger and larger rounds at seed stage and beyond, startup valuations are larger than most tech companies that IPO’d in the 1990s and 2000s. This institutionalization of venture capital and startup funding has also led to a robust marketplace of surrounding services for these startups, specifically in adjacent domains and non-core areas of the key business value proposition. This can be seen in the number of US unicorn startups going from 26 in 2013 to 140 in 2018, and the amount of VC money invested in startups in 2018 (~$131B).

The best example of the market of startups for startups can be seen within financial intermediaries, but other virtuous startup cycles also exist. The virtuous startup cycle allows for a startup to scale by offering a service specifically created for startups, ultimately enabling more innovation. A major example of this within public markets was cloud computing, but now this extends into legal, real estate, and financial components of running a startup. Essentially, the virtuous startup cycle enables the creation of more startups by lowering the barriers to entry of creating a startup. Additionally, in the market of startups for startups, by solving the problems of startups, these firms can adapt their offerings to scale and compete with larger enterprises.

Two prominent examples of unicorn startups that act as financial intermediaries are Carta and Brex. Carta is valued at $1.7 billion and helps private companies, public companies, and investors manage their cap tables, valuations, investments, and equity plans. This was borne out of the necessity to align stakeholders across the cap table of a startup, from employees to founders to investors, by facilitating cap table management, real time valuation, and analytics services. While Carta has enabled and automated a primarily back office function, it also has the classical network effects of a Silicon Valley startup, bringing transparency to startup valuation and ownership in a way that wasn’t previously possible.

Brex is valued at $2.6 billion and provides corporate charge cards to technology companies, with a focus on specific pain points that entrepreneurs face when starting a company. Their value proposition is virtual cards and digital expense management tools to efficiently extend credit to startups based on metrics that traditional financial institutions don’t consider, such as the amount of money in their corporate bank accounts, which bypasses the traditional banking model that depends on revenues. Additionally, Brex offers 60-day payment terms, interest-free financing, and rewards that are specifically geared towards high growth startups.

A unique component of both Carta’s and Brex’s business model is that they use startups as leverage to enter into larger TAMs. They do this bypassing traditional financial intermediaries and working backwards into a dominant market niche with startups. Brex estimates its TAM has expanded by multiple times since having proved they have traction with startups, as this provides a bridge into other value add services for larger enterprises. Additionally, Carta has the same opportunity, as they already have $530 billion of assets within their platform, and can further leverage their TAM to include other finance functions within a startup.

Beyond financial intermediaries such as Carta, and Brex, other virtuous startups include WeWork in real estate, Stripe in payments, and Atrium in legal services. Ultimately, this virtuous startup cycle continues to allow for and enable innovation, which will only lead to more innovation in the future, hence the term, startups for startups. **

AB5 Strikes at the Core of the Gig Economy

The implementation of the Assembly Bill 5 (AB5) in California is a misguided policy and will hurt employees, businesses and consumers rather than helping them as was originally intended. Therefore, it is unlikely that it will be fully implemented and might set a precedent for other states to be very careful before bringing in similar legislations.

For those who do not know what AB5 is, this bill was created in an attempt to overcome the “misclassification” of workers by redefining independent contractors based on the new “ABC” test and offer more protection to them in terms of employee benefits and rights such as unemployment insurance, healthcare grants, paid parental leave and rest breaks, overtime pay, compensation, at least the States’ minimum wage, and most importantly the right to unionize. Aren’t these supposed to be a good thing though? No! We admit that these privileges have a nice tune to it, but the negatives undoubtedly outweigh the positives. In order to better understand the potential adverse implications of this bill, we need to discuss exactly what it means for the employer, business and consumer.

From employees’ standpoint, AB5 will take away their liberty to work independently for more than one company, and deny flexibility and control over their job in terms of working hours and financial security. Let’s take a ridesharing services driver as an example. Assume that this driver works for both Uber and Lyft. With the advent of AB5, he must choose to work for either Uber or Lyft and terminate his affiliations with the other because an “employee” cannot work for a competitor, which means he will have to give up the earnings he receives either from Uber or Lyft and not be able to set his own hours. What if he makes up for the extra income he lost by working overtime? Unfortunately, this is unlikely as well because he may not be allowed to work overtime simply because the ride sharing service does not want to pay him more than it is necessary. Okay, so he can only work for one of the companies that operate in the same space. But what if this person already has a full-time job but wants to make some extra cash during his spare time to further support his family or simply go on a vacation? Even though being an Uber or Lyft driver does not require high levels of commitment time and effort wise, meaning that it will not intervene with the person’s actual job, his primary workplace may not allow him to take on a second job since he will become an employee of two companies before the law which can be against company policies. Then the individual will be denied the right to earn extra money which was formerly possible.

As for employers, business costs will increase materially by 30% according to the National Employment Law Project after factoring in employment-related taxes, benefits, overtime or at the least minimum wages that they were not previously responsible for. Furthermore, companies that operate in the gig economy should expect a decline in the number of workers due to losing former independent contractors to competitors or dismissing existing drivers because they will be unable to support and have (more) control over as much workers. So, the very same people who fought for the approval of AB5 to improve their quality of life may be assigned to less work slots, or even end up jobless, or be subject to stricter work requirements. Ironic, right? This scenario is more likely to occur if companies refuse to increase prices. According to a report by Beacon Economics, ridesharing services could end up losing up to 300,000 drivers nationwide. This implies that depending on “who gets who”, Uber can gain a competitive edge over Lyft, and vice versa.

The impact of AB5 is least apparent on consumers, but that does not mean the financial consequences are any less real or important. Since gig economy businesses will incur more costs, they will most likely increase prices. , which essentially means that the consumers will have to pay for it. For this reason, using these companies’ goods and services will become more expensive for consumers which will in turn result in a decline in consumption. In the case of Uber and Lyft, increase in trip fares will give rise to less bookings and higher waiting times. Morgan Stanley analysts argue that ride-hail bookings can fall by 1%-2% in California, and 5%-9% nationwide if other states decide to follow in the footsteps of the Golden State.

Unsurprisingly, Uber and Lyft first come to mind among those who will be substantially affected by this new bill since their drivers’ complaints were in fact what gave birth to the idea of such a legislation, but we need to zoom out and look at the bigger picture. Under AB5, the entire gig economy in California is facing disruption from food-demand delivery companies such as DoorDash and Postmates to newspapers, moviemakers to independent artists. In other words, every large corporation that uses independent contractors or freelancers will be affected to some degree. Based on Barclays analysts’ calculations, the reclassification and related costs will amount to $290 million, which could lead to several bankruptcies and thousands of job losses. For all the reasons above, California’s AB5 is bound to fail.**