The reliance on independent contractors as the backbone of the “sharing economy” has suffered a series of blows recently. A California Labor Commissioner ruling against Uber’s use of contractors and the July shutdown of on-demand house cleaning startup HomeJoy in the face of employee lawsuits have tech entrepreneurs and their investors spooked, worried they may lose their ability to designate workers as independent contractors.

The IRS allows workers to be designated as independent contractors if employers maintain the right to control or direct only the result of work, not what will be done and how it will be done. Critics argue the independent contractor designation has been abused to dodge employee benefits and payroll taxes, while proponents say that without the flexibility of the designation the modern on-demand tech economy would not be possible.

Now with government scrutiny bearing down on the worker designation, many are asking: Do on-demand tech startups that rely on independent contractors have a future?

We spoke with several people familiar with the debate: Saba Waheed, research director of the UCLA Labor Center; Tianxiang Zhuo, managing partner at Brentwood venture capital firm Karlin Ventures; Mike Jones, chief executive of Santa Monica startup studio Science Inc.; and Rattan Joea, founder and chief executive of Hawthorne’s Opoli, a ridesharing company that only contracts with those that have commercial driver’s licenses.

Question: Can the on-demand tech economy work without the flexibility of the independent contractor designation?

Waheed: There doesn’t necessarily need to be a tradeoff between independence and protection, between worker happiness and regulation. There are some examples of successful on-demand tech companies that rely on employees. Alfred, for instance, is a company that dispatches helpers to coordinate errands like laundry, cleaning and grocery shopping. The company trains workers, pays fair wages and offers benefits. The added labor costs are offset by potential litigation costs and the risk of paying back-taxes to the IRS for misclassification.

Zhuo: It would certainly be challenging. Firstly, the added cost of providing benefits would increase the cost to the end consumer and might make a lot of these services less viable.

The way it could work is if we reach an intermediate standard coined by several people as the “dependent worker,” where we retain the flexibility that has allowed the sharing economy to flourish so quickly but ensure that workers who participate in the sharing economy have access to the benefits they need, e.g. health care, unemployment (benefits).

Jones: Right now, forcing these marketplaces into making contractors full time is going to be bad for the platforms and bad for a subset of the workers who rely on them for supplemental income. Many of the most exciting startups in the space aren’t even nationwide yet, and are still in their infancy. I don’t know that there’s enough scale to create a vibrant full-time employee workforce, and without the flexibility of an independent contract designation, many workers run risk of alienation, and in turn the consumers who rely on their services will also suffer.

Joea: No. The costs are too high and the variables are too many to control.

Are there any aspects of the contract employee versus fulltime employee debate that aren’t being considered or given proper weight?

Waheed: The former chairwoman of the National Labor Relations Board has suggested a hybrid model, practiced in Canada, known as dependent contractor that would extend workers protections such as right to unionize and collectively bargain and be paid a minimum wage or receive overtime. Another direction is to move to user-owned cooperatives, where on-demand companies provide technology and payment processing services to user, rather than workers working for the company and generating profits off of that work.

Jones: Outside of the on-demand economy, startups and entrepreneurs over time have always used independent contractors at the earliest stages of business formation. We have to remember that when an individual ventures out to start a new company with little to no financial backing they look for variations of temporary labor to build the business. By constricting the employment types at the earliest stages of the business you will restrict business formation nationwide.

Joea: For us, the use of “contractor” hides the actual meaning of the word, entrepreneurship. Contractors – entrepreneurs – are really microbusiness owners who are empowered with flexibility and control.

Costs and revenue aside, do companies have a moral obligation to pay workers as regular employees, complete with benefits, Social Security, Medicare and employment taxes?

Waheed: The sharing economy came in during a time when many couldn’t make ends meet and created new opportunities. But it’s a model based on the lack of good stable jobs, and companies can have disincentive to reduce unemployment. These new business models enjoy profits while offloading risk to others. Whether it’s through less liability or lowering costs, the costs simply move elsewhere, whether to the worker or society.

Jones: I don’t think this is a black and white morality issue. One of the most interesting options that have emerged is Sen. Mark Warner’s advocating for a third class of worker. There’s a good argument for a third option so we can allow workers freedom and flexibility to have more mobile jobs to fit their lifestyle and needs.

Would you shy away from launching or investing in a startup that relied on independent contractors?

Zhuo: I wouldn’t. Independent contractors are one of the main reasons why startups have been able to scale so quickly. In fact, I am actively seeking startups that can better leverage independent contractors.

What would the effect be on the tech economy if the contract employee designation was no longer available?

Joea: The result would be devastating. Within our space, it is difficult to have an employee/employer relationship due to the variables of transportation. There are tons of unknowns. The bottom line is it would not make sense economically.

What should be the dividing line between designating someone as a contractor and designating someone as a fulltime employee?

Zhuo: Time allocation to a specific job would be a good dividing line. If someone spends 40 to 50 hours a week working for Uber, that would be their primary job, and in that case it makes sense to treat them as a full-time employee whether it be formally or through the type of employee benefits you offer. But it would be hard to justify designating someone as a full-time employee if they only work for your company for 1 or 2 hours a month.

Technology reporter Garrett Reim can be reached at [email protected]. Follow him on Twitter @garrettreim for the latest in L.A. tech news.