Proposition 22 (Prop 22)

Proposition 22 is a landmark California ballot initiative that passed in November 2020, fundamentally reshaping the legal landscape for the gig economy. Championed and funded by companies like Uber, Lyft, and DoorDash, Prop 22 classifies app-based transportation and delivery drivers as independent contractors rather than employees. This was a direct response to California's Assembly Bill 5 (AB5), a law that would have forced these companies to reclassify their drivers as employees, granting them benefits like minimum wage, overtime pay, and unemployment insurance. Prop 22 created a “third way” employment status, offering a limited set of benefits—such as a minimum earnings guarantee and healthcare stipends for qualifying drivers—while preserving the independent contractor model that is central to these companies' operations. For investors, Prop 22 is a critical case study in how regulatory risk can make or break a business model.

The debate boils down to one simple question: Is an Uber driver a self-employed business owner or an employee of Uber? The answer has billion-dollar consequences.

• Employee Status: If drivers were employees, companies would be on the hook for massive costs, including payroll taxes, workers' compensation, paid sick leave, and health insurance. This would have fundamentally altered their cost structure and likely forced them to raise prices significantly or even exit the California market.
• Independent Contractor Status: This model, cemented by Prop 22, allows companies to avoid most of those costs. The company acts as a platform connecting independent drivers with customers.

Prop 22 didn't just maintain the status quo; it created a unique hybrid model. It mandates certain new benefits for drivers, but these are tied to engaged time (the time from accepting a ride or delivery request to completing it), not all the time a driver is logged into the app. These benefits include:

• Earnings Guarantee: At least 120% of the local minimum wage for engaged time.
• Healthcare Stipends: Quarterly payments to qualifying drivers based on the number of hours they are engaged per week.
• Accident Insurance: Coverage for medical expenses and lost income resulting from injuries suffered while on the job.

For anyone invested in or considering an investment in a gig economy company, understanding Prop 22 isn't optional—it's essential homework. It directly impacts a company's profitability, scalability, and long-term risks.

The passage of Prop 22 was a monumental victory for the companies that sponsored it. They spent over $200 million on their campaign, the most expensive in California's history, because their business models depended on it. By classifying drivers as contractors, Prop 22 protected their low-cost, flexible labor model, which is a cornerstone of their path to achieving a sustainable profit margin. For a value investing practitioner, this is a double-edged sword. On one hand, the proposition secured a company's current operational structure and prevented a catastrophic increase in costs. On the other, it reveals a profound vulnerability: the company's profitability is heavily dependent on a specific legal interpretation rather than a more durable competitive advantage, like superior technology or an unshakeable brand.

The story of Prop 22 is far from over. This is not a “set it and forget it” piece of legislation.

1. Legal Challenges: The proposition has been in a legal tug-of-war since it passed. It was ruled unconstitutional by a lower court in 2021 before that decision was reversed by an appeals court in 2023. The case is now before the California Supreme Court, meaning its ultimate fate is still uncertain. This legal limbo represents a significant, lingering risk for investors. A final ruling against Prop 22 could vaporize billions in market capitalization overnight.
2. The National Blueprint: Other states and even national governments are watching California closely. The success of Prop 22 has emboldened gig companies to push for similar laws elsewhere. If they succeed, it could solidify their business models on a much wider scale. If they fail, or if Prop 22 is ultimately struck down, it could trigger a domino effect of stricter regulations across the country, posing an existential threat.

Prop 22 is a masterclass in analyzing a company's exposure to non-financial risks, specifically political risk and regulatory hurdles. While the stock prices of Uber and Lyft soared after it passed, a prudent investor must ask tough questions. Is the company's economic “moat” built on solid ground or on the shifting sands of politics and law? A core tenet of value investing is seeking a margin of safety. A business model that requires spending hundreds of millions of dollars to win a political battle and remains locked in a court fight might lack the durable, predictable earnings power that value investors cherish. Therefore, while Prop 22 provided a crucial win for these companies, the ongoing uncertainty means any valuation of these stocks must be heavily discounted to account for the very real risk that their entire labor model could be upended by a single court decision.