On Monday, more than 400 employees of a company that provides on-demand, virtual assistants were unexpectedly laid off with little explanation other than the company was "shifting" -- code for "likely shutting down." Customers received notices, and at least one of them said she was so upset she made arrangements to continue paying her assistant rather than give her up.
Everything changed on Tuesday for Zirtual, the unlucky company in question. Former customers received notice it had miraculously been saved and that operations will resume by the the beginning of next week. Luckily for Zirtual, one of its customers offered to acquire it, an 11th-hour miracle for both employees and customers. So as of now, Zirtual has been acquired for an undisclosed amount by Startups.co, the parent company of services like Launchrock, Clarity, and Fundable. It was an all-stock transaction.
So what exactly happened?
According to a blog post by Zirtual co-founder and CEO Maren Kate, she simply couldn't make the math work. The costs of running the company were greater than what it was bringing in, and she was unable to raise additional funding. But more specifically, she attributes that excessive "burn rate" -- the amount costs exceeded revenues -- to converting her workers from independent contractors to full-time employees with benefits.
"In total we raised almost $5 million over the past three years, but when we moved from independent contractors (ICs) to employees, our costs skyrocketed. (Simple math is add 20–30% on to whatever you pay an IC to know what it will cost to have them as an employee)," she writes.
After finding out about the shutdown yesterday, Startups.co co-founder and CEO Wil Schroter reached out to Zirtual and its board to work out a deal. He plans to restart the service next week. Schroter told Fortune that he's still not sure who, if anyone, from the management team will be kept onboard.
Though a startup's failure is hardly a unique event, Zirtual's case will likely resonate with the many others currently juggling significant labor costs and yet-unproven business models. The debate over whether on-demand startups, the trendy new category of startups delivering all kinds of services for relatively low fees, should—or even can—use independent contractors instead of company employees has hit the courts recently. Though most will never admit it, cost has been at the center of the decision to use employee contractors, and many are fighting hard to keep those models so as to avoid paying employee benefits and withholding their taxes.
Two weeks ago, on-demand cleaning service Homejoy closed its doors after a long fight to raise money and make its numbers work out (there appeared to be some problems with customer acquisition and retention). It also faces a lawsuit over its practice of employing contract workers instead of employees, something the company admitted went into its decision to close shop.
In the case of Zirtual, Schroter said that its failure stemmed from the fact that it grew its staff faster than its demand did, adding unnecessary costs it couldn't support. As he takes over, he plans to hire a small number of assistants to make the numbers add up, and grow the team more carefully.
Whether the practice of using contract labor instead of full-time employees gets abolished through regulation—Uber is about to duke it out in court—might not make a difference for some startups. Shyp, Instacart, Sprig, and Luxe have all voluntarily moved to convert contract workers to employees, showing that this cost-cutting technique is not universally used. Perhaps it's a bit more subtle. Perhaps contract labor can be temporarily used until a company reaches a certain level of customer demand and revenue at which point switching to employees won't cause bigger losses -- something Zirtual didn't do.
But at the very least, Zirtual's case should serve as a warning to those still believing they can use it as a crutch and that Silicon Valley's magical funding machine will save them. Startups.co likely won't dive in to save another one.