Any startup in a regulated market is going to carry some risk, the potential payoff—at the right company—could be worth it.
For years, investors have shared a standard piece of advice for founders looking to build in regulated markets: Don't. Don't take on the regulatory risk; don't put your startup at the mercy of political whims; don't try to grow fast in a market where regulators will require you move slowly.
Now that attitude is starting to change.
In a recent talk at Columbia University, entrepreneur Steve Blank, along with Bradley Tusk, Uber's first head of policy, and Evan Burfield, author of Regulatory Hacking, discussed how some of the most exciting unicorns of the last 10 years have been launched in heavily regulated markets—and why they think that trend will only accelerate.
When you look at ultra high-performing tech companies, most are in markets where regulators are absent. That's not an accident. As Burfield explains:
We've come through 20 years of the internet exploding in the economy, where you were able to pick off lightly-regulated slices of the economy, like media and retail... (But) you keep going if you're an entrepreneur. You keep looking for the next puzzle to solve. And then you're getting into healthcare, transportation, energy, defense.
In other words, when the internet first emerged as a disrupting force, the lowest-hanging fruits for entrepreneurs were largely unregulated markets. Decades later, the new frontier of untapped opportunity lies in sectors with heavy regulation.
Looking at the 10 largest rounds (Series D and earlier) funded in 2018, eight were raised by companies in regulated industries:
The trend is clear. If you're looking to join an earlier stage company where your equity might equate to a massive exit, you should be looking at companies in regulated markets. The difficulty, however, becomes choosing a regulated startup that will survive.
Paul Graham defines a startup as “a company designed to grow fast,” and so much of the startup lexicon reflects this. From Facebook's famous “Move fast and break things” motto, to the Lean Startup methodology's emphasis on iterating quickly and cheaply, most standard startup wisdom heavily emphasizes speed. Regulated markets, however, are a different game. As Burfield warns, in regulated markets “the rules that apply for low-friction or permission-less spaces can actually lead you in exactly the wrong direction.”
In other words, if you “move fast and break things” in the financial sector, the SEC can throw you in jail.
When you're considering joining a startup in a regulated market, you need to ask all the questions you would ask any startup before joining, as well as these two:
1. Are the investors or leaders experienced with the regulators?
Regulation are about relationships and leverage. Having a relationship with and leverage over regulators gives a startup the ability to navigate regulations. A great example of this, as pointed by Blank, is the Defense Innovation Unit (DIU). The DIU is a the Department of Defense's fund for investing in startups that build defense technologies. If the U.S. government is invested in a startup, you can assume it's going to have an easier time with regulators.
On the other hand, having a relationship with regulators also helps when a startup is forced to fight. Tusk was originally hired by Uber as its first head of policy when the company was going head to head with the New York City Council about Uber's right to operate in the city. Tusk—who'd made a career in New York politics working for Chuck Schumer and Michael Bloomberg—was experienced with these regulators. He leveraged his knowledge of NYC politics, along with Uber's massive user base, in what he gleefully described as “a vicious f****** campaign” to flip the city council and halt regulation blocking Uber.
If investors, founders, or leaders at a startup have experience with the regulators controlling their market, the company has a better chance of surviving.
2. Am I an expert in this field?
How much you know about the field dictates how early of a company you can join.
Not by accident, regulation tends to happen in markets where there is significant risk posed to the consumer. Even the worst digital analytics platform is unlikely to harm a user. The worst self-driving car, on the other hand, could be a deathtrap. Vetting whether or not a startup satisfies its burden of proof for demonstrating its product's safety—which Burfield mentions is one of the biggest hurdles to startups in regulated markets—requires an expert.
Mature companies that are already operating in the market are significantly derisked, from this perspective, as they've already passed some level of regulatory scrutiny. Earlier stage companies, however, have not been derisked, and if you're not an expert in the field, you're probably not qualified to determine whether or not the startup will survive.
One of the tricky parts of prescribing advice within regulated markets is every startup needs a different playbook. Different markets will have different entrenched interests, and the nature of the regulatory regimes and the mechanisms by which they regulate will vary greatly.
For example, Uber's strategy of running ads that directly attacked council members was all about mobilizing users to put pressure on their local governments. This worked because local politicians needed those users to vote. Airbnb, on the other hand, can't employ this strategy–Airbnb guests by definition are using the service in locations where they don't live.
As a result, the framework for picking a regulated startup to join is less about looking for a startup with a particular strategy, and more about looking for a startup that is as derisked as possible.
While any startup in a regulated market is going to carry some regulatory risk, the potential payoff—at the right company—is more than worth it.