Why You Should Join A Regulated Startup

Friday,February 01, 2019 10.37AM / By Caleb Kaiser / AngelList Talent / Image: Algorithm-X Lab

Anystartup in a regulated market is going to carry some risk, the potentialpayoff—at the right company—could be worth it.

Foryears, investors have shared a standard piece of advice for founders looking tobuild in regulated markets: Don't.Don't take on the regulatory risk; don't put your startup at the mercy ofpolitical whims; don't try to grow fast in a market where regulators willrequire you move slowly.

Nowthat attitude is starting to change.

In arecent talk at Columbia University, entrepreneur Steve Blank, along withBradley Tusk, Uber's first head of policy, and Evan Burfield, author of Regulatory Hacking, discussedhow some of the most exciting unicorns of the last 10 years have been launchedin heavily regulated markets—and why they think that trend will onlyaccelerate.

Why regulated marketsare a massive opportunity

Whenyou look at ultra high-performing tech companies, most are in markets whereregulators are absent. That's not an accident. As Burfield explains:

We'vecome through 20 years of the internet exploding in the economy, where you wereable to pick off lightly-regulated slices of the economy, like media andretail... (But) you keep going if you're an entrepreneur. You keep looking forthe next puzzle to solve. And then you're getting into healthcare,transportation, energy, defense.

Inother words, when the internet first emerged as a disrupting force, thelowest-hanging fruits for entrepreneurs were largely unregulated markets.Decades later, the new frontier of untapped opportunity lies in sectors withheavy regulation.

Lookingat the 10largest rounds (Series D and earlier) funded in 2018, eight wereraised by companies in regulated industries:

Katerra, a startup disrupting the construction industry, raised an $865 million Series D.
Zoox, an autonomous driving startup, raised a $500 million Series B.
Samumed, a medical startup working on tissue regeneration, raised a $435 million Series A.
Robinhood, a zero commission investing platform, raised a $363 million Series D.
Lime, an electric scooter rental startup, raised a $335 million Series C.
Devoted Health, an insurance startup, raised a $300 million Series B.
Bird, another electric scooter rental startup, raised a $300 million Series C.
Grail, a cancer screening startup, raised a $300 million Series C.

Thetrend is clear. If you're looking to join an earlier stage company where yourequity might equate to a massive exit, you should be looking at companies inregulated markets. The difficulty, however, becomes choosing a regulatedstartup that will survive.

How to pick a startupin a regulated market

PaulGraham defines a startup as “acompany designed to grow fast,” and so much of the startup lexicon reflectsthis. From Facebook's famous “Move fast and break things” motto, to theLean Startup methodology's emphasis on iterating quickly and cheaply, moststandard startup wisdom heavily emphasizes speed.

Regulatedmarkets, however, are a different game. As Burfield warns, in regulated markets“the rules that apply for low-friction or permission-less spaces canactually lead you in exactly the wrong direction.”

Inother words, if you “move fast and break things” in the financial sector,the SEC can throw you in jail.

Whenyou're considering joining a startup in a regulated market, you need to ask allthe questions you would askany startup before joining, as well as these two:

1. Arethe investors or leaders experienced with the regulators?

Regulationare about relationships and leverage. Having a relationship with and leverageover regulators gives a startup the ability to navigate regulations. A greatexample of this, as pointed by Blank, is the Defense Innovation Unit (DIU). TheDIU is a the Department of Defense's fund for investing in startups that builddefense technologies. If the U.S. government is invested in a startup, you canassume it's going to have an easier time with regulators.

On theother hand, having a relationship with regulators also helps when a startup isforced to fight. Tusk was originally hired by Uber as its first head of policywhen the company was going head to head with the New York City Council aboutUber's right to operate in the city. Tusk—who'd made a career in New Yorkpolitics working for Chuck Schumer and Michael Bloomberg—was experienced withthese regulators. He leveraged his knowledge of NYC politics, along with Uber'smassive user base, in what he gleefully described as “a vicious f******campaign” to flip the city council and halt regulation blocking Uber.

Ifinvestors, founders, or leaders at a startup have experience with theregulators controlling their market, the company has a better chance of surviving.

2. AmI an expert in this field?

Howmuch you know about the field dictates how early of a company you can join.

Not byaccident, regulation tends to happen in markets where there is significant riskposed to the consumer. Even the worst digital analytics platform is unlikely toharm a user. The worst self-driving car, on the other hand, could be adeathtrap. Vetting whether or not a startup satisfies its burden of proof fordemonstrating its product's safety—which Burfield mentions is one of the biggesthurdles to startups in regulated markets—requires an expert.

Maturecompanies that are already operating in the market are significantly derisked,from this perspective, as they've already passed some level of regulatoryscrutiny. Earlier stage companies, however, have not been derisked, and ifyou're not an expert in the field, you're probably not qualified to determinewhether or not the startup will survive.

The playbook forregulation is never the same

One ofthe tricky parts of prescribing advice within regulated markets is everystartup needs a different playbook. Different markets will have differententrenched interests, and the nature of the regulatory regimes and themechanisms by which they regulate will vary greatly.

Forexample, Uber's strategy of running ads that directly attacked council memberswas all about mobilizing users to put pressure on their local governments. Thisworked because local politicians needed those users to vote. Airbnb, on theother hand, can't employ this strategy–Airbnb guests by definition are usingthe service in locations where they don't live.

As aresult, the framework for picking a regulated startup to join is less aboutlooking for a startup with a particular strategy, and more about looking for astartup that is as derisked as possible.

Whileany startup in a regulated market is going to carry some regulatory risk, thepotential payoff—at the right company—is more than worth it.

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