For many years I’ve believed there are only three types of risks to a startup: market, technology, and the team. But recently another risk type is coming to the fore: government regulation.
Government regulation has long been a risk for medical devices and pharma companies. These are highly regulated markets. A biotech company can be worth billions or just pennies, all based on its ability to get past government regulators. (This is one reason why pseudo-healthcare companies like nutrition supplement company Herbalife can be so successful. Since these companies don’t sell drugs, the FDA doesn’t regulate them, although I firmly believe it should regulation nutrition supplements.
So lets take a look at these market risks and how founders can plan to mitigate them.
Whether anyone will care enough about your product to use it, even if it’s free, is usually the biggest problem founders face. Working hard at customer discovery before you develop your product is the best insurance that customers are out there who perceive your product as the solution to their problem. Is your market big enough? Most VCs won’t invest in a company unless they believe it can reach a valuation of a billion dollars in 5 to 7 years. So I advise most startups I see to not even bother trying to raise venture capital. If their markets expand dramatically in size, don’t worry, the VCs will be calling you. The National Science Foundation did a study of all the grants they had provided to scientists in the hope they would commercialize their research. What the NSF found was an overwhelming lack of success. The primary reason? The scientists built products no one wanted! As a result NSF started an entire program, I-Corps, to help scientists succeed in monetizing their research. MIT is a major player in I-Corps.
An associated market problem is that the cost of customer acquisition is far higher than the lifetime value of a customer. That’s why I believe built-in virality is a must in B2C markets – Google, Facebook, YouTube et al basically paid nothing to acquire their millions of users.
Most investors bet heavily on the team, and most heavily on the CEO, as I’ve posted about previously. The best way to mitigate this risk is to have worked with or been friends with your teammates. Y-Combinator did a study that showed that teams with pre-existing relationships were far more likely to succeed. A second order problem is that your team lacks one or two key roles. At MIT that is almost always a VP of sales and/or a VP of marketing. It is very hard for engineers to find teammates who can sell their product. So they are left to either take on the sales role themselves or to attempt to find a partner in a B-School like Sloan. But if you can show investors that you know what roles you need to fill and have a plan to fill them an incomplete team is not a show-stopper. VCs can even help you recruit. Investors will always bet on an A level team with a B level product rather than an B level team with an A level product. A-level players can pivot and find success with another plan. Not so with B players; B players often may fail to execute their A level plan!
Their are several ways you can mitigate this risk: one, rely on proven technology. Amazon built its success on breakthrough business ideas: one-click buying and their Prime customer plan. The second is to show that your technology works by getting your product out to tens of thousands of users without any show-stopping failures, such as poor performance or lack of reliability. Third, if your CTO or chief scientist is an acknowledged leader in a field that might seem risky, like genomic engineering, AI or robotics, investors may not only bet on your venture, but see real upside if you can ride that wave of a new technology.
One of my many mentor saying is, “I believe any one can build anything, given enough time. I don’t believe anyone can sell anything, no matter how much time they have.” However, you do have to be careful not to rely on technology that isn’t ready for prime time. That was our problem at Mobile-Mind. In the year 2000 apps weren’t even a gleam in Steve Jobs’ eye. In fact when he launched the iPhone there was no App Store! He had to be cajoled by his management team to finally launch what helped make the iPhone the amazing success it is: the App Store.
The Internet is that rare case where legislators have followed the first rule of doctors: first do no harm. The web, built on top of the Internet, was exempted from the many rules and regulations that constrain telecom companies that are heavily regulated, like all utilities. But now with the privacy, foreign hacking and disinformation campaigns and other breaches of the public trust that plague Facebook, Google, YouTube and others, rules and regulations may well come to play for Web-based companies. In fact, this has already happened in Europe with GDPR – General Data Protection Regulation. How do you mitigate the risk of government regulation? First treat it as a cost of business, as pharma and biotech companies do. Be upfront with your investors about how any domestic or international regulations may affect your business. Second, retain a great law firm that has a reputation for helping companies escape undue government regulation. Notice I said law firm, not lawyer. That’s because it is highly unlikely that a sole practitioner or small firm can possibly keep up with all the rules and regulations in both the U.S. and rapidly changing markets, like China. Finally read everything you can find about regulatory affairs in your target market and talk to your peers. New regulations can take a long time to enact; governments move very slowly. But new applications of existing regulations may happen far more quickly. The saying Forewarned is fore-armed is applicable here. No startup has the money to lobby Congress as Google, Amazon and all large tech companies have been forced to do. Millions of dollars are being spent by these companies when only a few years ago they had no presence in Washington at all.
I have a lot of experience with markets, teams, and technology but virtually no experience with government regulations. If you are going to launch your venture into a market that has been or will be subject to government regulation, make sure you have mentors and advisors with current experience with government regulation in your market.