Check Your Regulatory Debt

A guide for startups on moving fast without breaking too many things

By Johnny Reinsch and Jason Boehmig

Tech debt is a term most anyone working with or in technology companies understands. Very generally, tech debt refers to cutting corners on software development in order to ship product more quickly. In the near term taking on tech debt helps a company ship faster but you have to repay the tech debt — build the system to be robust — at some point in order scale the user base. Failure to pay back the tech debt ultimately means your product will suck and your business might fail. Regulatory debt is a similar concept and refers to whether a company is legally compliant. The key distinction is that while tech debt may make for a bad user experience, regulatory debt may result in legal trouble for a company’s founders, operators and even investors.

Check yourself before you wreck yourself

The spectrum of consequences of regulatory debt spans a nasty letter from a government agency on the light end and personal and financial ruin on the heavy. Somewhere in between a company may incur fines that can sink the business. Where a company and its stakeholders fall on the spectrum is largely a function of the industry in which one operates. Highly regulated industries — payments, insurance, financial services, securities, labor, alcoholic beverages, etc. — are guarded by countless laws and rules that are enforced by government agencies and industry associations. Usually strict compliance is the name of the game as well, meaning that compliance with the letter of the law dictates the punishment regardless of whether anyone (your users, society at large, etc.) actually got hurt.

There are some notable examples of when regulatory debt rears its ugly head:

• Parker Conrad, of Zenefits, was ousted for violating insurance regulations
• Uber’s ongoing employee misclassification lawsuit
• Charlie Shrem jailed for violating anti-money laundering rules
• Ross Ulbricht sentenced to life in prison for involvement in the Silk Road
• LendingClub and Prosper were shut down for months while digging through regulatory issues

Blitzscaling = Sexy

Why don’t we ever talk about regulatory debt? Well, compliance ≠ sexy. It’s actually pretty boring (we come from the legal world, trust us). Obtaining licenses or building a compliance program is also expensive and typically built on the back of an exorbitant hourly rate charged by an attorney or consultant. Most importantly, robust compliance flies in the face of the blitzscaling ethos underlying the tech company growth model.

Technology companies are under constant pressure to move fast, break stuff and scale rapidly. In fact, Reid Hoffman has even coined the term “blitzscaling” in his class at stanford on the topic. Up and to the right is the culture in silicon valley for a reason — it works. Sans his relentless obsession with growth, Mark Zuckerberg and facebook may not be what they are today. Had Netflix not scaled so rapidly the legacy content providers may have been able to squeeze them out by numerous means. Often failing blitzscale means a company is likely dead in the water. As such, regulatory debt racks up since cash, time and human capital are finite resources better spent on the metrics that “matter”.

Move fast and don’t break

How as a founder, can you strike the right balance between moving fast and (not) breaking things? We’ll attempt to offer a few thoughts from our own experiences, both as lawyers and entrepreneurs.

• KYR (Know Your Regulator). The first step in any good strategy for dealing with regulatory debt starts with knowing who your likely regulators are. This might not be as obvious as you think. Start by researching other startups and how they’ve approached compliance. Another trick is to actually call the agency or state office
• Know how to use your lawyer. Having gone to law school and practiced, we’re both *way* more likely to go to a lawyer. A great first team member here is your outside legal counsel, who can help quarterback a scalable strategy for complying with regulations that you’ll face as your grow. And don’t just get a lawyer on your team, get to know them (they have client development expense accounts for this express purpose). But you also want to be smart about using your lawyer. Strategic advice and counsel are worth $600/hour, but admin tasks aren’t. Don’t use them for everything.
• Build your response team early. As the company grows, you may want to think about hiring people with operational expertise in your area. Like hiring for all roles, get to know these people early. A great example of this is how Zenefits hired David Sacks.
• Build compliance into your funding roadmap. Price in an appropriate amount of compliance spend in your 18 month runway projections (an investor that knows your industry will get it and might even be impressed).
• Work with investors that specialize in your industry. There’s a reason why investors specialize and this can be super important where your company operates in a highly regulated space. An investor in social media / messaging apps has different priorities as compared to one in legaltech or fintech, for example. And, an investor that “gets it” can be a huge asset in helping you safely scale your business.

TL; DR: Regulatory debt is definitely a thing and can ruin your business and more. Be careful, stay informed and surround yourself with knowledgeable investors and advisors when attempting to blitzscale a business in a highly regulated industry.

About the authors:

Johnny Reinsch is CEO of Qwil, a payments platform that provides instant pay for independent contractors. Prior to Qwil, Johnny worked in bitcoin at Xapo and as an M&A lawyer at Goodwin Procter LLP.

Jason Boehmig is CEO of Ironclad, an intelligent contract management system. Prior to starting Ironclad, he practiced corporate law at Fenwick & West LLP.