Waking up to Regulation

Regulators have been far behind what’s going on in Silicon Valley for a long time. They’re catching up.

When Zenefits CEO Parker Conrad resigned in February, the news left many in shock. The wild west of “disruption with reckless abandon” that became the mantra of technology companies on both coasts seemed to come to a screeching halt… well, for a couple of days. Surely enough though we are back to the grind, failing to fully appreciate how what happened at Zenefits could easily happen in any company trying to reimagine what the world could look like 20, 30, or 200 years from now.

Amid the tumult in the public markets, the fear of the proverbial bubble, and the increasing incidence of down-rounds, there’s a much bigger trend we’re missing as entrepreneurs and as investors — regulators are waking up to what’s going on in the Valley. It’s now time for the Valley to wake up regulators.

The year of the 3-letter agency

2016 has already been the year of the 3-letter agency. From the Apple’s controversy over the iPhone’s encryption with the FBI to the increasingly confounding realities of Theranos’ ineffective Edison diagnostic testing as reported by CMS (The Center for Medicare and Medicaid Services) and the FDA, it’s becoming increasingly clear that the government is starting to internalize the broader implications of an unregulated technology sector. Many tech companies believe they’re immune to “regulatory risk”. They’re not.

Keep in mind, one of the reasons Zenefits got slammed was for giving away its software, which some state regulators saw as a rebate, an illegal activity in certain states. Conrad’s bigger problem of failing to ensure that Zenefits brokers were licensed is certainly a compliance misstep, but giving away software to offer a different, more profitable product is a strategy that any enterprise software company could embrace. How a company’s sales, marketing, business development, and operations teams interact with customers is just one example of how regulators could be just around the corner.

For any company, understanding the myriad of regulations and protections that could impact its business is becoming increasingly important. Of course we know that regulations and regulators exist. But oftentimes we overlook what a new business means to these regulations and what regulations mean for this new business. The days of overlooking these implications are soon to be over.

It may sound like I’m predicting the “end of days” for the Valley — an Atlas Shrugged moment for the entire technology sector. I’m not at all. In fact, I believe that those companies and investors who create the future with a new regulatory world in-mind will be far more likely to see their visions come to fruition. Regulation isn’t a constraint, it’s an opportunity to crystalize the world that’s yet to be.

Getting ahead (and behind) in the sharing economy

The sharing economy is a clear analog of what it means to get ahead and behind of regulation although I’d argue that no one got ahead of it soon enough. Take a company like honor, which provides elder care through a network of caregivers. While the jury is still out on the long-term value proposition of the business, it has made what many have considered a bold move by making all of its caregivers W-2 employees as opposed to 1099 contractors. Not only is the Company receiving free positive marketing for its efforts, its caregiver retention numbers have been notably high. Honor may have been reactive, but it put a stake in the ground and decided that owhow its future was going to look. Few companies have yet to go so far.

Uber has clearly done everything in its power to work through regulation. When Uber recruited former Obama campaign manager David Plouffe and former Googler Rachel Whetstone to drive its campaign for ride sharing, few expected mass-scale success given the opposition it felt in many cities. By the end of 2015, however, 22 states had adopted pro-Uber ride-sharing legislation. It’s important to remember though, that much of this activity was reactive. Had Uber planned this type of lobbying work prior to its initial scaling, it could have potentially avoided much of the controversy it did in its early years.

The failure of Homejoy in the summer of 2015 can be attributed to just the opposite. Rather than foresee the contagion of labor classification issues that uber and others in the sharing economy were facing both in courts of law and the court of public opinion, it continued full steam with a contractor model. Yes, other elements of the business were in trouble (it’s net churn numbers weren’t pretty either), but its failing to get ahead of regulation was in some ways a nail in the coffin.

Shaping the future means shaping regulation

The sharing economy is just one example of a “future world” where getting ahead of regulation has become integral — the bigger the departure from the status quo, the bigger the need to foresee and get ahead of potential regulatory roadblocks and opposition. Shaping the future requires shaping how regulation looks in that future.

SpaceX has done this particularly well. The Company, which is among the largest lobbyists and political contributors to PACs in tech, has not only won contracts from NASA, but President Obama has subsequently signed into law a bill that exempts private space companies from FAA oversight (HR 2622), a huge win for the Company.

Hyperloop Technologies (another Elon Musk brainchild), in contrast, has not. While it has committed resources to developing relationships with potential buyers (e.g. governments in Asia and the Gulf), it has not been a vocal player in shaping the conversation around high speed transportation here at home. With the potentially catastrophic impact that Hyperloop could have on automobile and train transportation (as well as truckload and LTL freight), getting ahead of the lobbying that will absolutely take place if Hyperloop is ever to be a reality in the US is essential.

The onus of understanding and getting ahead of regulation is not just on entrepreneurs — it’s the work of investors as well. Regulatory risk is typically an afterthought in due diligence unless it’s obvious that regulation is core to a business. If regulatory risk does exist, most investors will blankly decline to look at the deal altogether, rather than understand the Company’s plan for responding to, working with, or getting ahead of regulation. Andreesen Horowitz’ recent hire of former White House staffer Matthew Colford and Facebook General Counsel Ted Ullyot is a prime example of investors beginning to arm themselves with the ability to effectively diligence prospective investments and support its portfolio with respect to getting ahead of regulation.

There is much work to be done in understanding the interface between technology and the regulatory landscape. Regulators have been behind for a long time. They’re catching up and it’s time the Valley thinks seriously about what that means for the future world we hope to create.