Differences in Regulatory Impact

In this section, I identify three differences in the practical ways regu­lations may have impacted Main Street entrepreneurs in different ways than Silicon Valley entrepreneurs, drawing from the differences discussed above.

Labor and Regulatory Burden

Federal and state labor regulations may have a greater burden on mom- and-shops rather than small startups because of the different types of labor employed by these two types of entrepreneurial ventures. Because Main Street businesses employ significantly more low-skilled labor than do tech­nology startups, labor laws such as the minimum wage laws and overtime regulations are more of a concern for main street businesses and less of a concern for technology startups, which employ more high-skilled labor. Thus, to the extent that the theoretical and empirical research on labor laws and regulations find that they can cause harm on small businesses, startups are less impacted by these regulations, despite also being a “small business.”

The Fair Labor standards Act governs the federal minimum wage, although states have their own minimum wages that can be over the federal standard.

Employers must also pay for workers' compensation insurance—an insurance program that covers both lost wages and the cost of medical treatment from workplace injuries. Workers' compensation indirectly impacts more employers who have low-skilled labor rather than high- skilled labor because healthcare premiums are generally higher for those types of labor. Premiums generally are calculated as a percentage of wages and “range from as low as 1% for skilled workers, to 10% of wages for outdoor and maintenance workers, to as much as 50% of wages in certain injury-prone professions like roofing” (Meyer 2018, 46).

Furthermore, because of technology startups' greater reliance on independent contractors, laws governing employment also become less applicable for those workers who are independent contractors. These laws includes the minimum wage and overtime regulations under the Fair Labor standards Act; or laws requiring businesses to comply with The Patient Protection and Affordable Care Act (PPACA) for their employees; or worker's compensation which only covers employees, not indepen­dent contractors. Thus employers do not have to meet any of these same requirements for workers who are contractors with the company.

Moreover, Main street businesses may be burdened more by payroll taxes, which are paid for employees, but not for independents contractors.

These sentiments were also expressed by interviewees who discussed reasons why they relied mostly on independent contractors. A founder and CEO of a Fintech startup stated that he used only independent contractors for the first two years because it helped to “lower costs.”^[67] A serial startup entrepreneur explained how he uses mostly contrac­tors, especially in early stages of the company and then suggests that “everyone in a startup should be classified as contractors. All additional costs incurred by hiring employees in the first year or two can kill a company.”^[68] Furthermore, one venture capital investor remarked that California’s high costs of labor and employment regulation “encourage distributed teams,” who tend to be contractors rather than employees of a company.^[69]

As discussed above, these labor laws and regulations are an impor­tant aspect for businesses and can harm and reduce entrepreneurship. Thus, to the extent that these laws and regulations add burden to small businesses, they are less of burden to technology startups because tech­nology startups do not tend to employ low-skilled labor. In other words, although research indicates that small businesses face a greater burden from these types of regulations than large businesses, startups are prac­tically “exempt” from these costs because they do not generally employ low-skilled labor. This aspect is vital for understanding this differences in main street and technology startups in terms of regulation because while technology startups and main street entrepreneurs share the “smallness” aspect, their labor employment differences can make it such that they are “out of the purview” of certain labor laws and regulations.

Regulatory Compliance

Regulatory costs also come in the form of compliance costs—the costs that businesses must incur in order to meet regulatory obligations. Compliance costs may include, for example, filling out paperwork, buying new equipment to meet mandates, or hiring lawyers to advise on compli­ance strategies. As discussed above, compliance costs pose a greater burden for small firms than for larger firms.

Although startups also tend to be small, they may not experience the full burden of the regulator y costs of compliance. Because of the nature and characteristics of silicon valley technology startups, the incentive to comply with regulations may be lower than with Main street businesses. Recall that startups are small, young, and tend to aim for “high-growth” potential in a very short period of time. Thus, most startups are faced with the following within a 10-year timeframe: (1) Go public (IPO), indicating they have become a relatively large company; (2) Sell, thus being acquired by a large company, or (3) Fail, which happens to 85-90% of all startups. Few startups stay “small” for a longer timespan.^[70] In any of these three scenarios, noncompliance with regulation comes at relatively low cost. In the first scenario of going pubic, the startup has become sufficiently large in the short period of time (i.e., a “high growth” startup) that by the time the regulations “catch-up” with them, they are sufficiently large and have greater resources to deal with the costs of compliance. As one example, Amazon has stayed “under the radar” for several years, including not having to report for sales taxes. Although it was in existence since 1994, it was not until 2011 when Amazon first started to add sales taxes, albeit only in 5 states. By 2017, Amazon had to comply with all 45 states that have state sales taxes. Uber also has a similar story when it first started operating in local cities. Because it was small, it was “under the radar.” By the time regulators caught up to what was going on, Uber was a large company and had a large sum of resources to deal with various regulatory compliance issues (and in some cases to devote resources to change regu­lations).

In the second scenario, companies that plan to sell and become acquired are also faced with the “fly under the radar” strategy because their plan is to sell to larger companies in a short period of time. Knowing this, startups focus their time and money on developing the product and growing the company rather than on complying with regulations. However, it is important to note that under this scenario, the incentives to comply are much stronger than the IPO scenario because the acquiring company may care about this aspect of noncompliance. Whether or not the acquiring company “cares” depends in large part on the nature of the company and the regulatory apparatus, and the extent and type of noncompliance. For biotech or medtech startup, acquiring companies do care about compliance—startups cannot “ignore” FDA regulations from the onset because this aspect is important for acquisitions.

And in the last scenario, if the startups chance of failing is high, there is not a strong incentive to comply with the regulations at the onset. Unlike their small business counterparts, startups do not plan to exist for a long period as a small startup, and thus do not face as strong of an incentive to comply with the regulations. The culture of startups reflects an attitude of “go big or go home” or “we'll worry about the regulations when we make it,”—thereby indicating a priority to develop and grow the company until they either takeoff or fail.

This is evidenced by the fact that there is a culture of “noncompli­ance” among startups. This culture is discussed in news article, forums, inter views, and even highlighted in pop culture—for example, in several seasons of the TV-show “Silicon Valley,” many startups are depicted as either being ignorant about regulations or not caring enough to comply with the regulation.

This culture of noncompliance was also a common theme found during our fieldwork interviews.

In the May 2019 survey of 396 technology startup executives, only 7% of executives indicated that most companies are regularly fully compliant.^[73] Of the remaining 93% of startups who believe startups in their industry are not regulatory compliant, 87% of startups indicated that a primary reason (top 1, 2, or 3 choice) for why they do not fully comply with applicable regulations is because they lack awareness or clarity of the applicable regulations. 72% of startups also indicated as a primary reason (top 1, 2, or 3 choice) for not complying with regulation is that it is diffi­cult to comply during early stages of a startup. And 45% indicated they are able to operate regularly without full compliance.

Venture capital investment also reinforces this as some investors do not have a strong incentive to due diligence on every small investment they make to every small startup.^[74] This is coupled by the fact that most startups in the venture capital portfolio will fail. The venture capital investment strategy is to have one “unicorn” company that pays out (e.g., Facebook, Uber, Airbnb).^[75] Thus, to do due diligence on every small startup investment that has high probability of failure is not worth it. This aspect was discussed in some interviews with venture capitalists who explained that unless the noncompliance with regulations was egregious, they did not care.^[76] One venture capitalist directly said, “VCs don't do regulatory diligence.”^[77]

Furthermore, it may be difficult for regulators to “checkup” and “show up” when there is no real physical location of the startup. Whereas a regulator may visit a physical location of a hair salon to make sure the licenses of the hairdressers are displayed on the walls, regulators may have a difficult time tracking down the location of the startup. As mentioned above, in the early stages the startup may be working from home or from coffee shops, remotely in different cities around the country or world, at incubators, accelerators, or co-working spaces, and at later stages, in office spaces. Furthermore, because startup sizes tend to drastically fluctuate within a short time span, startups frequently change office spaces.

The “no physical space” aspect was discussed in detail with one founder of a startup in New York City.^[78] The founder described how New York State regulators sent letters regarding noncompliance to a family member's home address that he had associated with the company, but he did not receive these for over a year because his team worked remotely from different cities in the United States.

These are not the same aspects for more conventional mom-and-pop businesses, which tend to have a physical location, and they tend to be in existence for longer periods of time. And because they tend to be in existence for longer, there is more of a long-term relationship and experience with regulators. Interestingly, the COO of one startup acknowledged the “noncompliance” aspect but indicated that his star­tup's strategy was to work with regulators from beginning stages—he explained, “we are asking for permission, not forgiveness” (alluding to a common startup motto, mostly notably employed by Uber: “ask for forgiveness, not permission”).^[79] This particular startup had a large phys­ical space and large equipment and capital because they were in the business of building modular homes. in this case, the “ask for permission” strategy may have made sense because the costs of noncompliance would have been higher for this startup than for the typical “virtual” startup.

Regulatory Entrepreneurship

Borrowing the term from Pollman and Berry (2017), regulatory entrepreneurship refers to pursing a line of business where changing the law is a significant part of the business plan. Regulatory entrepreneurs (with Uber as the well-known example), make an issue as publicly salient as possible, rally the public to their cause, and the use their popular support as a force to change the regulations. These regulatory entrepreneurs pursue a line of business, sometimes in legal gray areas, with the aim of changing the law (through “rallying the consumer base” strategy) in order to continue operating.

Bradley Tusk, the former political adviser to Uber who currently has a company that “helps startups navigate through regulations,” provides an explanation of the different conditions for successfully changing the rules with this type of regulatory entrepreneurship (Tusk 2018) Two of the main conditions are: (1) Consumers must be excited about the product being offered because the strategy depends on mobilizing a passionate consumer base; (2) The institutions of the country have to be democratic so that leaders would be punished if they went against popular opinion (Tusk 2018). Tusk details how this strategy was used to defeat the New York City's mayor proposal to regulate Uber in July 2015, and provides examples of other startups that have continued to use this strategy to change regulations.

Yishan Wong, who was an early PayPal employee, the former CEO of Reddit, and now a silicon valley angel investor, shares this sentiment. He says that if you are a startup “who feels the violation of a law (or an excursion into a grey and questionable/undefined area of the law) will allow you to create a business that provides enormous value to people, the tactically wise thing to do is to move forward and try to build the business” (Wong 2013).

Pollman and Berry (2017) documents the rise of regulatory affairs in innovative startups, explaining that: “a generation of engineers has grown up in a culture of “hacking” problems and pursuing “permissionless innovation,” which has fostered a willingness to create technology that challenges existing legal frameworks” and furthermore that “changing market trends and regulations have helped startups stay private longer on average and, in some instances, raise millions or even billions of dollars that can be used to fund efforts to lobby, change laws, engage experts, and battle incumbents and regulators” (2017, 1-2).

Thus, while some industry-specific regulations may be hampering Main Street entrepreneurs, they may not be hampering some technology star­tups in the same way. For the Silicon Valley entrepreneur, complying with the law is not a first-order concern for startups whose aim is to get large enough to change the law. This is often supported directly by venture capital funding, and thus there are funds aimed specifically for altering the law to allow these companies to exist and function. This aspect was described in a handful of interviews with venture capitalists who described investing in startups in legal gray area as an “opportunity.” In one partic­ular interview, the venture capital investor says, “When there is regulatory uncertainty, it presents an investment opportunity.”^[80] One venture capi­talist alluded that legal gray area strategies are a potential way to get a unicorn company (such as Uber, Airbnb), and that it is one where there are “few competitors in the space.”^[81]

It's important to note, however, that this regulatory entrepreneurship aspect was absent from inter views with biotech and medtech startups and investors, who emphasized that the first-order priority was in fact to meet all the regulatory standards. This may be the case because the regulatory standards on pharmaceutical-related developments and medical devices are strict, and those involved view the laws as unlikely or diffi­cult to change. This makes it difficult to be a regulator y entrepreneur in the business of “changing the law.” In these industries, there may be few “legal gray areas.” Regulations are strictly defined. Thus while it is not impossible to be in a business of changing regulations in the medical technology industry, it is less of a path pursed by startups.

This aspect of regulatory entrepreneurship hinges on the ability for startup businesses to scale up quickly and create significant interaction with their consumer base. As a result, technology startups are able to grow despite industry-specific regulations that may otherwise make it difficult for other types of companies.