A recent Yahoo news announced the death knell of two startup companies:
“New airline rules regarding smart luggage claimed their second victim this week. Raden announced that it was shuttering after the largest American domestic carriers said they were imposing rules on battery-powered suitcases, disallowing those that contain non-removable batteries and forcing passengers to remove batteries from the rest before boarding. The rules are making smart luggage a major hassle for passengers and posing a serious challenge to manufacturers. Luggage-maker Bluesmart announced earlier this month that it was ceasing operations because of the restrictions.”
And just a few days earlier, I heard from the leadership of 2 other startups in very different industries where I felt that they did not consider the regulatory risks that would stop the growth of those startups like a truck hitting a stone wall. But the CEOs brushed off my comments as if immaterial.
The California lean startup methodology is very bare bones in comparison to fully developed business school textbook strategy. But this lean approach ignores other factors that severely impact a business, most importantly the regulatory. In the so-called smart luggage business lines, these companies did not consider the risks that the batteries would be banned by the airlines for safety reasons. It is nice and convenient for a suitcase battery to be available to recharge electronics or provide some smart, intelligent service. Sounds simple and attractive. But batteries blow up. And now the product will no longer be manufactured.
Young companies can make such mistake. Bankruptcy would be the solution costing the initial investors’ capital. Older, more established companies cannot afford such errors. In the case of Verizon, I reviewed many conversations among the senior managers relating to a backup battery required for the fiber optic lines in the home. They discussed the potential risks of installing those batteries. They searched exhaustively for means to mitigate those risks. Fiber optic installations costs several thousands per home. However, product liability risks originating from a defective battery would add to the capital expenditures. Such a risk would not break Verizon but could cost billions in shareholder lawsuits, if litigation came up from damages or even mortality from fires. Airlines felt the same exposure.
Yet, I am frustrated listening to the pitches of startups ignoring critical, fundamental regulatory risks. These are material risks that can impact severely the valuation or simply place the company in receivership. In one week, I spotted 2 companies with huge regulatory issues that will shut down the companies. The most recent one dealt with a means to handle efficiently in a pareto optimal approach to deal with kilowatt distributions within smart grids. The theory makes sense in a perfect world where there is one regulator, smart grids, and regulated renewable energy policies. Alas, the U.S. market is not that perfect. There are 51 public utility commission regulators throughout the U.S. Smart meters would have to be installed in homes and commercial districts. In California, the PUC forced the utility companies to install such meters. Many states have a long way to go. I doubt that this startup company can meet milestones when the U.S. energy markets are balkanized and have not adopted new regulations to facilitate renewable energy markets. A key component is the installation statewide of smart meters, without which one cannot measure input/output of kilowatt hours.
Another startup originates from Southern California with an online app to facilitate banking for the unbanked populations. Each transferor of funds would receive a fee for the services. When I heard that from the CEO, my alarms went off. Fees represent incomes. The IRS requires that the intermediary companies report such income. But, since the app is targeted for the un-bankables, then there would be a reluctance to provide social security numbers for the target market customers who might not have any or prefer not to have any identification. From personal observation, many Southern Californian Hispanics are not yet U.S. citizens. And the intermediary involved in each transaction may face financial penalties for not complying. First, the IRS will issue subpoenas. Second, the Service will demand records on every transaction. Not a place to be. But the founder CEO brushed that regulatory concern aside, stating that they had enough lawyers. And every point of the transaction had been covered. Lawyers are dime a dozen, but good lawyers represent less than 3% of their numbers. So his answer did not impress me.
Again, a simple thing — a review of whatever regulation that could have a critical impact on the business. Such knowledge is gained through the efforts of due diligence. Many lean startups ignore those issues, maybe from youthful hubris. Then they claim that the regulations don’t apply to them, the rules are outdated – Theranos attempted that futile approach. And every time I hear the startup CEO claim the same refrain, I can fairly predict that the company will shutter its windows in due time.