A startup founder in a regulated industry faces a brutal choice: pay $1,000 an hour for regulatory consultants, proceed in willful ignorance of the rules, or abandon the project entirely. A Fortune 500 company in the same industry spreads the identical compliance cost over millions of units of revenue. The regulation is the same. The burden is not.

In Encouraging Entrepreneurship and Innovation through Regulatory Democratization, I use fieldwork from the Startup Study — 88 interviews with founders, funders, and startup ecosystem participants — to show that regulatory compliance costs function like economies of scale in reverse. Large firms spread fixed compliance costs over more units. Small firms bear the same absolute cost with far less revenue. The result: regulation that is nominally neutral between large and small firms is structurally regressive.

This is not a bug. For incumbents, it is a feature. Complex regulatory environments create competitive moats. Every dollar a startup must spend on compliance lawyers before generating a dollar of revenue is a dollar that protects the market position of existing players. Incumbents do not lobby against regulation in general. They lobby for the kind of regulation that raises entry costs — complex standards with high fixed compliance overhead.

The taxonomy I develop classifies regulation along two axes: complex versus simple, and rules versus standards. Complex standards — regulations that are both hard to understand and require judgment to apply — are the most burdensome to startups. Simple rules — clear, bright-line requirements — are the most equitable, because their compliance cost does not vary with firm size.

The most practically useful finding from the fieldwork is that technology can flatten the compliance cost curve. I call this “regulatory democratization” — the use of cloud-based compliance tools (RegTech) to transform regulatory costs from large upfront fixed costs into small ongoing variable costs. When HIPAA compliance shifts from “invest tens of thousands in secure email servers” to “pay a SaaS provider a low monthly fee,” small medical practices can compete with hospital systems. The same pattern applies across healthcare, airspace regulation, tax compliance, and data privacy.

The biggest market opportunity may not be disrupting the regulated industry itself, but disrupting the cost of compliance that keeps competitors out.

Read the full article: Encouraging Entrepreneurship and Innovation through Regulatory Democratization (2020).