I once ran a business in Asia. And the only reason I made a bit of money was because I was more lucky than business savvy.
But when I went to Thailand, I was prepared. I had a great plan. Thailand had just approved some new environmental rules. It held gasoline distributors to a higher standard for what constitutes air contamination. It forced them to adopt airtight bottoms-up filling of gasoline tanker trucks at the large distribution and storage depots that dotted the country.
The problem: Thailand didn’t have the right equipment to adhere to the new regulations. So Thailand’s problem became my opportunity. A client of mine did have the right equipment. And the CEO was more than willing to go to Thailand to demo his equipment.
It should have worked. But it didn’t.
Because I didn’t have a strong network in Thailand, it took me about three months to find a site and set up the demo. It went amazingly well. But we never had a chance. Another company had demoed its equipment a month earlier using similar technology. It won the business. We arrived late to the party and returned to the U.S. empty-handed.
My second attempt at taking advantage of new regulations worked out much better. Indonesia had just approved new rules that prevented oil drillers from repurposing their crude for road maintenance. Year after year, in the dry season, they’d spray crude on local dirt roads to tamp down the dust and make them more drivable. But the oil was seeping deeper into the ground over time and threatening the country’s water table.
One of my clients had the perfect product for the job. It was an all-natural liquid product that did what the crude did but much better. We quickly held several demos to prove the product worked. They went very well. And the product took the country by storm. Needless to say, my client was extremely happy.
Before exiting Asia, I took advantage of a few more regulation-driven project opportunities that also worked out quite well.
Those experiences are why I became bullish on startups that take advantage of new regulations. Demand can go from pretty much nothing one day to a great deal the next day. This is the power of regulations that address big problems.
But what I have learned over the years is that companies still have to do it right. Being first to market doesn’t guarantee success, but it’s a hugely important competitive advantage. Governments are forced to pass regulations for a reason. Market players were not going to offer (or make money from) a solution otherwise.
But companies also have to make sure they’re not too early. Oddly enough, being early doesn’t give companies a meaningful head start in many regulation plays. Customers don’t know exactly when the regulations go into effect. Or they don’t know exactly what they will require and/or prohibit. Avoidance tends to govern their mindset more than preparedness.
Doing it right also means having a product that translates into compliance at an affordable price. Companies need to keep close track of the regulations as they go through the approval process. One aerospace company I recently recommended to First Stage Investor readers — a superb regulation play — plays an influential role in shaping the regulations themselves. That’s a great way to make sure your products will be compliant. Of course, not every company has that capability.
Regulation plays have other advantages. They’re not as fickle or subject to change as market-driven opportunities are. What you have is what you get. With the government being what it is, regulations tend to outgrow their usefulness before they are revised or dropped. That creates stability for the companies that do it right.
Regulations are also must-haves by definition. And must-haves are more powerful drivers of market growth than nice-to-haves.
Regulations can also drive or even force innovation. It’s silly to pass regulations requiring solutions for which no products or technology exists. So governments tend to work with the private sector to encourage and sometimes subsidize development of such products.
Startups getting grants or in-kind assistance from government agencies is a telltale sign that they have an inside track on what the regulations will call for. That’s one nearly foolproof way to predict first-to-market competitive advantage. And it’s a big reason why I liked the aerospace company I recommended so much. (Sign up for First Stage Investor to learn more about this and other promising startup investment opportunities.)
Against these advantages are two main risks to keep in mind. All bets are off if regulation enforcement is lax or inconsistent. So do your homework. And the timeline for the issuance of regulations can be longer than you think. I was guilty of that when I started recommending startups for Early Investing in 2013, two years before the SEC finally issued enabling regulations.
Oops. It happens to the best of us.
But in many ways, regulation plays are easier to evaluate and execute than market-driven plays. And they remain among my favorite startup opportunity plays.