How Should We Regulate Start-Ups?

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Eric Schneiderman, catch-up artist. Photo: Louis Lanzano/Bloomberg via Getty Images

Yesterday morning, house-sharing start-up Airbnb announced a milestone achievement in its quest for legitimacy: an agreement, hashed out with New York Attorney General Eric Schneiderman over the course of several contentious months, under which Airbnb will turn over anonymous data about its users, so that the state can comb through it for evidence of Airbnb rentals being used as illegal hotels.

Every day seems to bring another few of these stories — a regulation-averse start-up running up against existential threats and crackdowns. (Just yesterday, we had Nest, Google's $3.2 billion thermostat company, recalling all 440,000 of its Protect smoke alarms after the U.S. Product Safety Commission pointed out basic flaws in its design.) And we'll have more of them in the years to come. Silicon Valley is taking on big projects now — in heavily patrolled sectors like health, education, and transportation — and the people in charge of safeguarding those industries are going to have to keep pace. Which raises the question: Should regulators be doing as much as they are?

The tech world has certainly given us plenty of reasons to want more regulations. I don't necessarily want 23andMe making unscientific diagnoses based on my genetic data, or Nest making smoke detectors that turn off during a fire. And I'd be upset if my next-door neighbors were using Airbnb to run a makeshift hotel and fill my neighborhood with drunken tourists. On Wall Street, in Big Oil, and elsewhere in the economy, we've seen what happens when regulators fall down on the job, or when government overseers are captured by powerful interests in the industries they regulate. It's not pretty. And the libertarian techno-utopians who dream of self-regulating start-ups on floating, lawless islands are turning their backs on powerful counterexamples sprinkled throughout history.

But opponents of regulation have a point, too — it is hard to start a business, tech or otherwise, in many places in America. I talked to one start-up founder this week who told me that, before he could even open his doors to customers, he had to spend two years acquiring the necessary licenses and charters. That kind of waiting period isn't unheard of in heavily regulated industries — see AquaBounty's two-decade-long crusade to get its genetically altered salmon approved by the FDA — and the result is that many worthy products never make it to market, the incumbents preserve their advantages, and the consumer suffers. (In this founder's case, the start-up was a financial service, and the two-year waiting period only served to enrich his too-big-to-fail bank competitors.)

Noam Scheiber argues that start-ups should engage with regulators in "polite conversation" before hatching their grand plans, rather than the Uber/Airbnb approach of end-running around existing laws, racking up billions of dollars in revenue, and then, when confronted, banding users together to protest the regulatory overreach. The problem is that regulators are more reactive than proactive, and often respond only when something has reached a critical, threatening mass. If Airbnb had gone to Eric Schneiderman when it was a tiny, little-known start-up, it may well have gotten everything it wanted. But when Airbnb had grown large enough that deep-pocketed hotel operators felt it was threatening their business interests, Schneiderman would have needed to double back for a second look anyway.

In this way, regulating start-ups is a bit like regulating the lemonade business: When it's a kid selling lemonade out of a cart, we want government to leave it alone. When it's Tropicana, we want a robust regulatory framework that keeps corporate power in check. The same laws can't reasonably cover both.

It's possible, as Matt Yglesias has written, for regulation to be simultaneously too lax and too restricting, and that's a bit of what's happening here. But where tech start-ups are concerned, the problem seems to be more that the regulators are simply confused by uncharted territory. There are no laws governing Airbnb because until very recently, there was nothing like Airbnb in the world — not of the same scale, not with the same guiding philosophy. And when Airbnb came onto the scene, regulators were forced to slot it into existing categories where it, arguably, didn't belong — treating a bachelor renting out his spare room to make rent, for example, with the same rules as a scuzzy landlord operating an illegal hotel. They've been playing catch-up ever since.

The inability of regulations to keep pace with start-ups is not, as some tech leaders would argue, an indictment of the regulatory apparatus as a whole. More so, it's a statement about how many damn start-ups there are. (Take Jessica Pressler's laundry piece, and imagine the same chaotic land-grab happening in hundreds of industries all at once.) Confronted with a million kids' lemonade stands, a few of which will grow into Tropicanas, the only response regulators can have, really, is to address only the most urgent cases – which, in practical terms, means the ones powerful interest groups are pressuring them to address. At that point, they're no longer regulating. They're mediating a business dispute, and the resulting solutions often consist of tentative solutions and half measures that do neither side any good.

We deserve better. We need a regulatory process that knocks down barriers to entry for small start-ups, yet keeps close tabs on ones that operate in legal gray areas and are big enough to do real damage. We need adequate funding for regulators at the FDA, SEC, and other agencies, and forward-thinking leadership that will have them looking at new companies before the battle lines are drawn. In other words, the entrepreneurs of Silicon Valley shouldn't be the only ones pushing the envelope — as Airbnb's case shows, we need futuristic thinking from watchdogs, too.