Political risk for startups
It's not just for multinational corporations
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Most clients of political risk consultancies are large corporations or governments. Partly, this is because those organizations have the budgets for consultants. Mostly, it is because they are the ones who see themselves as vulnerable to political risk. A mature company with operations around the world looking to hit their quarterly earnings targets is going to care about threats to currency convertability more than the startup who’s still looking for their first round of funding.
But just because political risk matters less to startups does not mean that it doesn’t matter at all.
I recently held a webinar with Justin Vela of GEOSTREAMS for the startup community at Allianse about how political risk and ESG matters for them. You can check out the video here. Next week, we’ll bring you Justin’s tips for how startups should think about ESG.
Today, it’s four points on how startups can view political risk.
1. Immediate threat
Political risk is an inherently long-term issue, simply because the events it covers doesn’t happen all that often. If you’re concerned about a coup in a country happening this year, you’re in luck - it probably won’t. Coups very rarely happen, so if you have a time horizon of only a year or two, that political risk probably won’t matter to you.
Since startups are often focused on immediately getting up and running and then exiting within a few years, this would mean that investors and founders are going to be less concerned than in other industries, like mining, where the lifespan of an investment could be decades.
But sometimes these threats are immediate and apply to even the fastest-moving startup.
Take, for example, the crypto industry. This is awash in startups promising rapid returns in an expanding market. But any startup raising money today should be aware that the US government has started the process of regulation.
If those regulations come down in a year or two, your startup may face a drastically different environment as you launch operations than you faced when you first had your idea. They may make your startup not only unprofitable but also illegal.
2. Threatening your edge
Alan Kay, a computer scientist at Xerox PARC (where much of the modern world was invented), has said that if big companies were rational, no startup would ever exist. Large companies have resources to throw at problems and their solutions; startups emerge because incumbents have failed to spot a problem or come up with a better solution.
In other words, your startups have a chance because you’ve found an edge over everyone else out there. The problem is that the political world might pose a threat to your edge.
Uber is a classic example for this. When Uber was created, it used the possibilities of GPS-enabled smartphones, stored credit cards, and gig workers to disrupt the taxi industry. Its edge was not being a single cab company, but a marketplace between drivers and riders.
As it found out as it expanded, that edge went against existing regulations in most of the cities it operated in.
Uber lucked out, because it turned out that governments were willing to not enforce those regulations or compromise on how they would be enforced. Many other companies might not have been so lucky. It’s easy enough to say that you have a new way of doing things that is cheaper and faster; it’s another matter to turn that into a reality if a government says you can’t.
Any startup going into a heavily regulated area (food, pharmaceuticals, defense) probably already knows this. It should also be considered by any startup going into an area where your edge depends on a number of political or social factors that may be fragile.
A startup based around connecting Russian freelancers to Western customers, for example, would now find itself out of business even though it probably hadn’t thought of war as a risk to its business model. Its edge was the cost differential between Russia and the US, but that rested on geopolitical stability that should not have been taken for granted.
3. Giving you an edge
Sean West was the deputy CEO of Eurasia Group and now is the co-founder of a technology company based in London and Rwanda.
There are a lot of companies who would be too afraid to locate their development team in Sub-Saharan Africa. The political risks are too great, in their mind, even if it is cheaper than Palo Alto.
For someone who understands political risk, as I assume Sean does, this provides an opening. Rwanda is one of the most stable parts of the continent and their assessment was that it was stable enough to locate there.
Understanding where risks lie is just as important as understanding where risks don’t lie. Being the first into an area where others are too scared to go is a straightforward way of finding that edge.
4. Impress your investors
Part of every investor pitch is describing your team and their background. This is not because your potential investors care about your hobbies - it is because they want to be sure that you know what you’re doing.
I’ve listened to a number of startup pitches that focus on the problem at hand and their innovative solution. It tells investors why their money could make great returns. But the other important part of the pitch is to de-risk the investment, telling investors why you’re not going to lose their money.
Political risk is a potential threat and opportunity to your startup. It is therefore a way to impress your investors. You can show them that yet another obstacle has been foreseen and prepared against, and they won’t have to worry that in a few months they’ll be hearing how it all went wrong because you miscalculated what Putin would do.
Instead, you can stand out as a founder who not only knows the product, not only knows the market, but also understands the countries in which that market exists. It might not get you a check, but it can certainly help.
If you want more knowledge about how to use political risk to your advantage in the startup world, join the political risk academy and use the live sessions as a way to talk through the problems at hand.