Should you invest in a company launching a new product in regulated industry?

Q: I am considering a partnership that requires entering a regulated industry with a new product. Should I invest before or after regulatory approval?

Anonymous

A: For little-known companies struggling to introduce a new product, regulatory pressure can offer an unexpected benefit: a halo of legitimacy that marketing money can't buy.

Investors looking at small firms offering promising new products, invest during the development phase if it is a regulated industry, and in the marketing phase if it is unregulated.

In a research study of 286 small entrepreneur-run firms from eight industries ranging from the highly regulated (pharmaceuticals and medicines) to the largely unregulated (wood products manufacturing), my colleagues and I found that in a highly regulated industry, a new product with substantial advantages didn't need media coverage and endorsements once it was approved by regulators. Just getting the product approved was enough. But in industries that were unregulated, the companies needed more outside endorsements and positive media coverage.

It is difficult for an upstart product from an unknown company to achieve "legitimacy," or recognition from potential investors, influencers and customers that it is valid and useful. Moreover, more established competitors can deploy resources to discredit the upstart.

Our research looked at the interplay between product innovation, regulatory pressures and the degree of external networking, including courting the media and getting endorsements. Respondents answered questions about how radical their products were, the degree of positive media coverage, the connections they have with prominent individuals and organizations, the degree of regulation they face and whether they spend more on marketing than their competitors.

For companies in regulated industries, the regulation process vets the new product enough to make it legitimate in the eyes of others. On the other hand, respondents in unregulated industries said they needed more help from influencers to give their products legitimacy. However, even in regulated industries, getting approved is not enough if the product is not better than others already on the market.

David Deeds is a professor in the Schulze School of Entrepreneurship at the University of St. Thomas.