Regulating Unicorns

Even just ten years ago, Google was worth less than one billion dollars when it went public. But today, a new billion-dollar company emerges every three business days, and several startups, including Snapchat and Uber, are valued at over ten billion dollars. Notwithstanding these companies’ substantial size and impact on society, they often remain in private hands and do not issue shares of stock to the public. As such, they are not required to disclose their finances publicly, leaving unsophisticated investors and employees – who, unlike larger investors, do not have the capital to bargain for disclosure – blind to the possibility of significant losses. In a recent paper, University of Washington Law School Professor Jennifer S. Fan argues that once a private company reaches “unicorn” status – defined as having a value of over one billion dollars – it should be subject to the same disclosure requirements as public companies. Fan contends that enhanced disclosure will protect smaller investors and employees by illuminating the risks and benefits of their investments in unicorns. Historically, when a startup became sufficiently mature, investors would either take the business public through an initial public offering (IPO) – as Facebook did – or they would sell the company to a larger organization, as Skype did when Microsoft acquired it. By taking one of these actions, investors would turn their investments into liquid, usable assets. Today’s technology startups frequently aim to reach a billion dollar valuation before selling or going public. As startup founder Stewart Butterfield explains, achieving unicorn status is a “psychological threshold for potential customers, employees, and the press” that will lead to a business’s success. To achieve these valuations, startups are taking advantage of investors’ increasing interest in late-stage startups and are staying private for longer periods of time. In the first three months of 2015, says Fan, only five Bay Area companies went public, down from nine the year before. But because companies are waiting longer before taking advantage of these options, startups are now reaching unprecedented sizes before going public. The ballooning size of pre-IPO companies presents cause for concern, argues Fan. Unicorns have an “outsized impact” on society: they employ thousands of people and upend social norms. But little information about their finances is available to the public, leaving swaths of smaller investors and rank-and-file employees in the dark about unicorns’ risks. The U.S. Securities and Exchange Commission (SEC) requires companies of all sizes to register certain financial information with the agency in order to protect investors and employees and to “maintain fair, orderly, and efficient markets.” Any person can obtain a public company’s detailed financial statements on the SEC’s website. But private companies can take advantage of Regulation D exemptions, which allow them to keep most information from the general public. Under this regulatory scheme, smaller investors and members of the public only have access to two documents: the company’s Form D filing, which includes information about the company’s identity, the types of securities it offers, and how it uses its proceeds; and the company’s restated certificate of incorporation, which sets the rights and privileges for different types of company stock. On the other hand, “major investors” – usually skilled venture capitalists who provide startups with money and expertise in return for a stake in the company – often receive detailed information, including companies’ budgets, business plans, and financial statements. These major investors typically secure detailed disclosure through contracts, because their active roles in developing companies give them negotiating power. Because of this disparity, Fan argues that the SEC should require unicorns to disclose publicly and in layperson’s terms all information that is currently available to major investors, including periodic financial information and information about their board composition, stock prices, and voting arrangements. She says that enhanced disclosure will provide better visibility into the companies’ financial states and will minimize investors’ risks. Fan acknowledges that private companies have compelling reasons to remain in “stealth mode.” For example, startups need a certain level of secrecy to develop revolutionary products. But she argues that once companies achieve unicorn status, the risks that secrecy poses to smaller investors and the public outweigh these concerns. One prominent venture capitalist thinks we will “see some dead unicorns this year,” the deaths of which would hand investors significant losses. To demonstrate the need for increased regulation of unicorns, Fan presents case studies of five prominent unicorns: Airbnb, Dropbox, Pinterest, Snapchat, and Uber. For example, Fan claims that Airbnb – a 600-employee company worth more than many of the world’s largest hotel groups – is “burning cash,” and she forecasts an operating loss of about $150 million for 2015. But these projections are not public; Fan claims that she only found them after scouring the Internet. By requiring Airbnb to consolidate this information and make it easily accessible to employees and small investors, regulators would ensure that all of Airbnb’s investors are sufficiently shielded from potential harm