Regulating Unicorns: Disclosure and the New Private Economy

Headlines about unicorns—private companies with valuations of a billion dollars or more—have dominated newspapers such as The New York Times, The Wall Street Journal, and the like. It has become part of the fabric of the venture capital landscape and many startups strive to achieve unicorn status. In fact, unicorns are no longer rare and almost mythical, but are now ubiquitous. In 2013 when the term unicorn was first used by Aileen Lee of Cowboy Ventures and later popularized by others in the venture capital community and media, there were 39 unicorns. At last count, there were a staggering 144 unicorns globally (as of November 22, 2015). In the third quarter of 2015 alone, a new unicorn was anointed every four days.

In a world where we now have a blessing of unicorns, each one of which has the potential to transform financial and cultural norms, nothing has been done to expand or recalibrate the regulation of these companies despite their dizzying valuations and outsized impact on the marketplace. I argue in my forthcoming article, Regulating Unicorns: Disclosure and the New Private Economy, that the one-size-fits-all regulatory framework does not work within the unicorn context. It is simply insufficient to address the new reality of unicorns which have the size and influence of public companies, but are able to operate under the shroud of secrecy. As an example, Uber employs tens of thousands of employees and is affecting the way people think of and use transportation. No longer are people hailing taxicabs—they “Uber” it instead. Further, Uber’s designation of drivers as independent contractors, as well as the fact that the company strives to limit its liability as an online marketplace, has generated a fair amount of controversy. Its reach is not only national, it is international, and its valuation exceeds that of most public companies.

Under our current regulatory regime, private companies need to disclose very little information to the public. Restated certificates of incorporation[1] and Form Ds[2] are the only publicly available documents, the former of which are available for a fee. A review of the restated certificates of incorporation and Form D filings of Airbnb, Dropbox, Pinterest, Snapchat and Uber demonstrates the current failings of the regulatory regime. As an example, these documents do not require any material financial information despite the large impact these unicorns have on society. I also look at the increasing popularity of late-stage mega fundings, also known as “private IPOs,” which allow unicorns to continue to operate with little transparency. This may change, however, given the Securities and Exchange Commission’s recent focus on how mutual funds value their stakes in venture-backed companies. These so-called private IPOs are not initial public offerings at all, but raise $100 million or more in a financing that can include large mutual funds, hedge funds and corporate venture capital. In order to remedy the shortfalls of our current regulations, I recommend a hybrid disclosure regime for unicorns that is not as burdensome as a public company, but not as lenient as a private company. My recommendations include revising Form D to include more salient information about the companies, such as pertinent financial information. My other recommendations are to summarize the key terms of the restated certificates of incorporation and have the text of such certificates accessible and free through the websites of the Securities and Exchange Commission website and company. In addition, private companies should be required to provide periodic financial information to smaller investors and employees, similar to what is provided to major investors, on a quarterly basis. Since a large part of compensation for a startup employee is based on equity compensation that is typically based on options that will vest over a period of time, this information gives them a more robust picture of the financial health of the company rather than the soundbites they might hear in the media. Put simply, creating more transparency ultimately benefits employees, smaller investors and investors in the secondary market who otherwise do not have access to such information.

ENDNOTES

[1] A copy of a private company’s certificate of incorporation may be purchased from the Secretary of State of the state where the company was incorporated. See, e.g., Del. Sec’y of State, Pricing Sheet, available at http://corp.delaware.gov/certmemo.pdf.

[2] U.S. Sec. & Exch. Comm’n, Form D, Notice of Exempt Offering of Securities, OMB No. 3235-0076 (2008), available at https://www.sec.gov/about/forms/formd.pdf [hereinafter Form D]. If an issuer of securities relies on an exemption from registration provided in Regulation D, it must file a Form D within 15 calendar days after the “date of first sale” of securities in the offering containing the information requested with the U.S. Securities and Exchange Commission and with any state that requires it. Currently, the Form D must include the following:  issuer’s identity, principal place of business and contact information, related persons, industry group, issuer size (which includes revenue range and aggregate net asset value both of which can be marked “Decline to Disclose” by issuer), federal exemption(s) and exclusion(s) claimed, type of filing, duration of offering, type(s) of securities offered, business combination transaction, minimum investment (if there is no minimum investment amount it will be “0”), sales compensation (if a person has been or will be paid directly or indirectly any commission or other similar compensation in connection with sales of securities in the offering), offering and sales amounts, investors, sales commission and finders’ fees expenses, use of proceeds, and signature and submission.

The preceding post comes to us from Jennifer S. Fan, Faculty Director of the Entrepreneurial Law Clinic and Law Lecturer at the University of Washington School of Law. The post is based on her article, which is entitled “Regulating Unicorns: Disclosure and the New Private Economy” forthcoming in the Boston College Law Review and available here.