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Winter 2018

It’s Time Unicorns Grew Up

Like modern-day millennials, our fastest growing tech companies have decided to delay adulthood. Unlike earlier generations of entrepreneurs, today’s founders grow their companies into multi-billion dollar enterprises without planning for an IPO—the traditional rite of passage for successful start-ups. When a young adult fails to launch, she may end up living in her parents’ basement. When an influential tech company fails to mature, the impact can be more severe: toxic corporate cultures, consumer fraud, and billions of dollars in losses for investors.

Controversies at Uber draw attention to problems created by a growing number of high value private companies in our economy. These billion-dollar start-ups, the so-called unicorns, have multiplied. Today, there are more than 260 unicorns compared to only 40 in 2013.

Uber’s recent troubles include investor lawsuits, a major data breach, and a scathing report on workplace culture by former Attorney General Eric Holder. Uber is just the latest in a string of unicorns to face major scandal. The blood testing start-up Theranos collapsed in 2015 when reports showed its technology did not work as promised. The CEO Social Finance recently stepped down amid reports of a frat-like atmosphere at the company.

The rise of the unicorn did not happen by chance, and the extent of unicorn misconduct should not surprise us. As I explain in a recent essay, “The Unicorn Governance Trap,” in the University of Pennsylvania Law Review Online, these shifts connect to legal reforms that allow start-ups to raise billions in funding while indefinitely delaying an IPO. Google and Facebook went public because of a simple rule that required large companies with at least 500 shareholders to disclose financial information to the public. When faced with this requirement, most start-up companies chose to pursue an IPO.

Congress abolished this rule in 2012. The Jumpstart Our Business Startups Act (JOBS Act) raised the number of shareholders that requires public disclosure from only 500 to 2,000. This new law eliminated the one hard and fast rule that drove many tech companies toward an IPO. Start-ups can now stay private as long as they want, and shield themselves from public scrutiny indefinitely.

Delaying an IPO often means deferring steps needed to create internal controls and provide for external accountability. Before an IPO, a company aims to impress the professionals who will help sell their shares. Underwriters, accountants, and analysts all closely scrutinize the company and its management team. To prepare for this intense vetting, a company will hire seasoned professionals and recruit independent directors to help put its best foot forward.

Without pressure for an IPO, unicorns lack incentives to develop internal systems appropriate for their size and scale. Unaccountable unicorns pose dangers to employees who often endure chaotic and hostile work environments. Their lack of transparency creates space for unicorns to skirt or flout the law.

How should Congress address unicorn risks? The recent truce at Uber provides a blueprint for reform. To attract new investors, Uber agreed to a timetable for an IPO by 2019. In setting a path forward, Uber abandoned a feature of start-up governance that contributes to unicorn failure. Congress should learn from Silicon Valley’s recent misadventures and reinstate the rules that once forced companies with a significant number of shareholders to disclose financial information to the public. It’s long past time for unicorns to grow up.

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