Regulators should finally require some transparency of large private firms

The rapid growth of private markets has been among the biggest shifts in the capital raising ecosystem since the end of the financial crisis. In the United States, more money was raised on the opaque private markets than on the well-oiled public markets in each of the past 10 years. And most of this money has poured into private companies valued at over $1 billion.

Named “unicorns” in the early 2010s because they weren’t supposed to exist, such companies now number more than 1,100 worldwide, with more than half based in the U.S. Unicorns are even part of the cultural zeitgeist thanks to recent binge-worthy shows such as “WeCrashed” (about WeWork), “The Dropout” (Theranos) and “Super Pumped” (Uber).

Despite the carefree innocence associated with their namesakes, unicorn companies have provoked frequent consternation from investors, employees, customers, suppliers and regulators. After years of regulatory inaction, Sens. Jack Reed (D-R.I.) Elizabeth Warren (D-Mass.) and Catherine Cortez Masto (Nev.) introduced an ambitious new bill last month that is poised to shine some much-needed light on unicorns by subjecting them to regulatory obligations that now apply to public companies. The bill would help protect ordinary investors, such as those saving for retirement, and it would also benefit unicorns’ employees, who are often heavily invested in their employers. Congress needs to pass this bill.

Though far-reaching, the bill would simply correct some of the deregulatory excesses of the past decade. As I discussed in recent research, private markets and private companies did not register as an investor protection concern until recently because they used to be the exclusive domain of professional and sophisticated investors, primarily private equity and venture capital funds. Retail investors and the institutions that held their retirement savings stuck to the liquid and transparent public markets. But a deregulatory cycle that started with the JOBS Act in 2012 and ended with new SEC rules finalized the day before the November 2020 election has undone this traditional balance between public and private markets.

For example, the new SEC rules made it easier for retail investors to invest, both directly and indirectly, in risky private companies. The monetary thresholds above which an investor is presumed to be sophisticated have not been updated since 1982, so the mere passage of time has increased the share of households deemed sophisticated by 550 percent. The quest for higher returns has also pushed institutional investors, retirement schemes and broadly-marketed mutual funds to invest in private markets. The JOBS Act, meanwhile, effectively erased the existing triggers that required private companies to transition to the public markets.

Unicorns have taken advantage of investors’ appetite and the absence of regulatory constraints and have opted to stay private for much longer. When Amazon went public during the 1990s, it was within three years of its founding; by contrast, Uber waited 10 years, and the average age of all firms going public since the JOBS Act is even higher.

None of this would be a problem if private markets were orderly and efficient and if private companies didn’t harm investors. But the evidence suggests just the opposite. Private markets are illiquid, prone to valuation bubbles and incapable of serving as a disciplining mechanism for wayward founders and management.

Private companies often embrace a “move fast and break things” philosophy that may be fine for a small startup but is bound to cause large-scale harm in the case of large unicorns like Uber. Indeed, the most recent spate of revelations reaffirms what we already knew about Uber’s culture of lawbreaking in its pre-IPO days. The larger the private company, the greater the potential for harm. During its unicorn days, Uber’s valuation was as high as $69 billion and outranked most of America’s well-established public companies. And when things go south, investors suffer. WeWork lost 80 percent of its value in just a year and a half trying to unwind a series of bad decisions that no one – not even its largest shareholders – knew about.

The problems often boil down to lack of transparency and supervision, which enable poor governance and waste. This is where the new bill, the Private Markets Transparency and Accountability Act, would come in.

The bill would require private companies in the United States to register with the Securities and Exchange Commission (SEC) if they either reach a valuation of $700 million (excluding shares held by affiliates), or have at least 5,000 employees and $5 billion in revenues. Once a company is registered, it would need to start reporting much of the same information currently required of public companies: financial and operational performance, business strategy, risk factors, conflict of interest transactions and the like. As proposed, the bill would capture several hundred of the largest and most problematic unicorns and bring much-needed transparency to the capital markets.

Because registration would provide many of the obligations of a public listing without the benefits, we can expect that the private companies that would be caught by it would prefer to undertake a traditional IPO, which would provide them with those benefits.

This, in turn, would boost the number of public companies, whose dwindling number has been an ever-present concern, and give mainstream investors more investment options. A public listing will also ensure that the price at which those investors buy and sell a firm’s stock reflects its underlying value. And it will give employees who receive stock options as part of their compensation a much better sense of the value of that compensation. 

To be sure, implementing a proposal like this will not be straightforward, and the registration thresholds may well need to be adjusted upward. It may also be necessary for the SEC to act on its own existing authority if the bill doesn’t receive the bipartisan support it deserves.

But the underlying rationale behind the bill is solid and uncontroversial: Companies that look alike in terms of size, investor profile, number of employees and societal imprint should be subject to the same transparency and accountability obligations, regardless of whether they are private or public. Watching an investment landscape teaming with ever-larger unicorns over the past 10 years may have been fun, but it would now be better for all involved if those unicorns shed their horns and became regular public companies.

George S. Georgiev is a law professor at Emory University specializing in corporate and securities law. Follow him on Twitter @GeorgievLaw.