Unicorniphobia in Law: Why the Legal World Needs to Embrace Change

The Evolving Landscape of Startup Growth and Regulation

Historically, a startup achieving substantial success would pursue an initial public offering (IPO) – offering its securities to the general public, listing on a stock exchange, and accepting the responsibilities of a publicly traded entity under federal regulations.

The Rise of the “Unicorn” and Regulatory Concerns

The current business environment has shifted. Today’s thriving startups are increasingly capable of significant expansion without relying on traditional public capital markets. The term “unicorn”—a private company valued at over $1 billion—was once exceptional. Currently, more than 800 companies meet this criterion.

This trend has prompted concern among legal scholars. Recent research suggests that, lacking the constraints imposed on public companies, unicorns may be more susceptible to risky and unlawful practices that negatively impact investors, employees, consumers, and the broader public.

Proposed Regulatory Solutions

The suggested remedy involves extending existing regulatory frameworks to encompass these unicorns. Specific proposals include mandatory IPOs, expanded disclosure requirements, increased secondary market trading of unicorn shares, enhanced whistleblower protections, and more rigorous enforcement by the Securities and Exchange Commission (SEC).

Notably, a prominent advocate for this approach has recently been appointed to lead the SEC’s Division of Corporation Finance, signaling potential forthcoming changes.

Challenging the “Unicorniphobia” Narrative

A new paper, “Unicorniphobia,” argues against the growing belief that unicorns inherently pose greater risks and require stringent new securities regulations. It presents three primary counterarguments.

The Potential Detriment of Public Company Status

Forcing unicorns to become public may not be beneficial and could even exacerbate existing problems. Extensive academic research on “market myopia” indicates that it is publicly traded companies that often face incentives to take on excessive debt and risk, underinvest in compliance, compromise product quality, reduce R&D spending, harm the environment, and engage in fraudulent accounting practices.

These incentives stem from factors unique to public companies, such as executive compensation tied to short-term stock performance and pressure to meet quarterly earnings targets. Implementing proposed reforms could simply replace one set of potentially harmful incentives with another.

Rhetorical Tactics and Anecdotal Evidence

Advocates for new regulations often employ rhetorical strategies and rely heavily on anecdotal evidence, particularly focusing on high-profile cases like Uber and Theranos. However, they frequently fail to demonstrate how the proposed reforms would have effectively prevented the harms caused by these specific companies.

The Case of Theranos

Consider Theranos, where the founder and CEO faces criminal fraud charges. Would increased securities disclosures have altered the course of events, given allegations of widespread deception towards the media, doctors, patients, regulators, investors, and even the board of directors?

Furthermore, market players already possessed avenues to challenge Theranos indirectly through short positions in partner companies or long positions in competitors. Their failure to do so suggests that expanded trading options may not be effective.

Potential Harm Outweighing Benefits

The proposed reforms could inadvertently hinder the positive contributions of successful unicorns to investors, employees, consumers, and society. These benefits are often a direct result of the current regulatory environment.

The Moderna Example

Moderna, a biotech company that developed a highly effective COVID-19 vaccine, exemplifies this point. Prior to its IPO, Moderna was a controversial and secretive unicorn with no marketed products and a history of internal challenges.

Had the proposed regulations been in place during Moderna’s early stages, its development could have been significantly hampered, potentially delaying the creation of the vaccine. Our pandemic response has benefited from the existing regulatory approach to unicorns.

Climate Tech and Innovation

The lessons from Moderna are also relevant to efforts to address climate change. Currently, 43 unicorns are focused on “climate tech,” developing solutions to mitigate or adapt to global climate change. These ventures are inherently risky, facing technological hurdles, resistance from established industries, and uncertain regulatory landscapes.

While they may be led by demanding or unconventional CEOs and backed by investors lacking complete scientific understanding, these companies represent a potentially vital resource in addressing climate change. Policymakers should carefully consider the potential impact of regulations on this crucial sector.

These companies may also have core investors who do not fully understand the science underlying their products, are denied access to basic information and who press the firm to take risks to achieve astronomical results.