Unicorns have come full circle.
In 2016, Mary Jo White, chairman of the Securities and Exchange Commission, bluntly warned investors about excessive unicorn valuations and lack of transparency. Unicorns, private growth firms worth at least $1 billion, may not have sufficient checks in place to safeguard investors, she said.
However, earlier this month, Jay Clayton, who succeeded White as SEC chair, said he’s making it a top priority to encourage people to invest in those very same unicorns. One idea under consideration: instead of just allowing people with a certain amount of wealth to buy private securities, the SEC would also take into consideration an investor’s education and professional credentials.
“The SEC is committed to efforts to develop a regulatory framework that equally serves…the social media company looking to conduct its IPO and the Main Street investor saving for the future,” Clayton told a conference in Nashville.
This is a big deal for the private markets. The leader of the most powerful financial regulator in the United States seems to think unicorns are a legitimate asset and worthy of Main Street money.
“Opening up the private markets allows more people the opportunity to back early-stage companies they believe in and to participate in their success,” former SEC Commissioner Troy Paredes told me. “There are no guarantees, but venture-capital-like returns can be very attractive.”
Paredes, who served under Presidents George W. Bush and Barack Obama, founded Paredes Consulting in New York, which advises companies on regulation and corporate governance issues.
But why the sudden shift in just two years?
We first need some historical context. For one thing, no one really anticipated that these companies would even exist.
In 2010, President Obama signed the Jumpstart our Businesses Act (JOBS Act), a law meant to encourage more companies to go public. The act allowed companies to more easily solicit investors and keep private information like operating performance and executive compensation.
Instead of filing IPOs, companies chose to stay private longer because they were raising significant sums of capital. As result, there are nearly 270 unicorns in the world, late stage growth firms worth at least $1 billion.
Regulators seemed unsure how to deal with this new phenomenon. When then SEC chair White made her remarks in 2016, two high profile unicorns were attracting negative attention.
Zenefits, backed by venture capital powerhouse Andreesen Horowitz, forced its CEO to resign because employees were selling insurance without obtaining proper broker licenses. And Theranos, founded by then superstar entrepreneur Elizabeth Holmes, faced questions about whether its blood testing technology really worked.
Zenefits eventually paid millions of dollars of fines to state regulators. Theranos shut down and federal prosecutors indicted Holmes for securities fraud.
“Rapidly growing enterprises present significant risks if the appropriate control structure is not in place,” White told a conference at Stanford University at the time. “As the latest batch of startups mature, generate revenue, achieve significant valuations but stay private, it is important to assess whether they are likewise maturing their governance structures and internal control environments to match their size and market impact.”
There was also considerable doubt on whether these billion dollar valuations were really true. A number of unicorns suffered down round IPOs or were sold to buyers at prices much lower than their original valuations.
But over the past two years, unicorns have offered better transparency and market performance.
From 2016 to 2018 to date, 64 percent of unicorns, including Spotify and DocuSign, saw their IPO prices jump above their private valuations, compared to just 10 percent in 2015, according to a SharesPost analysis.
Mega unicorns like Uber and Airbnb now offer some financial data to the public. Mutual funds have also not hesistated to mark down their unicorn holdings should circumstances call for it.
“Over the years, we believe private growth equity asset asset class has become less opaque, valuations have become better informed and accredited investors increasingly feel they have what they need to invest with confidence,” said Rohit Kulkarni, SharesPost’s director of research.
There has also been a significant shift of wealth from the public to private markets.
Since 2009, emerging growth firms have raised $330 billion, including single rounds of more than $100 million; the number of such mega financings has grown 830 percent in recent years.
What has received less attention is that significantly fewer Americans are buying publicly-traded stock despite the Dow Jones Industrial Average and Nasdaq reaching record highs.
From 2007 to 2013, the percentage of U.S. households owning stock dropped from 49.1 percent to 46 percent, according to study on household wealth published last November by the National Bureau of Economic Research (NBER). It then rebounded to 49 percent in 2016, though still below its 2007 peak.
In 2016, 54.9 million U.S. households, or 43.6 percent, owned a mutual fund, noticeably down from 2013 when 56.7 million, or 46.3 percent, did, according to research from the Investment Company Institute.
Gallup recently released a poll that says that for the 5th straight year, most Americans think real estate, not equity, is the best way to create wealth.
Unicorns might offer more Americans who have shunned stocks an opportunity to increase their wealth, especially as wages continue to stagnate.
“The private markets are awash in capital these days,” Clayton recently told the Wall Street Journal. “The question is, who is participating?”
Answer: not enough people.
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