Forcing A Unicorn Into The Open: Using The Law To Get Financial Disclosure From Start-Up Companies To Prove Their Worth
Do you believe in unicorns? If not, you're in good company—many investors and employees of so-called unicorn companies (start-ups valued at over $1 billion, like Uber and Snapchat) are questioning the actual value of their company shares. Many of them meet with some understandable resistance because the unicorn companies aren't eager to divulge their financial information, partially for fear that the values might not hold up to inspection. If you own shares of a private start-up that seems to be almost mythically lucrative, what can you do to force them to disclose information?
Small investors should look to state laws for relief.
Since companies typically only reveal their financial information to major investors, those with minority stakes often get left in the dark. Most states have laws to remedy this. In Pennsylvania, for example, there are at least two laws designed to protect minority shareholders from oppression by closely-held companies.
If the company is incorporated in Delaware (which many are, due to the state's notoriously lax regulations and aggressive marketing as a corporate-friendly place), the law does give you the right to inspect the company's financial records if
- you own at least one share of the company,
- you want to determine the value of your shares,
- you make your request in writing for the specific documents you need.
If the company ignores your request or denies it, you can then file a lawsuit to force the issue. You may consider reaching out to other shareholders who are in a similar position, in order to split the costs of any legal fees associated with the action.
Employee investors should ask if the company meets the federal threshold for disclosure.
What if you're an employee of one of these unicorn companies, who has traded a slightly more lucrative position or some other benefits for shares in the company itself? It isn't uncommon for start-ups to offer shares to employees both as a way to foster a feeling of joint-entrepreneurship or to simply take advantage of certain tax breaks. Unfortunately, the feeling of entrepreneurial camaraderie may not extend to giving those same employees access to the financials they need in order to really determine what their shares are actually worth.
Rule 701 of the Federal Securities Act may force the company to open the records a little wider. If the company sells $5 million or more of its securities in a 12-month period (which isn't hard to do if you're a company valued at $1 billion or more), rule 701 goes into effect. Employees can ask the company to voluntarily comply with the rule and seek relief through the Securities and Exchange Commission (SEC) if they won't.
If you're a minority shareholder in a unicorn start-up company, don't assume that you can't get access to the information that you need to really place a value on your shares. If you're struggling with a company that is less-than-willing to be forthright about your shares, talk to an corporate lawyer.
