Billionaire and Aon Plc Founder Patrick Ryan sold his stake in Mu Sigma Inc. after learning the founder said the data-analytics startup’s prospects were dimming. Eleven months later, Mu Sigma raised millions in fresh capital at a much higher valuation. Ryan wasn’t happy and sued, arguing Mu Sigma’s founder bought back the stake for an artificially low price and set himself up for a bigger payday.
Expect a lot more lawsuits like this. Listed companies must give all investors the same important information at the same time. Private companies have more leeway. But an explosion of "unicorn" startups valued over $1 billion and more opportunities for smaller investors to buy and sell stakes has made the market for pre-IPO companies more like the public equity market. As a result, investors are pushing for startups to behave like their publicly listed counterparts. Even the Securities and Exchange Commission is starting to poke around.
"Most of these unicorns do not practice best practices. I think they violate some of the core securities laws," said Ken Sawyer, co-founder of investment firm Saints Capital, which oversees more than $1 billion.
Saints has purchased shares in more than 200 private, late-stage startups from hedge funds, mutual funds, venture capital firms, executives and employees. Lacking a standard procedure, Sawyer and the sellers custom design each transaction.
"Different information comes with different sellers," he said, adding that most private company transactions violate the spirit of securities laws, if not the letter as regulations are scant.
Mu Sigma said Ryan’s suit has no merit and is fighting it. Ryan declined to comment, as did Sequoia Capital, a leading venture capital firm, and General Atlantic, a large private-equity growth investor, which both invested after Ryan sold.
Moving Slowly
Over a decade ago, public companies from Compaq Computer Corp. to Abercrombie & Fitch Stores Inc. were criticized for selectively disclosing sensitive information. That brought Regulation Fair Disclosure, or Reg FD, into the world, which requires listed companies to give all investors the same important information at the same time.
The closest thing to Reg FD for startups is last year’s RAISE Act, which calls for standardized private company disclosure for all shareholders. But it’s optional: Companies are invited to disclose things like their most recent balance sheet in exchange for some legal protection if investors sue later.
Bill Siegel, head of Nasdaq Private Market, which handles trading in startup stock, thinks the response to RAISE has been muted with few companies using it. "It’s going to take time," he said. "Private markets move slowly."