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Taking Stock of Startup Stock Options: Addressing Disclosure and Liquidity Concerns of Startup Employees

Posted by on Tuesday, March 28, 2023 in Notes, Volume 76, Volume 76, Number 2.

John Rand Dorney | 76 Vand. L. Rev. 609

U.S. capital markets are becoming increasingly private. Initial public offerings have steadily declined since the 1990s, and private companies are remaining private over twice as long as they have in the past. Furthermore, private company financing has reached unprecedented levels. Private securities offerings now greatly outpace the value of publicly traded securities. Additionally, recent regulatory changes seem to be accelerating this shift from the public to the private markets. One result of this shift is that private company valuations have grown immensely, so much so that private companies with valuations of over $1 billion exist and are known as “unicorns.” While the term “unicorn” connotes rarity, these companies are no longer rare—there are now over 1,200 worldwide. Although this investment and growth in private companies benefits the entrepreneurship industry, it raises serious concerns in the U.S. securities law regime, which inherently assumes that private companies need to go public for access to public investors’ money, and are willing to provide information to these public investors to receive said money. As it appears, however, private companies are progressively less reliant on money from public investors.

One stakeholder group caught in the middle of this dilemma is large, private company employees. Employees of private companies commonly receive stock ownership in the company as compensation, and many companies base a large portion of an employee’s payment in stock. As a result, employees are substantially invested in their employer. But these large private companies are now staying private much longer than in the past, so employees cannot convert their shares to cash by selling them nor can they rely on others to value their shares by relying on mandatory public disclosures. Furthermore, scholarship has demonstrated that the prevailing private-company valuation method leads to substantial overvaluation. Additionally, the founders of these companies can misrepresent to employees the value of their compensation. If one of these large companies fails or underperforms, its employees leave the firm undercompensated for their work. This Note proposes that implementing modifications to the existing securities laws will provide employees with information that will help them accurately value their stock options and convert these options to cash. Through this solution, employees and employers will have closer bargaining positions without overburdening employers.

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John Rand Dorney