Untamed Unicorns: Why Startup Finance is Broken and How to Fix It

Disgraced Theranos founder Elizabeth Holmes is back in the news, dominating the screen in You Can See Everything which recently opened to critical acclaim and surprising box office success. As voyeuristic entertainment the film delivers, allowing viewers to see and believe what they want to see and believe. By focusing so intently on Holmes’s unknowable state of mind, however, the film leaves a critical question unanswered: Why did so many experienced investors and respected public figures disregard mounting evidence of Holmes’s deception, thereby enabling and helping perpetuate her devastating fraud?

When we dwell on Holmes’s pathology, as the film invites us to do, we risk overlooking the flaws in the startup ecosystem that helped propel the Theranos ruse, flaws that have contributed to other major startup scandals. My book, Untamed Unicorns: Why Startup Finance is Broken and How to Fix It (Harvard University Press), analyzes the legal structure that contributes to startup fraud, shifting the spotlight from the colorful personalities that animate these stories to the decades of deregulation of securities markets that helped set the stage for Theranos and similar scandals.

Theranos was once a darling of Silicon Valley, attracting nearly a billion dollars in investments from such luminaries as Larry Ellison and Rupert Murdoch, and reaching an estimated valuation of $9 billion. Based on the value of her ownership stake, Holmes was hailed as the youngest ever female self-made billionaire.

Although Holmes claimed to have invented technology that could perform dozens of medical tests on a single drop of blood, insider accounts, investigative reporting, and a federal criminal trial have established that Holmes deceived investors and the public about the true state of Theranos technology. Through her deceit, Holmes exposed patients who relied on Theranos blood tests to unnecessary anxiety and serious health risks.

Theranos represents just one of a growing number of colossal startup failures, raising doubts about the soundness of the venture capital (VC) financing model often credited with creating the most innovative companies in the world. As another example, FTX Trading Ltd. filed for bankruptcy protection in November 2022. The startup raised nearly two billion dollars from some of the world’s most respected VC investors and operated the second largest crypto asset trading platform. Its thirty-year-old founder Sam Bankman-Fried, portrayed in the press as an altruistic wunderkind, had a reported net worth of $16 billion.

Like Theranos, FTX’s success was largely illusory. Soon after the bankruptcy filing, prosecutors indicted Bankman-Fried on multiple counts of conspiracy and fraud. As shown at trial, Bankman-Fried had diverted billions of dollars of customer funds from FTX to Alameda Research, a crypto trading hedge fund he also controlled. Alameda used the money to prop up its failing business, and to loan huge sums to FTX executives which they spent on luxury real estate, charitable donations and illegal campaign contributions. In November 2023, Bankman-Fried was convicted on seven counts and sentenced to 25 years in prison.

The misdeeds of Holmes and Bankman-Fried grabbed headlines and have been dissected in books, TV series, and now a popular film. Yet, these debacles are merely the most visible examples of a troubling trend of founder-led fraud enabled by changes in the Silicon Valley investment model in recent decades. Travis Milton of Nikola, Carlos Watson of Ozy Media, and Charlie Jarvice of Frank are just a few examples of other startup founders recently convicted of securities fraud.

Untamed Unicorns addresses the question: Why does this keep happening? In a search for answers, the book traces decades of deregulatory reforms, implemented by Congress and the SEC, that have fundamentally altered the startup ecosystem. It shows how a trend of steady, often stealth, market deregulation has compounded over the years to create our current system where private companies are able to grow to enormous scale while avoiding the transparency and accountability mechanisms that help ensure the efficient functioning of our securities markets.

Two reforms, in particular, have upended the traditional balance of power between startup founders and their investors. First, in 1996, Congress adopted the National Securities Markets Improvement Act (NSMIA), eliminating the cap on the number of investors in private funds, including hedge funds, private equity and venture capital funds. After NSMIA, assets under management in private funds soared, which allowed startups to raise most of the money they needed in private markets.

Then, in 2012, Congress enacted the Jumpstart Our Business Startups Act (JOBS Act), which eliminated the rule that had once compelled large startups like Google and Facebook to pursue their IPOs. Specifically, the JOBS Act amended Section 12(g) of the Securities Exchange Act, changing the 500-shareholder threshold for mandatory SEC registration to a 2,000-shareholder threshold, and excluding employee-held shares from the count. After the JOBS Act, startups could stay private indefinitely. The median age at IPO expanded from 9 years in 2012 to 13 years in 2024, and the number of billion-dollar startups—the so-called unicorns—grew from only forty in 2013 to more than 1,500 today.

Taken together, these laws, along with other incremental SEC reforms, drove a shift in control over startups from their investors to their founders. The flood of capital into private securities markets (facilitated by NSMIA) meant VCs had to compete with non-traditional investors, including sovereign wealth funds, hedge funds, and private equity, for access to the most attractive deals.

As a result, VCs began offering funding on “founder-friendly” terms. In the founder-friendly model, now prevalent in Silicon Valley, founders receive shares with supervoting power, typically ten votes per share, at an early stage in a startup’s life. With supervoting power founders can control the board of directors, essentially choosing their bosses. This makes it difficult for investors to discipline or dismiss ineffective or misbehaving founders—once a traditional role for VCs that ensured a measure of accountability in the startup ecosystem.

After the JOBS Act eliminated the 500-shareholder rule, founders no longer saw a need to create robust controls designed to root out unethical conduct and fraud. Under the 500-shareholder rule, which had been in place since 1964, founders of thriving startups understood they had to get their house in order to prepare for an IPO, and to withstand the scrutiny that comes with public status. This looming prospect of an IPO had a disciplining effect on founders and their investors, and compelled them to professionalize as they grew, by hiring experienced executives and building out their compliance and financial reporting staffs.

Today, many founders resist adopting the internal structures and controls appropriate for enterprises of their scale. Despite handling billions of dollars of assets on behalf of its millions of customers, FTX “lacked independent or experienced finance, accounting, human resources, information security, or cybersecurity personnel or leadership, and lacked any internal audit function whatsoever.” (First Interim Report of John J. Ray III to the Independent Directors on Control Failures at the FTX Exchanges, April 9, 2023).

The absence of effective internal controls has enabled illegal conduct, unethical behavior, and fraud to take hold at many unicorns. In this new era of founder control, investors are often hamstrung in any efforts to address these problems as they arise. It is therefore unsurprising that scandals have erupted at startups like Uber, WeWork, Theranos, FTX, and dozens of lesser-known startups that have failed spectacularly or engaged in fraud.

How do we gain control over these unicorns gone wild? Untamed Unicorns proposes a roadmap for reform that would restore a proper balance between public and private markets. The recommended reforms would ensure that investors have access to information they need to make sound investment decisions whether they are investing in public or private markets, while preserving the exemptions that allow small businesses to access capital at minimal cost.

These proposed reforms would 1) require disclosure to investors for the largest private offerings; 2) require disclosure by startups with shares trading in private markets; 3) expand disclosure requirements for a startup’s offerings to its employees; and 4) restore the legal rule which once required all large companies with a broad shareholder base to become public reporting companies. If Congress doesn’t act to restore Section 12(g)’s 500-shareholder rule, the SEC should close loopholes, including the use of special purpose vehicles (SPVs), that startups and their investors rely on to evade the Exchange Act’s disclosure requirements. These recommendations can serve as a guide to policymakers as we prepare for a post-Trump SEC.