Jennifer S. Fan, Nontraditional Investors, 48 BYU L. Rev. 463 (2022), https://digitalcommons.law.uw.edu/faculty-articles/924
Brigham Young University Law Review
Startup, Investors, Venture capital, Unicorn
In recent years, nontraditional investors have become a major player in the startup ecosystem. Under the regulatory regime of U.S. securities law, those in the public realm are heavily regulated, while those in the private realm are largely left alone. This public-private divide, which is a fundamental organizing principle of securities law, has eroded with the rise of nontraditional investors. While legal scholars have addressed the impact of some of these nontraditional investors individually, their collective impact on deal terms, deal timelines, due diligence, and board configuration has not been discussed in a holistic manner; neither has their impact on the investor landscape and securities law. This Article provides the first descriptive account of nontraditional investors throughout startups’ lifecycles and the normative implications of their participation in the venture capital ecosystem. Ultimately, nontraditional investors helped to facilitate the rise of unicorns which contributed to the “breakdown” of the public-private divide, with the attendant problems related to investor protection, corporate governance, valuation bubbles, and the like. Once thought of as outliers, nontraditional investors have influenced the venture capital market and the ways in which deals were conducted in significant ways. They drove capital investment trends and created an increasingly competitive deal environment in venture capital. Outsized funds became the norm, and the size and valuation of venture capital deals at each stage of a startup grew ever larger. In some cases, it led to less investor oversight and due diligence. Although one of the hallmarks of venture capital investors is their hands-on approach, that is not the case for all of the nontraditional investors. Board dynamics and economics and control—the two underlying principles of venture capital deals—shifted in favor of the founders as nontraditional investors proliferated and the economy remained strong. However, the recent economic downturn has led to a recalibration of nontraditional investors’ influence. In this environment, founders are no longer able to dictate the terms of venture capital financings, the investment pace has slowed, and while some nontraditional investors may retreat and reassess, their influence in the venture capital ecosystem will continue to reverberate in the years to come.