Thanks for joining me for this week’s Metrician, a newsletter by me, Dave Edwards and X Foundry, with insights on modern startup finance and the metrics that matter. If you haven’t signed up yet, you can do that here.
This week, let’s review what we’ve learned from the WeWork IPO disaster. This story is evolving with fresh news about WeGrow closing and a possible new financing coming out just today. But the overall story is a brilliant lesson in how things can go wrong for investors and entrepreneurs. And a great lesson on how things can go badly—very badly—even for the most lauded founders when they act badly and solve too much for themselves.
[Note, a few months ago, the company changed its name to We but I find it irritating to write about a company using a pronoun so I’m sticking with the much more easily understood name WeWork. Btw, changing the name right before the IPO shows that Adam wasn’t listening to his bankers at all. Equity research analysts use the third person plural to refer to their opinions as the firm’s opinion—i.e., “We think Amazon is the greatest thing since sliced bread.” Was Adam expecting analysts to write “We think We is great”?!]
Ok, on to my Seven Things We’ve Learned from WeWork:
1. Software may be eating the world but it doesn’t mean software-enabled companies should be valued like software companies.
WeWork tells a fancy story about using AI to organize its real estate—a Marie Kondo neural net, if you will. I’ll give them the benefit of the doubt that this technology allows them to provide better service. But it doesn’t mean that WeWork is a software company. It doesn’t sell software—it leases real estate which makes it a real estate company. WeWork will never be as profitable as a software company. And without those profits, it shouldn’t be valued like a software company—it should be valued like a real estate company.
On August 29th, I wrote that if the market ended up valuing the company like a real estate company, investors could lose 90% of their money. So far my prediction has been close: public market investors have reportedly said they think WeWork is worth about $10 billion—79% lower than the last private round valuation of $47 billion.
Why the delta? Because the value of a company is the discounted value of future cashflows: always has been, always will be (h/t Mary Meeker). And there’s no chance WeWork can generate enough future cash flow to be worth $47 billion.
2. Magnetic founders can be magical but that doesn’t mean they are magicians.
I was lucky enough to work for the ultimate magical CEO, Steve Jobs. Steve made almost anything seem possible and pulled a rabbit out of the hat so many times it made people’s heads spin. But even Steve was bound by the laws of physics and financials. He couldn’t make a chip faster and he couldn’t make materials cheaper.
Adam seems to have deluded countless people that “elevating the world’s consciousness” would create an excessively valuable business. The problem is his investors seem to have forgotten the laws of physics and financials. WeWork leases buildings and rents them out in pieces. There are physical limits to how much many people it can rent space to and financial limits on how much that space is worth.
Adam’s magnetic personality may have convinced investors to join him but he doesn’t have magical powers to allow WeWork to make magical amounts of money.
3. If it doesn’t seem to add up, it probably doesn’t.
Commercial real estate can be a great business, especially because owners can get long-term commitments from their tenants. WeWork’s problem is that they are on the wrong end of this equation. WeWork is a tenant and has $47 billion in lease obligations to the owners of their buildings. On the other side of the deal, they have only $4 billion in commitments from their renters—about a year’s worth of rent. A company that has expense commitments equal to 28 times its revenue commitments is one hell of a risky investment.
4. Bad behavior likely means more bad behavior.
Adam was well known as a wild man with big tequila parties, big spending and some self-dealing. What’s amazing is what investors and the media uncovered once the IPO came around. It’s only during that process that we learned about the extent of bad behavior (transporting drugs across international borders) and self-dealing (using company loans to buy personal property and then leasing those properties back to the company, keeping personal ownership of the “We” brand until selling it to the company for $6 million, a $60 million private plane, hiring family members, extracting $700 million prior to the IPO, multi-generational family control…the list goes on and on…).
This bad behavior wasn’t limited to Adam himself. The company’s IPO documents highlighted some odd self-dealing practices between the parent company and its subsidiaries that are, at a minimum, highly questionable. And some combination of the board and executive team (including the now co-CEOs) approved or supported Adam’s self-dealing.
I’m confused why Silicon Valley supports companies managed like frat parties (Travis-era Uber), magic shows (Theranos) and cults (Adam-era WeWork). Yes, these companies are exciting and could be good investments through their disruption. But bad behavior will inevitably bring a company down. And enough bad behavior will bring down the public market’s appetite for Silicon Valley exports.
5. Preferred share structures are preferred.
Venture investors used to manage their crazy founders by having some control over their investments. They’d take board seats, have preferred shares and have at least as much voting power, if not more than anyone else. This kind of control got a bad rap with founders because they were afraid of getting kicked out of their own companies. What they miss, though, is that all founders need good guidance and coaching—and some need to be forced into accepting that guidance in order to be successful, or at least not run themselves into ruin (i.e., Travis, Elizabeth, Adam, etc).
Venture capital firms get paid to manage money for their investors. Part of this is attracting and picking the best new companies to invest in. Part of this is managing those investments to success. Giving up control to founders so that the only way to stop disaster is through a public fight (i.e, Uber, WeWork) doesn’t seem to be the “value add” that venture investors claim to provide.
Benchmark Capital was the early lead investor in both Uber and WeWork and set the standard to allow Travis and Adam to have complete control of their companies. It’s damn hard to question Benchmark’s strategy—they’ve had exceptional success for almost 25 years. But I do wonder if they’re rethinking allowing founders to have voting control of companies. Even though Benchmark has made huge returns on Uber (and maybe WeWork), the headache of public battles with Travis and Adam certainly can’t be fun.
6. Conflicts of interest mean people are conflicted.
Important culprits in the WeWork IPO disaster story are the investment banks, in particular JPMorgan. Part of the role of investment banks in an IPO process is to act as gatekeeper. An investment bank should only take companies public (aka, sell shares to their clients) that they believe in. They should work to clean up any issues before offering it to the public. And they should price the deal at a reasonable level, balancing the need of the company to raise capital with investor’s desire for returns.
In this case, the banks failed. The banks tried to price the deal in fantasy-land territory and they published sloppy documents with all kinds of holes and issues. Why? It’s hard not to speculate that the banks didn’t do their job as gatekeeper well because they were conflicted. The banks needed the IPO to be successful to collect their fees—juicy fees on the $6 billion in debt that was contingent on the IPO—and to support the $500 million in personal loans they had made to Adam with Adam’s WeWork shares as collateral. There’s no question, the banks were conflicted. And conflicts of interest make people do stupid things.
Btw, some credit is due to my old firm, Morgan Stanley, for proposing a valuation range of $18 billion to $54 billion. While the high of the range seems ridiculous now, the low is pretty close to reality. Morgan Stanley lost out to JPMorgan and Goldman Sachs, likely because those banks proposed valuations of $46 billion to $96 billion.
7. Houses of cards collapse quickly and are hard to rebuild.
Once WeWork pulled its IPO, the house of cards has come down very quickly. In the span of a few weeks, the company has indicated large layoffs, has announced it will shutter its WeGrow private school (an idea that was absurd from the start) and is rumored to only have enough cash to last through the end of November. Adam is out as CEO (along with his wife and other family members), has lost his voting control and has lost his status as a billionaire. There are rumors (paywall) that JPMorgan will organize a $5 billion financing to keep the company afloat. Given the number of financial players who don’t want to see WeWork fail completely (yes, some people are predicting the company will file for bankruptcy), it wouldn’t surprise me if they can pull off a new financing…but it also wouldn’t surprise me if the terms of the debt are pretty harsh for the new WeWork. When a borrower is desperate and proven to be high risk, lenders have a habit of demanding terms that will help make sure they achieve their objective: getting their money back with interest.
What happens next?
This story certainly isn’t over. The company will need to undergo some serious financial restructuring in order to survive. Employees will want a complete revaluation of options in order to stick around. The new co-CEOs will need to prove that they are able to run the company differently than they did with Adam as CEO (note: it’s a bit odd to see the CFO of the company get promoted to co-CEO after a failed IPO). And the company will need to convince their lenders, landlords, tenants, investors, employees and everyone else that they will survive and will be a good business to work with. Cleaning out the Cult of Adam is a good starting point. But they still have a long way to go.
Finally, if the company hopes to go public in the future, it will need to show how it will make money. It can’t rely on made up financial metrics like community-adjusted EBITDA. It will need to show unit economics that make sense. Until WeWork can do that, it had better hope that Softbank and JPMorgan keep it afloat.
Thanks for your time. If you think a friend might enjoy this newsletter, please forward it along. You can follow me on Twitter at @dedwards93 or email me at dave@xfoundry.io.