Like many successful entrepreneurs, WeWork founder Adam Neumann failed a few times, identified a real need, built an innovative product and succeeded in creating a real business.
By ELLIOT COHEN, OMER MATITYA
My endodontist, a rather intelligent fellow from Johannesburg asked me a simple question while I was in his chair: how can a company lose so much money just from renting offices? With my mouth full of his equipment, I couldn’t answer – so Dr. S, let’s follow the money trail.Like many successful entrepreneurs, WeWork founder Adam Neumann failed a few times, identified a real need, built an innovative product and succeeded in creating a real business. His first company, Green Desk, was sold to a real estate investor for a reported $3 million. Using part of those proceeds as initial financing, Neumann created WeWork.Charisma, vision, hard work and a profitable business model led WeWork to a reported seed financing of approximately $8m., which they used wisely. Off to a very good and cautious start, in 2012 they had 5 locations in two markets and a clear plan to profitability after only two years.Benchmark Capital’s Series A round valued WeWork at a realistic figure under $100m. Even at today’s reduced valuation, their $17m. investment seems to be worth over $600m. They identified WeWork as a company that would change the world and make money in the process. As early investors in Twitter, eBay, Uber and many others, Benchmark is pretty good at finding superstars.Then it was time to get the “Start-Up Nation” involved. So, along comes one of Israel’s respected investors: Michael Eisenberg of Aleph, affiliated at the time with Benchmark, to lead WeWork’s 2013 series C funding, effectively creating a “unicorn” level $1 billion valuation.WeWork met the other main criteria of a unicorn, namely a privately held startup adopting a get-big-fast strategy while fueled by private equity.It is hard to feed a unicorn. In their case, that meant pushing the boundaries of unicorn territory by delaying profitability to as far away as “never,” as well as out of control growth fueled by a continuous flow of private equity and not by revenue and creating a corporate culture that worships “excess”.How can investors justify ignoring the very long road to profitability? Possibly because that’s what lots of unicorns do. Amazon created that model – they bled cash for 12 years. Now they are basically printing it.Unicorns may also attract conservative investors, and 2014’s Series D round included Investment Banks and University endowments at a pre-money valuation of $4.6b. Growth companies that are not yet showing a profit usually have the valuation estimated by comparing to other similar competitors. So, using Regus as a comparable, WeWork was being grossly overvalued at $2b more than their competitor in spite of the fact that Regus showed revenue 30 times higher and had over 2000 locations compared to WeWork’s 50 .Fueled by a continuous stream of cash, locations spouted up around the globe and losses grew exponentially. While investing in growth had enabled Amazon to dominate the online retail market, WeWork was not able to build a substantial barrier to entry, so competitors popped up in their backyards. Since coworking is basically a real estate business, investing in growth to achieve a monopoly is virtually impossible.However, WeWork still had a jump on its competition and was creating global buzz. Had this trajectory continued it is likely that WeWork would have remained in the same club as Uber and Airbnb – service providers that change the way we have been doing things for years.In 2017, Neumann hosted Masayoshi Son, the CEO of SoftBank, for a 12-minute walk around a WeWork facility. Without much due diligence and in Son’s own words, “I turned a blind eye to many of his negative aspects,” a $4.4b. check was handed to Neumann. A Decacorn and the bubble that went with it were born, only to (spoiler alert) burst two years later.This spurred the seemingly out of control growth cycle with WeWork spending huge sums to open hundreds of locations, many of whom were losing money. The negative cash flow was covered by SoftBank investing additional billions. A few years prior, looking at the financials one could conclude that WeWork had so much money they could operate in the red for years to come, with more modest growth. By the summer of 2019, analysts were saying that the company would be flat broke by the end of the year.Prior to the recent meltdown, multiple funding rounds by SoftBank poured a total of $12.8b. into the company at valuations that had grown to $47b. For his part, Adam Neumann led WeWork to spend the funds as quickly as they came in.The two visionaries, thinking “centuries into the future” were feeding off each other. Neumann was starting to sound a bit delusional. His reportedly stated goals of opening a WeWork on Mars and becoming the world’s first trillionaire should have indicated to the directors that he might not be the right person to run a company on this planet – not to mention presenting a serious conflict of interest if he were to realize his goals of becoming both the President of the World and Prime Minister of Israel.So what does a Decacorn do when investors have put up as much money as they want to, the valuation has pretty much reached the theoretical limit and billions more are needed to survive beyond New Year’s day 2020?Simply move ASAP to the long-discussed IPO! The investment banks are on board – they make many millions in fees. The company receives a cash infusion, which incidentally, in the case of WeWork was to trigger an additional $6b. credit line by major investment banks.While most ventures head to their IPO with heads held high and the founding team ringing the opening bell, WeWork’s attempted IPO never got to the point of investors taking the S-1 filing seriously. Once the curtain was lifted, the magic disappeared, replaced by harsh financial reality. Skipping the gory details of the crash, the IPO was canceled on September 30, 2019. The investment tribe had spoken.Many investors would have gone into a salvage operation. To paraphrase Miracle Max the Wizard in The Princess Bride: Go through their pockets and look for loose change.SoftBank did the opposite – they poured in close to $10b. more.That would wrap up the story – a massive down round, diluting most existing investors almost to nothing and removing Neumann and his allies from the board. SoftBank would control the whole company and just might succeed in reaching profitability, an idea that seemed to be almost an anathema to Neumann and his team. Given the proven popularity of the product as well as global branding, the post-Neumann WeWork might still pull through. And as far as the hottest financial news story of 2019 – “there is no such thing as bad publicity.”Besides poor governance, lack of oversight and a nearly unlimited supply of investor money, SoftBank failed miserably by giving Neumann voting preference and a high degree of control. The same Son who previously considered Neumann a man valuable enough to justify a $47B valuation, then became the person Son paid $1.7b. just to take a hike (or a last ride on his $60m. Gulfstream Jet). This will be studied in Harvard Business School for years to come, although they may neglect to mention that Harvard’s Endowment Fund was one of the investors.Elliot Cohen is CEO of Coworking Israel. Omer Matitya is a legal intern and financial analyst.
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