What has and hasn’t changed in the VC ecosystem
After two years, several books and a deluge of hot catches, We work closed the last chapter of his private business life.
The saga has changed the way the public perceives high growth companies and their investors. For these companies and businesses, however, many lessons have yet to be ingrained.
The WeWork drama feels like a Greek tragedy: the pride that led to the downfall of a hero. Such stories are meant to provoke catharsis and to show the public how to avoid similar pitfalls.
But what has changed? Certain investment and management practices have been changed. SoftBank, WeWork’s biggest backer, has flip-flopped on some of the practices that have left him overexposed and overconfident in WeWork. Its new strategy is more diversified and comes with a clearer thesis on the future of technology.
But the investment culture that gave birth to WeWork has only deepened, from creative accounting and tech washing to the tendency of investors to bow to the founders. These behaviors and others threaten to drag WeWork sequels down the road.
Adam Neumann’s main gift was his charisma and his vision. He convinced seasoned investors that he could create a sprawling real estate empire that would cover work, home, education, and childcare, while raising awareness of the world.
Neumann accomplished this feat by exploiting a well-known weakness among investors for pattern-matching, which stems from the belief that successful entrepreneurs share certain traits. This is in part what led SoftBank CEO Masayoshi Son to believe so strongly in Neumann, who allegedly reminded Son Ali Babait’s Jack Ma.
It is difficult to say, on the whole, if investors are taking steps to combat this instinct.
Geographic and demographic trends may offer some clues. A global pandemic has accelerated the interest of VCs in companies outside of Silicon Valley, a sign that they have at least changed the way they meet entrepreneurs. But despite the pressure to invest in more startups led by women and minorities, progress is slow to come.
No matter who is funded, the founders of the technology continue to be treated generously.
Neumann’s 20-vote-to-one share structure was shocking even for a tech company, but founding CEOs show no signs of relinquishing control.
According to data collected by Professor Jay Ritter of the University of Florida, about 43% of U.S. tech IPOs last year were dual class, compared to 12.6% for non-tech IPOs. In a recent IPO filing, Nerdwallet revealed that CEO Tim Chen had 92.6% of the voting power through the power of 10 for one of his shares.
Tomorrow’s IPOs will be no different, as the terms of venture capital deals become increasingly favorable to startups, according to PitchBook research. The fierce competition among venture capitalists has allowed the founders to negotiate more favorable terms, which has resulted in declining redemption rights for years in the United States, a barometer of investor protections in the market. Today’s founders are also giving up a smaller share of their business in the rounds than in the past.
“When there are multiple offers and term sheets, founders can choose what works for them,” said Kyle Stanford, senior analyst at PitchBook.
This competition left investors with increasingly limited power to curb the rebel founders.
Even after being made public, technology leaders are continually pampered. In recent years, CEOs of newly listed tech companies have seen their salaries rise dramatically, according to an analysis released last week by the Wall Street Journal.
A striking example is Archer Aviation, whose founders were able to increase their stake in the company from 11% to 18% thanks to a generous remuneration that was part of its SPAC Agreement with Atlas Crest Investment Corp. earlier this year.
WeWork’s SPAC merger confirmed a fact that critics had complained about long before the 2019 IPO failed. Namely that it was never a tech startup, despite Neumann’s persistent efforts. to make one.
The company’s new valuation of $ 9 billion is 2.1 times the expected revenue for next year. This multiple is perfectly in line with IWG and PremierService, two former property management operators and well below its real estate technology counterparts like Airbnb.
But those kind of more humble financial expectations have yet to be anchored when it comes to other newly public high profile names. Warby Parker recently went public more than 12 times its historical turnover, a higher price for a eyewear manufacturer backed by VC whose growth strategy is based on opening more physical stores.
WeWork, in a cheeky attempt to downplay some of its biggest costs, invented its own industry accounting metric and dubbed it “Community Adjusted EBITDA.”
While few companies have been this creative, examples of good accounting tips are everywhere. Take the presentation to investors of a PSPC merger of a company with no revenue, and you will likely see an exponential graph of sales hitting hockey stick growth in the years to come.
WeWork’s failed IPO was expected to push investors to demand clear pathways to profitability, but it is not clear that such a change has materialized. The share of money-losing companies going public stood at 80% in 2020, according to data from Professor Ritter.
SoftBank’s overexposure is a reminder that diversification is essential in a high risk asset class. For its part, the Japanese investor has apparently learned this lesson. Its Vision Fund 2 has built up a much more diversified portfolio by issuing more small checks than in the past.
Meanwhile, however, other leading investors are showing a disturbing trend of doubling and tripling their perceived earnings. Insider tours are on the increase, a practice that raises concerns that higher valuations will not be validated by new investors.
Global Tiger, for example, supported Data bricks to $ 28 billion in February, to return in August to a valuation of $ 38 billion. It also doubled its funding this year Credit, Getir, Dutch and others.
Maybe investors took a while to learn from WeWork because it sounds like an outlier.
All of its issues – culture, corporate governance, financial quarrels – were so overblown that they always felt like the flaws of a failed business. Meanwhile, the investor mindset that created WeWork lives on.
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