6 Lessons Startups Can Learn from Wework’s Mistakes
The summer of 2019 seems like a lifetime ago; global pandemics and interest rates were nearly zero. The Softbank Vision Fund (SVF), formed in 2017, represented unprecedented levels of capital for tech investment at over $100 billion. This exponential quantum, 10x larger than other top venture funds, became available thanks to loose financial conditions.
The massive SVF distorted the private startup landscape, encouraging founders to dream ever bigger with similarly sized funding checks. According to reporting from WSJ, The Japanese investment giant SoftBank posted a net loss of $6.2 billion for the quarter ending Sept. 30 — and much of that can be owed to the decline and bankruptcy of WeWork. SoftBank has been WeWork’s leading investor since 2017 and bailed out the company for $9.5 billion just three years ago after WeWork’s botched IPO attempt.
WeWork’s dramatic rise and fall from a $47 billion valuation to bankruptcy in four years offers sobering lessons on misguided entrepreneurship and understanding sustainable business models. While pursuing unrealistic ambitions against the odds is intrinsic to startups, the WeWork example represents more than bold ambitions. The company’s failure stems from arrogance about established rules of markets, strategy, capital, governance, and sustainability no longer applying.
Before VC-backed startup schadenfreude becomes no longer in vogue, it helps to remember most startups fail. An article by Manish Sabharwal, in the Indian Express stated that “progress needs genetically diverse, risky bets by founders underestimating failure odds. High failure rates are manageable if a few innovations succeed, generating gains.” Meaning that most startups fail, but society can benefit from the innovation, productivity, and job creation that successful ventures bring.
However, WeWork discounted past learnings, believing its “disruption” rendered proven practices obsolete and disregarding marketplace realities, prudent strategy, governance, and sustainability fundamentals courts disaster. The lesson is to learn from mistakes, align strategy with industry needs, and wisely respect and utilize capital for lasting success.
More than ample funding led to ‘think big’ mentalities
An article by Janus Henderson Investors wrote about this topic, stating:
- Capital-intensive business models were ideally suited to soak up this significant capital infusion.
- No other company dreamed bigger than WeWork, looking to disrupt the US $1 trillion+ real estate market.
- Pitching itself as a tech company, WeWork rented commercial office space, claiming to digitalize real estate through a global platform, selling memberships and other services.
1 Tech startup in real estate – don’t mislead investors
Despite its physical office leasing footprint, WeWork cultivated a Silicon Valley-style image as a tech disruptor. This branding aimed to tap into tech’s cultural cachet and rich valuations. WeWork trumpeted innovation and technology, though these played marginal roles in its core business.
In reality, WeWork operates in commercial real estate and services, leasing and subleasing offices. But the tech messaging granted mystique. Hot tech companies often receive higher valuation multiples from venture capital due to their rapid scaling, network effects, and high margins.
In 2019, The Verge pointed out that WeWork’s main competitor is IWG, a real estate company that is not pretending to be a tech company, as Recode points out. “IWG has had substantially more square footage and more customers and has ‘actually’ made a profit — yet its market cap is just 8 percent of what SoftBank’s latest funding round thinks WeWork is worth,”. Wework is a real estate company that’s taken a lot of money from SoftBank and other firms by just saying “tech” a lot in the S1 filing to justify a multiple tech valuation. Portfolio Manager Richard Clode of Janus Henderson Investors explains that they examined WeWork’s tech stack and determined “none of them were truly proprietary. The business model to make money was based on leasing long-term office space and renting it out at higher rates in the short term.”
However, no network effects or scalability barriers are inhered in its capital-intensive model. WeWork ultimately remained hostage to asset economics. Behind the tech veneer, fundamentals mattered, as they do across sectors. WeWork’s bankruptcy illuminates the risk of disconnecting its image from practical strategy and operations.
2 The growth at all costs strategy does not work with all types of businesses or when funding is scarce
In 2019, the NYT reported that “for WeWork, one of the most important measures of its success is its breakneck growth — even if that means huge losses.
At the time, the co-working company disclosed that its losses more than doubled last year to about $1.9 billion, even as its total revenue also doubled to about $1.8 billion. But instead of expressing concern about the mounting losses, executives argued that they were a sign of the company’s giant ambitions.
The concept of blitzscaling (coined by Reid Hoffman), prioritizing growth over avoiding losses, doesn’t universally apply, and WeWork’s attempt in property leasing proved unsuccessful. It can work for certain tech companies such as Amazon, which intentionally invested aggressively in the future and, despite its accounting losses, generates a ton of cash. This strategy didn’t suit property leasing, highlighting the importance of aligning strategies with industry dynamics.
3 Prudently managing capital is crucial for startups and long-term growth
WeWork excelled at fundraising but failed to respect and utilize capital effectively, overlooking the importance of return on equity. The quantity of money raised couldn’t compensate for the lack of a solid strategy, emphasizing the importance of savvy spending. Pitching investors and raising Series A funding is essential, but respecting and utilizing capital wisely is equally crucial for sustained success. The world of free money is gone (except for startups building AI, maybe), and with higher interest rates now mean there is a higher cost of capital, companies have to emphasize efficient capital allocation decisions.
4 The need for vigilant boards and governance to ensure ethical practices
Weak corporate governance allowed unchecked actions by the founder, showcasing the need for vigilant boards to ensure ethical practices. Corporate structure: WeWork’s multi-class stock structure gave former CEO and founder Adam Neumann more power than other stockholders. Neumann’s shares had ten times the voting power. Facebook and Google founders have similar voting board structures.
Weak governance allowed unchecked actions by the founder, showcasing the need for vigilant boards to ensure ethical practices.
Boards should ensure they have the right skill sets and experience to navigate a crisis properly. Ideally, though, these people should be in place ahead of time.
5 Why building a positive culture that encourages diverse perspectives at a company matters
WeWork’s cultural issues have come under scrutiny. In 2017, bloomberg reported that some employees made allegations over a chaotic workplace environment, including unfair pay and organizational mischaracterization that have led to past lawsuits. Civilsdaily stated, “WeWork’s culture stifled dissent, hindering a healthy exchange of ideas between thinkers and doers, impacting long-term sustainability.” An article in Amazon AWS about this topic stated that for founders to achieve their goals, they must build strong teams they can trust to implement their vision. And they need to cultivate a strong workplace culture that encourages experimentation, quick decision-making, and learning from mistakes.
6 Creative accounting issues such as “community adjusted EBITDA” to avoid
In an article by Reworked,co, they pointed out that when WeWork filed its S-1 form first to go public, S&P Global Ratings and Fitch Ratings gave them ratings of B and BB-minus, respectively — putting the investment into “junk” territory.
Why the poor score? For one, investors questioned the firm’s creative accounting. Companies typically offer “adjusted earnings,” but WeWork decided to use a number they called “community adjusted EBITDA,” which subtracted not just interest, taxes, depreciation, and amortization but also expenses like marketing, general and administrative, and “building- and community-level operating expenses,” a category that includes rent and tenancy expenses, utilities, internet, the salaries of building staff, and the cost of designing the building amenities.
Creative accounting is known in the business world as non-GAAP accounting: GAAP, or generally accepted accounting principles, is the legal standard for financial reporting. Qz stated that “companies invent these measures to take numbers they don’t love but are required to report and turn them into results that look more attractive in their earnings releases.” The QZ article also mentions that WeWork is far from the only company to dabble in these accounting acrobatics. Uber reports adjusted EBITDA, adjusted net revenue, and other metrics derived from that (core platform adjusted net revenue, core platform contribution profit, and so on).