The business model was perfect. Rent out workspaces to startups and small businesses in some of the most desirable locations around the world. Give them free perks like coffee and beer, build a social atmosphere, and provide customers with them with state-of-the-art workspaces.

WeWork

It seemed like WeWork was on top of the world. Until it wasn’t. The company that was seen as one of the fastest rising startup companies in the world is all of a sudden in the doghouse with investors. A slew of bad business decisions and questions surrounding the company’s CEO makes WeWork a potential cautionary tale in a world that has a tendency to overvalue startup companies.

The Business Model

Both Adam Neumann and Miguel McKelvey recognized that in a world where business was becoming more remote, people would need great workspaces to suit their needs. Since the turn of the century, more and more businesses were using remote workers or small teams scattered across the globe. This meant, these workers didn’t have a typical office location but weren’t satisfied working at their local coffee shop.

On its website, the company’s mission is stated as wanting to, “Create a world where people work to make a life, not just a living.” This sentiment is shared among the millennial generation, and one that WeWork was looking to capitalize upon while injecting community and better amenities into their workspaces.

The WeWork model allows its customers to rent space on a month-to-month basis, shattering the previous norms of long-term rental leases. It’s various membership options — from a single “hotdesk” to private offices and even custom build-outs for larger teams — was able to capture a wide variety of employees and businesses around the world.

The company was able to make money by purchasing or taking out long-term leases on real estate in desirable cities like New York and Tel Aviv, and transforming the spaces into smaller office spaces for rent.

Exponential Growth

The company experienced immediate growth since its inception in 2010. Well-known startups such as Reddit, HackHands, Whole Whale, and others put employees in WeWork office spaces in their early years, while more established companies like Microsoft also began to use WeWork spaces around the United States.

Exponential Growth

By the end of 2015, WeWork was on its seventh round of funding, totaling over $1 billion, giving the company a valuation of over $10 billion. At one point, WeWork was the second most valuable private company in the United States as it grew from 52 to 551 locations in a matter of four years.

It secured partnerships with Microsoft to house 300 of the company’s employees, and Mastercard to reduce friction in office payments. WeWork secured several rounds of financing from private investors. After its Series H round of investment led by SoftBank, the company was valued at $47 billion.

With big names supporting the company and a strong brand across the globe, it appeared that WeWork was on its way to the top.

A Failed IPO and Downfall

When the company announced its decision to opt for an initial public offering (IPO), they were forced to open their books and give the public full transparency into their business. Unfortunately, the results weren’t as good as expected. While WeWork had grown its business more than ten-fold in the few years it had been in operation, it was failing to produce a profit. In 2018, the company lost $1.6 billion while bringing in $1.8 billion in revenue after losing $900 million the previous year, paltry numbers for a company valued so highly.

Still, investors weren’t buying that the company was on solid footing. Jane Leung, chief investment officer of Scenic Advisement, explained, “The bigger you get, the more scrutiny there is, and the larger the losses you have, the more sensitive investors are to it,” she said. As investors expressed their concerns, WeWork began scrambling to show that it could continue its growth trajectory via alternate streams of income. At the same time, its new business brought even more expenses that hamstrung the business.

For instance, one of WeWork’s newest projects, WeGrow, is an alternative school located in New York City. WeGrow comes at a hefty price tag — up to $42,000 per year — and gave children the opportunity to learn in a variety of alternative environments. Unfortunately, WeGrow wasn’t successful enough to last more than a few years, and it will be closing in 2020. The company cited cost-cutting measures as the main culprit for its closing. “As part of the company’s efforts to focus on its core business, WeWork has informed the families of WeGrow students that we will not operate WeGrow after this school year,” WeGrow said in a statement.

When news surfaced of CEO Adam Neumann leasing office space to his own company and collecting large checks, WeWork began to lose its luster in the public eye. Eventually, Neumann would step down from his position and leave the company altogether.

After reducing its valuation several times, WeWork decided to pull its IPO which was steadily losing value. Instead, the company found a financial backdoor by allowing SoftBank, the telecommunications firm, to takeover WeWork at a valuation of around $8 billion, well below its $47 billion valuation the company attempted to sell investors just several months before. What’s even more surprising about the deal is that former CEO Adam Neumann will make off with $1.7 billion in the deal, one of the best deals ever for a startup CEO.

Is This a Trend?

The WeWork debacle lends itself to a scary question: is this a systemic problem within the startup world, or an isolated case of a single company that went wrong?

Ride-hailing apps Uber and Lyft also went public while in the midst of billions in losses. Uber currently sits at a market capitalization of $54 billion, and Lyft at $12 billion, however, this doesn’t underscore the fact that both of these companies have seen their respective stock prices drop by more than 35% from their highs over the past year. For its IPO earlier in 2019, Beyond Meat sold shares at a $1.46 billion valuation, a seemingly large number given the company had lost almost $30 million the previous year.

On the flip side, there are a slew of cases where companies were able to use their exponential growth to build successful businesses even after years of losses. Amazon may be the perfect example of such a company, as it failed to turn a profit for the first six years of its operations, and turn as much profit in its first 14-years as it did in a single quarter in late 2017. This shows that high growth and valuation companies can stall for quite some time before finding their financial footing.

What to Watch For

There may be no way to know for sure if a startup will become the next Amazon, or fail to live up to expectations like WeWork. However, there are a few things that investors and other interested parties can watch out for when examining these companies.

Startup

Cash Flow

A company without enough cash can’t pay their invoices, make payroll, and will ultimately wither away. Still, most companies in their infancy will generally fail to pull in cash quickly enough to cover most of their expenses. Therefore, the stage of the company also matters when looking at their cash flow, and this metric should be scrutinized more heavily for companies later in their business cycle.

Profit

This one should be obvious. A company that doesn’t make money can’t support itself in the long-run. But multiple years of net losses doesn’t necessarily mean doom for a startup. Expect new companies to struggle to turn a profit, but make sure to take note of the company’s business model and plans to turn those losses into future profits.

Founders

One of the biggest things that can sink a startup boat — much like what happened with WeWork — are founders that don’t act in the best interest of their company. A founding team with past success is worth its weight in gold, as it shows their ability to grow companies to financial success. But even a founding team with several startup failures can be valuable, as these founders will likely have learned valuable lessons from their previous ventures.

Failure Abounds

It is rare for a company to pull its IPO after so much hype, but WeWork was not a normal startup. Its founder used the company’s power to benefit himself while leading to a valuation with little-to-no tangible justification. Not all fast-rising startups will be met with the same fate as WeWork, but given the fact that 90% of startups fail, it should be no surprise that the successes will be few and far between. Still, it’s not often you will see a startup fail in such a public manner the way WeWork fell from grace in 2019.