News Analysis: WeWork’s biggest problem? It had too much money

In early 2017, Japanese billionaire Masayoshi Son gave Adam Neumann the kind of advice no entrepreneur can afford to ignore.

Son’s investment firm, Softbank, was on the verge of pumping more than $4 billion into Neumann’s office subleasing start-up, WeWork, at a $20-billion valuation — making it one of the world’s most valuable private companies, at least on paper. Despite the 10-figure vote of confidence, at the deal closing, Son told Neumann he had been “not crazy enough” to that point, according to Forbes.

“Make it 10 times bigger than your original plan,” Son said, in his own recollection. “If you think in that manner, the valuation is cheap.”

Whatever else you can say about Neumann’s tenure at WeWork, which ended Tuesday when he stepped down as CEO, you can’t say he didn’t try to please his most important investor. (He will remain on the board as nonexecutive chairman.)

WeWork’s fall has been astonishing. When the New York company filed paperwork for an initial public offering in mid-August, it had a private valuation of $47 billion. By this week, investors had pressured Neumann to postpone the IPO indefinitely after toying with a markdown to as low as $10 billion.

Neumann’s woo-woo pronouncements, party-hearty proclivities and shameless self-dealing made him an easy, and deserving, target for criticism — especially as the company incinerated capital on his pet ideas such as inland surfing parks and something called WeWork Mars.

But to finger him for WeWork’s belly flop misses the structural incentives that shaped his behavior — and those of every other money-losing mega start-up, from Theranos to Uber. If you define his job as responding to those incentives, his performance was pretty good, until it wasn’t.

“Silicon Valley has fundamentally changed its business model,” says Randy Komisar, a partner at Kleiner Perkins, one of the valley’s most pedigreed venture capital firms. For decades, Komisar says, he and other venture capitalists invested cash and expertise in start-ups aimed at serving different segments of customers, from consumers to large corporations to the government. A venture capitalist’s job was to build portfolios of self-sufficient companies, a few of which might become wildly successful.

That has changed in the last 10 years thanks to a massive influx of private money looking to get in on the hottest start-ups before they cool off and become mature public companies. Hedge funds, sovereign wealth funds from countries such as Saudi Arabia and Singapore and mammoth vehicles such as Softbank’s $100-billion Vision Fund need returns large enough to justify their existence — the kind of returns that are hard to find in a world of low interest rates, outside tech.

In the before times, a start-up that reached a certain size — say, $1 billion in revenue — would begin facing pressure from its early investors to get its balance sheet in order for an IPO. Its founders, eager to convert their paper money into real wealth, would have reason to heed them.

The arrival of the mega-funds and their bottomless coffers has changed all that.

For traditional venture investors, it meant they could take some of their own money off the table pre-IPO and gamble on the proposition an already gigantic late-stage start-up might have still more upside left in it. “Effectively, the early money gets all these layers of money after them that protects them from price issues,” says Roger McNamee, managing director of Elevation Partners and author of “Zucked: Waking Up to the Facebook Catastrophe.”

For founders like Neumann, the new money offered an opportunity — or an imperative — to double down on unproven and money-losing business models on the theory they would suddenly turn profitable once all competitors had been forced by their own losses to throw in the towel.

“The explicit assumption is if you get enough growth, it doesn’t matter how much you lose,” McNamee says. “That clearly was the way both WeWork and Uber have been run.” (Softbank also pumped billions into Uber, which has seen its share price slide 25% from its May IPO as it continues to absorb heavy losses.)

For those who believe in a tech industry that produces companies that contribute something real to society, the financialization of Silicon Valley is a pernicious trend. “The good news is most of the ‘unicorns’ are actually run really well, but the exceptions are pretty egregious,” says start-up guru Steve Blank, using an industry term for start-ups valued at $1 billion or more. “When cash is essentially free and there’s more cash than opportunity, you get these kinds of start-ups.”

Mega-funds like Softbank’s encourage entrepreneurs like Neumann to go for broke because they’re so huge, the difference between a so-so exit and a fire sale is a rounding error. “They’re writing small checks for their purposes, but those checks are gigantic and distortive” to the companies taking them, Komisar says.

“The real customer in the valley today is the investor,” he says. “It’s become the Wall Street of private capital. Our customers are the investors, our products are entrepreneurs.”

And, unfortunately for Neumann and the WeWorks of the world, that customer is always right.