WeWork got here out with dear unicorn with a valuation of virtually $50 billion, which is a warning to naive investors value just $8 billion inside a few months. It did this in part by wrapping its real estate subleasing business under the guise of a tech startup that goals to “change the world.”
Have investors like SoftBank and JPMorgan been duped by the hype of a charismatic founder, as was the case with Elizabeth Holmes and Theranos?
How finance lecturer and someone who had been managing investments for 20 years, I think there was something like that combined with behavioral biases that lead people to make bad decisions. But I also think there was something else going on that ought to give investors pause for thought the next time they arrive across a visionary founder promoting a “change the world” brand strategy.
Reuters/Eduardo Munoz
“We” will change the world
WeWork was founded in 2011 as a company coworking enterprise.
But Adam Neumann created and presented a vision for his company that went far beyond sharing offices and real estate. He said the “we” culture he was building would change the world.
“The influence and impact that we will have on this Earth will be so great,” he added. he told the staff during a music festival-style retreat, where he suggested that the company could “solve the problem of parentless children” and even eliminate world hunger.
Such statements weren’t unusual for him. Moreover, they fit perfectly into the messianic world of Silicon Valley technology, where corporations imagine that their inventions can actually “free the world”.
Neumann’s ambitious plans recently became a reality investors became disgusted with the company in the period preceding the planned initial public offering. On October 23, existing investor SoftBank agreed to avoid wasting the crisis-ridden company billions in additional capital in exchange for an increase in shares to 80%. The transaction pushed out Neumann, who, despite burning through previous investments, will receive $1.7 billion.
Neumann’s “exit” package may be unusual in its scale, but otherwise a similar fate has befallen many other founders, comparable to Holmes and Travis Kalanick from Uber. It often seems that even Elon Musk, CEO of Tesla and founder of SpaceX one outrageous tweet away from his ignominious end.
Each of those leaders embodied different qualities it has inspired an almost cult-like following among investors who have spent over billions to share in their growth. In cases like Tesla and Uber, corporations have managed to succeed despite the shortcomings of their CEOs. Theranos and WeWork are examples of what can go fallacious when the founder is each owner and director of a venture-backed startup.
Directors and agents
Financial scientists like me think of it in terms principal-agent relationshipa key issue for the management of virtually every company and organization.
A principal is a party or group that obtains an agent to administer some asset or process in its best interests.
In a healthy corporate structure, the combination of principal and agent is achieved through management and executive compensation policies that provide management with incentives to act in the best interests of householders. For example, a CEO’s compensation may include company stock, which vests over a period of years and whose amount depends on specific performance goals.
In the case of WeWork, Neumann played each roles: he was the major investor with a controlling stake and the agent as the director responsible for managing the company. Even prospectus language was attached to the company’s ill-fated IPO that might have given him control for life.
Reuters/Kate Munsch
Why is this a problem
You may wonder what the problem is with this solution, provided that managers are often owners, as is the case with small businesses and family-owned businesses.
When their very own money is at stake, they’ll surely look out for their very own best interests, right? In such situations, yes, and the risk of worsening the situation is taken over by the owner-managers.
The difference between most of these corporations and corporations like WeWork and Theranos is that startups typically have significant outside investment capital. SoftBank, for example, was also an executive at WeWork. In such situations, the interests of a founder comparable to Neumann do not necessarily have to coincide with the interests of the company itself and its other investors.
For example, when creating WeWork, Neumann borrowed tons of of tens of millions of dollars in relation to his shares in the company, putting itself and WeWork at risk depending on future stock valuations. He also charged his own company $5.9 million for the trademark rights to the word “we” – the amount he gave back after severe criticism.
He managed to do this even after leaving the company negotiate a generous travel package, including the choice to money out nearly $1 billion in stock and receive a $185 million advisory fee. At the same time, the way forward for the company is uncertain and it is lay off 2,000 employees – which he delayed because he couldn’t afford to interrupt them up.
Unemployed staff and wasted capital are collateral damage when investors fall victim to the prime agent problem. And unfortunately I do not think it can be the last time.
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