It's Deja Vu All Over Again

It has been a while since I’ve witnessed capital destruction the likes of what the botched We IPO hath wrought. Perhaps We (Won’t) IPO is a better way to put it. One month ago We filed an S1 and the estimated value of the company being discussed was $47 billion. Then after a few people who are clearly not suffering from the aftermath of one of the company’s parties took a critical look at the S1 and the attacks on We began to snowball until the valuation expectation fell by a mere $37 billion!

Back in April of 2019 I wrote a post about how the world’s largest flexible-office company announced a strategic business model shift and was looking to accelerate growth through franchising. No, I wasn’t talking about We. I was was talking about IWG, a profitable company in the same business that at the time was valued at a $3.24 billion. Even without the benefit of the S1, which exposed a host of other issues that would substantially lower We’s valuation, I simply couldn’t make sense of the “innovative business model” and how it would be defensible against an onslaught of competitors, a future recession, or the laws of physics. An analyst on CNBC was extolling the virtues of the We model claiming the the genius of the model was a lower square footage per tenant. I immediately had a flashback to Spinal Tap when the band leader boasted that his band’s speakers went to 11.

There is simply no differentiation in what We does. Even legendary real estate investor, Sam Zell, explained numerous times on CNBC why We was a business model that had been tried several times in the past and failed each time. He went as far as to compare the dynamics of the company’s business model to the S&L Crisis in the 80’s.

So, why in hell does this keep happening? Are failures like Theranos, We and a host of other ill-fated startups the cost of an innovation economy, or are they avoidable through better corporate governance and less available capital.

Enough people have already elaborated on the breakdown in governance at We. I can’t even imagine how the S1 made it through the board and a legal review, but I can’t wait to read more about it in the coming weeks and months.

We’s issues are as much a failure of too much cheap money as they are poor governance. In 2011 I was asked to give a presentation on the state of the venture capital industry. Below are two slides from that presentation. The first explains how the fund raising cycle in venture had worked in the prior to the first Internet Bubble. In short, a few partners set out to raise a small fund. It took a loooong time to raise a fund. The size of the fund forced partners to invest prudently and make their carried interest worth something. The fund might be fully invested in three to four years at which time there might have been an early exit, several markups from subsequent rounds, and one or two smoking holes in the ground. If all appeared to be going well, they set out on the slog to raise a new small fund. Once you had a few small funds going, the fees were enough to pay themselves well, but the focus was still on carried interest.

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The Internet Bubble ushered in the billion dollar fund, a shorter investment cycle, a shorter time between new funds, and a desire to keep everything in the portfolio alive so as not to have any potential black marks that might interrupt the short fund raising cycle.

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More LPs rushed into venture capital, which meant more and bigger funds, more fees, and, well, more fees. The typical partner was now taking home more in fees than carried interest and the speed with which investments were being done at higher and higher valuations meant paper gains that eventually turned into realized losses.

We’ve all heard the phrase, “This time it’s different.” No it really isn’t. There is now five times the amount of capital under management then there was five or six years ago. The number of firms keeps growing. The size of funds keeps growing. The valuations keep growing. Until they don’t. All it takes is for one canary in the coal mine to drop dead and everyone begins to head for the exit. Could We be the canary?