Review & Outlook

Our take on the investing, financial, & economic themes of the day

When Start-Ups Take Investors’ Cash Just Because They Can

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

— Chuck Prince, CEO, Citigroup (June 2007)

money falling

The music is still playing for “disruptive” start-up companies and their venture capital and private equity financiers, so the dancing continues.  The Wall Street Journal reports today that the co-working start-up WeWork has been valued at $10bn by its backers, including Fidelity.  A few months ago I camped out at a co-working site in Salt Lake City for a few days.  I enjoyed it and found it a great way to get work done while I was traveling and was staying in a hotel that lacked a decent library or business center.  As a business, however, its hard to see how WeWork deserves its valuation.  As the Journal article points out, WeWork is basically engaged in office rental arbitrage.  It rents office space at scale and long-term rates and sublets the space to many different and smaller renters at much higher short-term rates.  Apart from providing hipster cachet and amenities like beer and ping pong, it’s hard to see what WeWork’s competitive advantages are, and why it isn’t just a dispensable middleman who can be cut out by landlords if it really starts to succeed.

The most revealing aspect of the WeWork funding round is the exculpatory remarks by WeWork’s founder and CEO, Adam Neumann, who sounds like he’s positioning himself to avoid blame when investors’ expectations get crushed:

Mr. Neumann said the company hadn’t been looking for additional funding recently but kept getting a barrage of calls. “We didn’t seek this out,” said Mr. Neumann, 36 years old. “We kept having offers and kept ignoring them.” Ultimately, he said, he warmed to the offer, though he adds that it comes with higher pressure.  “This is an increase in responsibility, an increase in expectations,” he said. “A higher valuation with more cash invested by investors just means you need to deliver higher returns.”

In other words, he took the money just because he could, not because there was a good business reason to do so.  The music was playing and Neumann couldn’t ignore it anymore, so he just got up to dance.  Neumann’s remarks echo the comments of Stuart Butterfield, who is the founder and CEO of Slack, the messaging service that is one of the hottest members of the Billion Dollar Startup Club.  In April Slack raised $160m from private investors that valued the company at $2.76bn, even though the company had yet to spend any of the $120m it had raised just a few months before in October of last year, and at that time Butterfield remarked that $120m would be enough to fund the company for 60 years.  By April, however, he’d changed his mind:

It’s the best time ever in the history of the world, or at least the tech industry, to raise money. Will it get better? It’s possible. Six months from now, we might say darn it, we should have waited ….  On the other hand it’s a pretty amazing deal. In a certain respect it would have been irresponsible not to take it for five-ish percent of the company on clean terms.

When the music stops, things will be complicated.