A top professor is already teaching WeWork in his venture capital class. Here are 5 lessons that investors need to know.
- Six weeks ago, WeWork was valued at $47 billion. Now, there are whispers of bankruptcy.
- Erik Gordon, clinical assistant professor at the Ross School of Business at the University of Michigan, told Business Insider about the main lessons investors can learn from WeWork's example.
- They include treating valuations with healthy skepticism and looking for holes in business models.
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When Erik Gordon walks into his venture investing seminars at the University of Michigan, he likes to ask students about the most compelling events happening in business.
As of late, one company has dominated conversation: WeWork.
Gordon's class is a little nontraditional, which is to say, innovative. Students at the Ross School of Business have the chance to be part of actual, in-house venture funds, where either undergraduates or MBAs. They deliberate together to invest real money, provided by donors, into startup firms across the country.
And WeWork, Gordon quickly realized, has become something of a cautionary - and instructive - tale for investors of all kinds.
The saga of Adam Neumann ties into an overall theme he teaches to would-be venture capitalists. "Most people pitching an investment give a pretty good pitch," he says. "The better it sounds, the more thinking you have to do. And the more digging you have to do."
To that end, there are five main lessons that the WeWork odyssey (to date) should give investors.
Think ahead: What's part of the culture now will become known later.
Even if a company gains traction and subsequent recognition for its successes, the actions embedded in its culture will eventually become known. Like sex, tequila, and a tiger.
When institutional investors start vetting the startup, behaviors a VC might gloss over suddenly become deal-breakers.
"What would they think about you leasing the property through an outside entity that you control?" Gordon asked. "Think about what it means when you put family members in positions. Think about what it means to throw wild parties."
These elements reflect on the founder's leadership ability, and will be remembered. Behavior that might be acceptable and humorous at a 20-person startup could cause investors to think that a founder is unsuitable to lead the company years down the road.
As Business Insider previously reported, a founder's early decisions can actually be linked to measurable growth later on. A Columbia researcher analyzed data on 10 million US companies and found that incredibly simple early actions - like how you treat your intellectual property - shape growth potential down the line.
Beware the dangers of full executive control.
Gordon points to the dangers of giving full control of a public company to a founder who hasn't had previous experience running one. Whether this control is given through voting rights or contractually, its result could be an Adam Neumann or a Travis Kalanick. Elizabeth Holmes of Theranos is another example: She couldn't be removed by her own board.
When presented with this scenario, investors must consider the alternatives.
"How do you satisfy a founder who doesn't want the company to be stolen from them?" Gordon asks. "What kind of compromise, what kind of revisions can you come up with, if the founder has gone from being the person who built all the value to the person who's destroying the value?"
At Uber, the VCs threatened to cut off funding if Kalanick didn't give up control.
More typically, investors or the board will move founders to a position like board chair or chief technology officer or chief visionary in the interest of the company's future. The convincing factor is saving the company, or elevating the company to the next phase, and reminding founders that their futures are tied to the success of the company.
Be skeptical of valuations
WeWork was valued at $47 billion, and as early as six weeks ago, was the most valuable tech startup in the United States. Now observers wonder about potential bankruptcy.
Read more: How WeWork spiraled from a $47 billion valuation to talk of bankruptcy in just 6 week
When WeWork filed for IPO, the valuation that had propped it up with credibility folded under the weight of almost 30 pages of risks listed to investors.
"When investors got past all of the hype about 'we're raising the consciousness of the world' and 'look how fast we're opening these things,' when they looked carefully at the business model, they saw a business model that they actually didn't like," Gordon said.
As Gordon pointed out, WeWork's business model revolved around Neumann saying that he could make the business profitable by just flipping a switch and not expanding. It wasn't actually clear how he would do that based on what he had already done.
Look for "counterfactuals" to the business model
One way to evaluate an existing business model is to look for counterfactuals or answers to the question of whether the model will actually work the way that it's presented.
For example, Gordon says, the logic behind the Blue Apron business model was that it would cost less to acquire new customers over time because existing customers would spread the word themselves.
"That's logical," Gordon said. "That's possible. But they actually had no evidence of it."
Within Blue Apron's S-1 was evidence to the contrary. It cost the company more to acquire a new customer, not less.
The lesson here, according to Gordon, is that investors should rely on evidence to support their logical premises. It was possible that customer acquisition costs could decrease because of the word of mouth effect, but it wasn't a certainty. Investors who didn't catch the evidence in the S-1 "got killed," says Gordon: Blue Apron shares are about two years old, and they've already lost about 94% of their value.
Embrace your fear of missing out
VCs naturally want to invest in the next big thing. They want their investments to have impact and, in their heart of hearts, want to appear on magazine covers as one of the initial backers behind a world-changing company.
This intense fear of missing out can lead to regrettable investments in companies, says Gordon.
"In WeWork's case, investors backed a company with a highly questionable CEO," Gordon said. "If you weren't afraid of missing out, you would have said, 'This isn't how you build a great company.' "
The key is not losing your equilibrium in the need to invest in a potentially big hit. In some cases, VCs should be more afraid of investing than they are of missing out. WeWork was one of them.
"WeWork is a real mess," he said. "But it's not a surprising mess."