KE1182

January 21, 2021

©2021 by the Kellogg School of Management at Northwestern University. This case was prepared by Professor Sarit Markovich and Evan Meagher ’09. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Some details might have been fictionalized for pedagogical purposes. To order copies or request permission to reproduce materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail [email protected] No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Kellogg Case Publishing.

S A R I T M A R K O V I C H A N D E V A N M E A G H E R

The Harder We Fall: The We Company’s 2019 IPO Fiasco

“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”

—Ernest Hemingway, The Sun Also Rises

WeWork cofounder Adam Neumann burst onto the stage at Madison Square Garden in January 2019. Before him sat nearly 7,000 employees of the rapidly growing coworking space landlord, which offered shared and short-term office space and services mostly for startups and freelancers. This number was an impressive increase from the company’s 4,000 employees just one year ago. Swaggering with the confidence of a rock star and the Zen spirituality of a yoga guru, Neumann quieted the crowd before launching into a passionate speech extolling the company’s accomplishments during 2018. The vaunted “unicorn” startup* had actually accelerated its growth rate in total membership, workstations, and revenues, which had soared to $1.82 billion. With his wife, Rebekah, serving as WeWork’s chief brand officer, Neumann had led the company’s diversification into adjacent product lines WeGrow (an innovative private elementary school startup), WeLive (a communal living service), and Powered by We (a design, renovation, and office-management service). 2019 would bring more of the same, he promised as employees rose to their feet, cheering.

* A term coined in 2013 by venture capitalist Aileen Lee of Cowboy Ventures. Unicorns are startups with a post- money valuation above $1 billion.

D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

2

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C o KE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

“And I’m happy to announce that our most recent fundraise has been a complete success. . . and values our little company at $47 billion!” The crowd roared, but again, Neumann quieted them.

“I got this call, and it’s a good thing,” he continued, turning contemplative. “It could be a blessing. We raised a smaller amount, kept our investor base intact . . . It’s a change in strategy, but change . . . teaches you. It teaches you lessons. It’s a good thing.”1

“He literally said, ‘Our valuation is based on energy,’ and everybody just said, ‘OK, whatever,” a senior WeWork employee recalled later. “We went along with it. The way everything came together, from his energy, to his vision, to how people-oriented it was, the camaraderie. We banded together, and it was fun. You know, ‘band of brothers, we’re in the trenches together, the adversity and two-minute miles.’ I give a lot of credit to WeWork. It had Uber’s aggressiveness but Lyft’s heart.”

But just nine months later, the company was backing off its IPO, and Neumann had been forcibly ejected from the company amid scathing public critiques of his greed and egotism.

WeWork In early 2008, Israeli entrepreneur Adam Neumann found himself running a struggling baby-

apparel company out of an office at 68 Jay Street in Brooklyn, New York. Called Krawlers, the business focused on selling onesies with padded knees to parents with crawling babies.2 “We were working in the same building as my co-founder Miguel McKelvey, a lead architect at a small firm. At the time, I was misguided and putting my energy into all the wrong places,” Neuman recalled years later in an interview with a business publication.3 Recognizing an opportunity in the vacant space in the building, the two teamed up as co-founders of an incubator they called GreenDesk, offering environmentally friendly coworking spaces with recycled furniture and sustainably generated electricity.4 The business took off as GreenDesk rented space from the building’s owner Joshua Guttman and subleased it at a premium to startups and freelancers. In 2009, Neumann and McKelvey sold GreenDesk to Guttman, earning “a few million” in the process, and launched a more ambitious version of the same basic business model—this time, without having to share any profit with Guttman—as WeWork in 2010.5 The pair raised $15 million—at a $45 million post- money valuation—from local real estate developer Joel Schreiber. “I didn’t negotiate; I said yes. I loved Adam’s energy,” Schreiber said later.6

WeWork thrived, arguably by selling a more polished, more aggressively promissory version of the standard coworking space model. Whereas most coworking competitors, such as Regus, Impact Hub, and Industrious, followed a similar strategy of leasing large office buildings and subleasing out smaller portions for a premium, WeWork’s marketing materials sold a vision of collaboration between diverse, creative urban professionals. WeWork spaces featured beer and kombucha on tap, frequent social gatherings among tenants, and foosball and ping pong tables. “We are changing the way people work,” Neumann said in 2013. “It just happens to be that we need space to do it in.”7 WeWork commanded premium prices from sublessors—structured not as a lease payment but as a ‘membership fee’—by promising an environment of collaborative innovation wherein D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

3

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C oKE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

a member company needing freelance design help could meet a potential such contractor over regularly scheduled happy hours, bagel brunches, or yoga classes. As part of the membership fee, WeWork also bundled in services like security, reception, high-speed internet, and printing.

But the real perk is having other people around. WeWorkers network at weekly bagel-and- mimosa parties, where they might find a software developer to produce an app for them. Members pitch their ideas at informal demo days and get free advice during office hours from willing outside partners like ad agency Wieden+Kennedy. Handshake agreements and job referrals are made over the wagging tails of members’ dogs.

“Other offices are just depressing compared to here,” says Nicole Halmi of Neon, an image- selection platform in the WeWork Tenderloin location in San Francisco. “The old model of office space is dead,” adds startup veteran Gary Mendel, who runs Yopine from a WeWork in the renovated Wonder Bread factory in Washington, D.C.8

The company offered a variety of pricing plans to accommodate everyone from solo proprietors needing only WiFi and coffee to so-called “enterprise” customers (those with more than 500 employees worldwide) who needed full-scale-miniature offices as the first step in national or international expansion. As of March 2020, the most basic membership cost only $45 per month and included access to WeWork offices in 845 open or coming-soon locations in 188 cities worldwide. It also featured access to WeWork’s social network, WeWork Commons, which enabled entrepreneurs to interact and exchange ideas. Actual use of the facilities cost an additional $50 per day, however, so it was best suited to those who were interested primarily in networking and who needed office space only occasionally.9

Additionally, WeWork’s sudden massive global reach purported to offer those larger enterprise customers—which made up approximately 43% of the company’s membership base—a great deal of flexibility in short-to-medium term leasing options overseas. Many countries required the formation of a local, tax-paying entity to execute a commercial lease, a process that often proved prohibitively expensive given the legal and tax costs of foreign entity formation. With WeWork leasing out spaces around the globe, larger companies could simply sublease space from WeWork, bypassing or delaying many of the regulatory frictions traditionally associated with foreign expansion.

To support the community vision, WeWork offered a networking application, The WeWork Member Network, which it described as “a private, professional, social network for our members to access the global community, as well as the perks and features of their membership. It’s the best place to solve business problems, find clients, and connect with other members.”10

Coworking Industry Overview In its S-1 form, dated August 14, 2019, WeWork—freshly renamed the We Company—

estimated a total coworking industry addressable market size of between $945 billion and $3 trillion. This market was spread across the 280 global target cities the company had identified (111 of which it already served, as of June 1, 2019, with plans to expand into 169 more).11 At the D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

4

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C o KE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

time, the We Company estimated it had less than 1 percent market share in what it described as a highly fragmented industry, with both individual and institutional players fulfilling the basic value proposition of leasing out office buildings and then subleasing portions thereof at a premium that, to justify its cost, often included value-added services such as security, high-quality internet, and advice on fundraising proposals.

The dominant player prior to WeWork’s meteoric growth was IWG (née Regus), founded in 1989 by Mark Dixon, an executive who had grown tired of working out of hotel conference rooms. By WeWork’s reckoning, IWG had less than 3.5% market share, with its 1,284 locations producing revenues of $3.2 billion in 2018.12 (The vast majority of these locations were in the United States, its largest and most mature market in 2018, which also trailed only EMEA as its second-fastest-growing market).13 As WeWork flourished, other players began to enter the marketplace and hold themselves out as WeWork alternatives, including traditional landlords and developers like Boston Properties and Tishman Speyer. “I think a lot of landlords will step in to manage the space if WeWork exits,” said Daniel Lisser, senior director at real-estate brokerage Marcus & Millichap Capital Corporation, in a 2019 interview with an industry publication. “They will try to be WeWork without the drama.”14

The growth of the gig economy provided a tailwind to the industry’s 46% compound annual growth rate during the decade of WeWork’s ascendance. Freelancers, part-time employees, and entrepreneurs flocked to coworking spaces and paid premium prices for low-commitment spaces that offloaded the burden of office management and maintenance to the coworking space provider (see Exhibit 1).

Leasing and Locations WeWork initially acquired the office space it leased out to members by signing long-term

leases with terms as long as ten or fifteen years. As it grew, the company shifted from leases to co- management arrangements, in which WeWork’s landlord would make a financial concession or contribution to the buildout or operating costs in exchange for a share of membership revenues or profits. (The company found the most success with this approach in softer markets, often overseas, as the pricing in hypercompetitive markets such as San Francisco or Tokyo made such arrangements more difficult to arrange.) As WeWork grew, it found it easier to get landlords to share some of the buildout costs. In addition, the We Company set up a real estate investment fund called ARK to begin purchasing properties outright, with long-term mortgages financing the acquisition.

The company chose new locations based on their proximity to facilities and businesses like coffee shops, restaurants, and gyms. Once it had secured a location, WeWork designed that site to maximize space usage, minimizing square footage per person while still providing ample common spaces and meeting rooms. According to the company, its use of data from other offices allowed it to predict meeting room usage better and thereby to design their new offices more effectively.15 Compared with the 250-square-foot space per person in commercial offices industry-wide, WeWork’s buildings offered an average of 50 square feet per person.D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

5

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C oKE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

WeWork’s buildouts of new spaces on average were completed in nine months, although some buildings were ready in as little as four months. According to data analytics firm CB Insights, WeWork’s efficiency in construction and design, together with its buying power, lowered the company’s cost of adding a new desk to $9,504 in September 2017, from $14,144 the year before.16

Growth and Expansion WeWork’s geographic growth also scaled the services it offered its members through acquisitions

and partnerships. For example, WeWork’s store offered members discounts on software and office services. The company’s acquisition of the Flatiron School, a coding boot camp, allowed WeWork to offer members coding courses and programs, and a partnership with online personal finance company SoFi offered WeWork members in the United States a 0.125% rate discount on student loans. All of these incentives were part of the company’s vision of building a WeWork ecosystem.

The company’s ambitious brand promise was matched only by Neumann’s ability to fundraise. By 2014, the company’s roster of investors included J.P. Morgan Chase & Co, T. Rowe Price Associates, Wellington Management, Goldman Sachs Group, the Harvard Corporation, Benchmark Capital, and Mortimer Zuckerman, former CEO of Boston Properties—all of whom were drawn to WeWork’s promise of creating a network that enabled entrepreneurs within as well as across locations to interact, exchange ideas, and collaborate.17 WeWork had joined the ranks of the unicorns with its November 2013 Series C, but the company’s future changed forever when Neumann met Masayoshi Son, the founder and CEO of Japanese financial services conglomerate SoftBank.

Masayoshi Son and the Vision Fund Born the son of Korean immigrants on the Japanese island of Kyushu in 1957, Son studied

computer science and economics at the University of California Berkeley. Before turning 21, Son had already experienced entrepreneurial success, selling a translator to Sharp for approximately $1 million. A few years later, he founded SoftBank, originally a computer parts store that quickly diversified into publishing, trade shows, and software. Son took the company public in 1994 at a valuation of $3 billion and became a holding company in 1999, with a focus on venture capital investing during the go-go late 1990s technology boom. In 2000, Son led an investment into a Chinese startup named Alibaba; by the time Alibaba went public in 2014, SoftBank’s $20 million investment was worth over $60 billion, a more than 300,000% return.18

That extraordinary success prompted Son’s most ambitious move to date: the May 2017 launch of the $100 billion Vision Fund. The sheer size of the fund seemed, to many venture market observers, to turn the traditional venture capital model on its head, as it takes time to put billions and billions of dollars of capital to work. Son chose a different approach: He selected what he considered to be the most likely winners in large and growing markets, and he persuaded their CEOs to move faster, think bigger, and deploy more SoftBank-funded dollars to reach escape velocity in their vertical. He referred to this strategy as gun-senryaku, Japanese for a flock of birds flying in formation.19D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

6

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C o KE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

The Vision Fund’s impact on the venture market was profound and immediate; by October 2019, it had single-handedly deployed more than 10% of total global VC dollars that year (see Exhibit 2). The Fund deployed more than $7 billion into high-flying ridesharing application Uber in 2017, about as much as the total target of competitor Sequoia Capital.20 Because it takes roughly the same amount of time and effort to perform due diligence on a $20 million investment as it does on a $200 million or $2 billion investment, Son prioritized massive bets on companies that by definition were already or would become unicorns upon closing an investment from the Vision Fund. “It’s really altering the structure of venture pretty fundamentally,” Trinity Ventures general partner Patricia Nakache said in 2018. “I feel like over the past three years, the venture environment had bifurcated into this world of ‘haves’ and ‘have nots,’ where there are some companies that have struggled to raise money and some companies that have been able to raise gobs of money.”21 Those so-called “mega-rounds” often included secondary portions, wherein founders and employees could sell shares they had acquired via exercising low-priced employee options. This allowed founders to get liquidity for their ownership without the burden of going public, incentivizing them to remain private and therefore to avoid the public markets’ more rigorous reporting requirements. It also prompted an increase in M&A activity, as companies with overflowing war chests pursued growth at any price, often choosing to grow through acquisitions rather than organically. WeWork was no stranger to this strategy, acquiring more than 20 companies from 2017 to 2019 (see Exhibit 3). Only slightly more than half of those related to WeWork’s core business proposition, a trend that grew even more pronounced after SoftBank’s first investment into the company.

Son and Neumann first met at an event called Startup India in January 2016; Neumann had agreed to speak at the event in exchange for an opportunity to speak with Prime Minister Narendra Modi to discuss WeWork’s expansion into the country. Son and Neumann dined together that night, but Son passed on a $750 million financing round two months later, which was instead led by Chinese venture capital firm Hony Capital. By December, however, Son had reached back out to Neumann to schedule a tour of WeWork’s headquarters in Manhattan. Son arrived hours late and said he had just 12 minutes to hear the WeWork story. The two continued the frantic conversation in the back seat of Son’s ride to the airport, during which Son sketched out the terms for a $4.4 billion Series G investment that would value the company at over $21 billion. With the extraordinary sums of capital came extraordinary expectations; Son compared meeting Neumann to the feeling he got meeting Jack Ma, the founder of Alibaba, with the clear implication that Neumann would be expected to deliver similar returns.22 The pressure for growth increased exponentially, with employees reporting that Son’s insistence on accelerating growth made Neumann more impetuous. One executive recalled the WeWork founder returning from a meeting with Son, upset because Son had told him that he wasn’t growing the company quickly enough.23

“[Son] believed that nine women could make a baby in one month,” the senior WeWork employee said later. “‘Amazon took 15 years? Let’s do it in five.’ But building great businesses takes time. It’s a process. It’s an evolution. And of all the people in the world, to tell that to [Neumann] was going to produce a supercharged outcome. [Neumann] was always talking about ‘growth, growth, growth’—so giving him a billion dollars, and asking him to go even faster had massive downstream effects on incentives and behavior, all the way down to the most junior employee.”24D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

7

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C oKE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

“That’s When Things Got Shaky” By the end of 2018, WeWork was the toast of Silicon Valley. At Son’s urging, Neumann had

repositioned WeWork as a technology platform, noting the vastly richer revenue multiples that technology companies receive from public markets than do real estate companies. Neumann promised, for example, to outfit WeWork floors with sensors that could monetize analysis of tenant activity using artificial intelligence. WeWork then began expanding its offerings, acquiring companies and opening new businesses that spanned a variety of industries and markets. It established Rise by We, a luxury gym offering in a Manhattan-based WeWork space; WeGrow, a private elementary school led by Rebekah Neumann; and WeLive, a co-living business that attempted to replicate WeWork’s success in commercial real estate with a similar turnkey product for communal residences.

Meanwhile, Neumann’s free-spending ways became infamous within the company. He overcame mild pushback from the board to purchase a top-of-the-line Gulfstream G650ER private jet for $63 million and insisted on first-class office space in the newly opened Salesforce Tower for WeWork’s San Francisco office. Costs for the buildout exceeded $550 a square foot, which was about three times the amount WeWork usually spent renovating an office.25 (By late 2019, it had surpassed $800.)26 Employees reported that they would receive Neumann’s mantra from the early days of WeWork—‘Activate the Space,’ which once meant throw a party so the coworking space would look lively while Neumann pitched early investors—and suddenly the office would be completely revamped. “The next day, one office is painted pink, and it has a $3,000 sofa in it, and everyone just knew, ‘Oh, that’s going to be Rebekah’s office.’ And she would be there for like two days,” the senior WeWork employee recalled.27

To maintain that pace of spending, Son and Neumann had agreed to structure a $20 billion buyout of all of WeWork’s early investors, granting SoftBank majority control over the company and allowing WeWork to grow while avoiding the regulatory scrutiny that an IPO would entail. Much of it would hinge on the blessing of Mohammad bin Salman, the crown prince of Saudi Arabia, who, with $45 billion, was the Vision Fund’s largest backer. The revelation, on October 3, 2018, that the Saudi Arabian dissident and Washington Post reporter Jamal Khashoggi had been murdered in the Saudi consulate in Istanbul put the deal on hold; the crime was almost immediately traced back to bin Salman, creating a public relations nightmare for the Vision Fund. Soon afterward, SoftBank’s stock fell by more than 20%, or approximately $20 billion in value. “We want to see those responsible [for Khashoggi’s murder] held accountable,” Son said during SoftBank’s quarterly earnings call a month later. “But at the same time, we have also accepted responsibility to the people of Saudi Arabia, an obligation we take quite seriously, to help them manage their financial resources and diversify their economy.”28

SoftBank suffered another setback in December when its Japanese mobile phone division held its initial public offering during a disruptive week in the public markets. It immediately cracked its IPO price while falling 15% on the first day, setting a record as the worst first day of trading in Japanese history.29 The one-two punch of the stock-price tumble and the busted IPO provided just enough of a headwind to the proposed buyout to allow a longstanding issue to scuttle the now tenuous deal: voting power. If WeWork’s IPO went through, Neumann would maintain D o

N ot

C op

y or

P os

t

This document is authorized for educator review use only by SHAJAN NINAN, Lead College of Management until May 2022. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

8

T h e h a r d e r W e F a l l : T h e W e C o m p a n y ’ s 2 0 1 9 I p o F I a s C o KE1182

K e l l o g g s C h o o l o F m a n a g e m e n T

supermajority control over WeWork by making his Class B and Class C shares enjoy 20 votes to every one vote for his investors. “That’s when things got shaky.30 There was some bad luck—the Nikkei took a huge hit, and the Saudis refused to re-up,” the senior WeWork employee said. “They were already $8 billion into the company, and [Neumann] wanted his 20-to-1 voting rights, so between the voting issue, the Nikkei tanking, and the crazy valuation, it just fell apart. It was supposed to be like $16 billion on $46 [billion]. But it turned out to be like $1 billion on $46, and it all came from the balance sheet of SoftBank, because the Vision Fund had bailed.31

“I have no idea how they got to $47 billion,” the senior WeWork employee continued. “They probably had some rhyme or reason, but there was a lot of hope and faith. Every time you fundraise, you ask yourself how much runway that bought you. When we raised the $4.4 billion, that bought us two years, but to get to the next milestone valuation point, it was going to take us four years. But you’ve only got two years of runway! We were kicking the can down the road. So, let’s load up the tank, raise more money, but by the way, now you’re burning even faster so if you raise $3 billion that’s only eight months of runway you raised, and now to get to the next valuation milestone, you’re seven years out. How are you going to close that gap?”32

Things Fall Apart With WeWork’s revenue growth outpaced only by its losses—it had lost $1.9 billion in 2018

on revenue of just $1.8 billion (see Exhibit  4)—the company needed greater and greater cash infusions to keep afloat. When Son called Neumann on Christmas Eve 2018 to let him know the $20 billion buyout would not be going through, it only left one potential source of those infusions: the public markets. Four days later, Neumann filed documents registering WeWork for an IPO, finally filing its S-1, in August 2019.

Even by Wall Street standards, the market reaction was savage.

Critics lampooned the document’s pretentiousness and its idolatry of Neumann, who was mentioned 169 times. In a scathing retort entitled WeWTF, published two days after the prospectus’ release, Professor Scott Galloway of NYU’s Stern School of Business pointed out that the average unicorn filing document referred to founders only 25 times.33 The S-1 featured a …