After WeWork: What has and hasn't changed in the VC ecosystem

After two years, several books and a deluge of hot takes, WeWork has closed the final chapter on its life as a private company.

The saga has changed how the public views high-growth companies and their investors. For those companies and firms, however, many lessons have yet to take root.

The WeWork drama resembles a Greek tragedy—hubris that led to a hero's fall. Such stories are meant to induce catharsis and show the public how to avoid similar pitfalls.

But what has changed? Some investment and management practices have been altered. SoftBank, WeWork's biggest backer, has done an about-face on some of the practices that left it overexposed to and overconfident in WeWork. Its new strategy is more diversified and comes with a clearer thesis on the future of technology.

But the culture of investing that gave rise to WeWork has in other ways only deepened, from creative accounting and tech-washing to investors' tendency to bow down to founders. These behaviors and others threaten to result in WeWork sequels down the road.

This article appeared as part of The Weekend Pitch newsletter. Subscribe to the newsletter here.

Adam Neumann's principle gift was his charisma and vision. He convinced seasoned investors that he could create a sprawling real estate empire that would span work, home, education and childcare—all while elevating the world's consciousness.

Neumann accomplished this feat by exploiting a well-known weakness among investors for "pattern-matching," which stems from a belief that successful entrepreneurs share certain traits. This was in part what led SoftBank CEO Masayoshi Son to believe so unflinchingly in Neumann, who reportedly reminded Son of Alibaba's Jack Ma.

It is hard to say, in the aggregate, whether investors are taking steps to fight this instinct.

Geographic and demographic trends can offer some clues. A global pandemic has accelerated VCs' interest in companies outside of Silicon Valley, a sign that they have at least changed how they meet entrepreneurs. But despite pressure to invest in more women- and minority-led startups, progress is slow to come.

Regardless of who is being funded, tech founders continue to be treated generously.

Neumann's 20-to-one voting share structure was shocking even for a tech company, but founder CEOs show no signs of ceding control.

About 43% of US tech IPOs last year had dual-class shares, versus 12.6% for non-tech IPOs, according to data collected by University of Florida Professor Jay Ritter. In a recent IPO filing, NerdWallet revealed that CEO Tim Chen held 92.6% of the voting rights thanks to the 10-to-one power of his shares.

The IPOs of tomorrow will be no different, as venture capital deal terms are becoming increasingly startup-friendly, according to PitchBook research. Stiff competition among VCs has allowed founders to negotiate more favorable terms, which can be seen in a yearslong decline in redemption rights in the US, one barometer of investor protections in the market. Today's founders also give up a smaller share of their company in financing rounds than they did in the past.

"When there are multiple offers and term sheets, founders can pick and choose what works for them," said PitchBook senior analyst Kyle Stanford.

This competition has left investors with increasingly limited power to rein in wayward founders.

Even after going public, tech leaders are continuously coddled. In recent years, CEOs of newly public tech companies have seen a massive jump in pay, according to an analysis published last week by The Wall Street Journal.

One striking example is Archer Aviation, whose founders could increase their stake in the company from 11% to 18% thanks to a generous compensation package that was part of its SPAC deal with Atlas Crest Investment Corp. earlier this year.

WeWork's SPAC merger has cemented a fact that its critics had complained about long before the failed 2019 IPO. Namely that it was never a tech startup, despite Neumann's persistent efforts to brand it as one.

The company’s new $9 billion valuation is 2.1 times the revenue it expects next year. That multiple is neatly in line with IWG and FirstService, two legacy property management operators, and well below real estate tech peers like Airbnb.

But those kinds of more humble financial expectations still have yet to sink in when it comes to some other newly public high-profile names. Warby Parker recently went public at more than 12x its trailing revenue, a premium price for a VC-backed eyewear maker whose growth strategy hinges on opening more brick-and-mortar stores.

WeWork, in a brazen attempt to minimize some of its largest costs, invented its own industry accounting metric and dubbed it "community-adjusted EBITDA."

While few companies have been quite that creative, examples of rosy accounting tricks are everywhere. Grab the investor presentation from a SPAC merger of a company with no revenue, and you're likely to see an exponential chart of sales hitting hockey-stick growth in the coming years.

WeWork's failed IPO was expected to push investors to demand clear paths to profitability, but it's unclear such a shift has materialized. The share of money-losing companies going public stood at 80% in 2020, Professor Ritter's data shows.

SoftBank's overexposure was a reminder that diversification is paramount in a high-risk asset class. For its part, the Japanese investor has apparently learned this lesson. Its Vision Fund 2 has amassed a far more diversified portfolio by writing a larger number of smaller checks than in the past.

Meanwhile, however, other top investors show a worrying tendency to double- and triple-down on their perceived winners. On the rise are so-called insider rounds, a practice that raises concerns that higher valuations aren't being validated by new investors.

Tiger Global, for example, backed Databricks at $28 billion in February, only to return in August at a $38 billion valuation. It has similarly double-dipped this year in funding Cred, Getir, Dutchie and others.

Perhaps investors have been slow to learn from WeWork because it feels like such an outlier.

All of its problems—culture, corporate governance, financial chicanery—were so over-the-top that they still feel like the shortcomings of one broken company. Meanwhile, the investor mindset that created WeWork lives on.

Featured image by Joe Raedle/Getty Images