Anik Joshi: How did We get here and what’s next?

Wednesday, October 9, 2019 - 4:24pm

The We Company (formerly known as WeWork), a massive coworking and office space company, was once the honor of Softbank. Softbank is a Japanese conglomerate that has been making a name for itself via massive investments either directly or from its subsidiary, the Vision Fund. We represented years of work and development and was one of two shining jewels in Softbank’s crown — the other, of course, being Uber. All of the good press and positivity culminated in an eye-popping $47 billion valuation for We that recently fell so fast and hard that their IPO was temporarily pulled. Valuations are meant to be based on numbers and We shouldn’t have fallen as quickly as it did, but the downfall might have demonstrated that it was the end of an era.

We’s $47 billion valuation is big, but it is not out of the norm. In May 2019, Uber was valued at $82 billion at their IPO and in March 2019 Lyft was at $24.3 billion during their IPO. In addition, DoorDash is planning to go public with a valuation of $12.6 billion in 2020. Each of these four companies shares a few traits that made these valuations especially noteworthy. A big one is a lack of profitability. Uber reported a $5 billion dollar loss during their second earnings report, Lyft lost $644.2 million during that same period, DoorDash was still not profitable, and finally, We lost $900 million during the first six months of 2019.

So why then were these companies’ valuations so high if not for their profit and loss statements? Could it be the assets they held? Not quite, since Uber, Lyft and DoorDash don’t really have many assets. People drive their own cars for Uber, Lyft and DoorDash — they do not drive cars owned by those companies. Along these lines, We does not own all of its real estate. 

The valuations were neither based on cash flow nor assets, so what then could it be? The real answer lies in a deeper issue with venture capital today — companies that primarily use software are getting treated as software companies, which is having incredible ramifications on their valuations. A similarity between these startups and software companies is that software companies often run big losses at the start but eventually turn profitable because the marginal cost is close to zero and products can scale very efficiently. This is not quite true with Uber, Lyft, DoorDash or We. None of these companies can scale like software. Nor can the cost be that low, because the constraints for them are fundamentally different. Uber, Lyft and DoorDash are constrained by the amount of people who can and want to perform the service, and We is constrained by the fact that they are unable to buy more buildings because the marginal cost for skyscrapers is not one that typically trends downwards — there is no two-for-three special on Empire State Buildings. We’s entire business model is based on acquiring real estate to turn into coworking spaces. That well eventually runs dry though, and the marginal cost never falls off. 

This problem has been compounded by the fact that a lot of successful startups (especially in Silicon Valley) have been software companies. As a result, when software is key to a company’s bottom line, investors are more interested in helping to secure funding because they feel that the valuation could rocket up. The crucial difference is that while all of these companies use software, some are actually companies whose bottom line is dependent on software (Snapchat App, Facebook Website and Instagram App) and some are companies that merely use software. They make their money off of car rides, deliveries or rentable office space.

So, where does We go from here and what does this mean for the wider field of startups? We is probably not a $47 billion company, and most startups are not either. In the future, more attention should be paid to these things prior to filing a security registry form, also known as an S-1. Does this mean that the idea behind We — coworking — is done? It’s doubtful. Coworking will still be a lucrative market as more and more companies eschew modern offices and embrace working from home. Regarding startups more broadly, this is a time for a conversation to understand why companies should be valued the way they are and what that value is really based on. If it is based on lots of growth, with a very slight potential for profitability, then obviously the system is in need of being reworked. If the We saga can lead to venture capitalists rethinking some of their strategies with regard to investing and valuation, perhaps We’re not so screwed after all. 

Anik Joshi can be reached at anikj@umich.edu.