WeWork: The Pets.com Of Our Moment

Just like the 2000 collapse of the wildly unprofitable online pet food store pets.com, WeWork has become a symbol of venture capital (VC) excess, the end of an era, and the catalyst for shifting investment priorities.

Who can forget pets.com? Most people remember the 2000 Super Bowl for ‘the Tackle' – when Rams linebacker Mike Jones stopped Titans wide receiver Kevin Dyson one yard short of the end zone with six seconds left, sealing the Rams win. But others remember pets.com's Super Bowl commercial, in which a weirdly charismatic sock puppet massacred KC & The Sunshine Band's "Please Don't Go" while a pet owner drove away, leaving his dog at home.

In retrospect, the commercial was emblematic of the company and the entire dot.com bubble, which arguably began collapsing a few months later when the Yahoo! and e-Bay merger negotiations fell apart. The idea that a massive marketing spend could overcome disastrous unit economics, an immature marketplace, and a profoundly uninterested consumer died in 2000. Pets.com filed Chapter 11 just nine months after its initial public offering (IPO), having generated just $600,000 in revenue in its first fiscal year against an $11 million advertising budget. 

The collapse of pets.com revealed the company for what it really was – a sock puppet, an insubstantial illusion propped up and animated for a brief time by outside investors [in this case, Amazon.com, Inc. AMZN].

WeWork, though a very different company from pets.com in terms of its scale and business model (pets.com was possibly more high tech than WeWork), has a similar role to play in the current cycle of venture capital investment. 

This cycle has seen technology startups stay private for longer – no one would dare enter the public markets with revenue under $1 million. Companies stay private for longer, taking advantage of illiquid, opaque private market dynamics, which supply them with cash and swell their valuations. According to CB Insights, there are now 404 unicorns – private companies valued at greater than $1 billion – in the United States, valued at a collective $1.28 trillion. 

Companies stay private for longer and stay unprofitable for longer, and when they run out of large-scale investors, they participate in an IPO, hoping that their years of scaling on the back of venture capital investing has bought them a brand name recognizable to the retail investor. The public markets were supposed to scrutinize the company and guide it toward profitability, eventually bending down the unicorn's growth curve toward sustainability and positive net income. 

Instead, this time, there was a revolt. A company valued at a vertiginous $47 billion prepared for its IPO, saw its valuation cut in half and then half again, to (hopefully) around $10 billion, got its IPO postponed, and then saw its CEO canned. The same sell-side analysts who said that Uber would be the biggest thing since Facebook would not sign on to sell shares of WeWork to retail investors and ultimately to your 401-k.

Now WeWork may struggle to survive, because if it does not raise equity through an IPO by the end of the year, it will lose access to a $6 billion revolving line of credit it needs.

The smoking crater of WeWork's valuation has effectively killed the current VC model. A venture capitalist told FreightWaves this week that "revenue growth with negative unit economics is done." Another VC said that future rounds would be priced on a multiple of gross margin, not annually recurring revenue – the first time that idea has been posited to FreightWaves. 

Markets appear to have returned to the fundamental truth that the only justification for rich technology valuations is the combined advantage of the high incremental margins in software sales and the stickiness of subscription revenue, particularly in enterprise software. Trendy interior design firms going all-in on a real estate arbitrage à la WeWork should have not made the cut and will not, going forward.

Freight tech and mobility marketplaces, including companies like Uber and Lyft, will see multiples compress to public market comparisons. These companies don't have software's incremental margins – they have roughly the same costs for every dollar of revenue – and they don't have sticky annually recurring revenue, because their users have very low switching costs and they cannot build an economic moat. 

On the other hand, true software-as-a-service (SaaS) businesses with favorable unit economics yet still burning cash may actually benefit from WeWork's sudden repricing. Investors may reallocate their capital away from companies promising to hyperscale negative margins and instead look for software companies who establish deep customer relationships by adding value. Investors will increasingly favor startups that have proven they have sustainable growth, which for SaaS means net revenue retention somewhere north of 110 percent. 

In FreightWaves' view, SaaS will be re-priced as the highest quality revenue available in the American economy.

At this point, the particular eccentricities of WeWork have become irrelevant – the goofy mission to elevate the world's consciousness, the copious weed smoking, the hideously mismatched duration risk of long-term liabilities and month-to-month revenue. All that now just seems like the unfortunate but inevitable result of combining Masa's undisciplined valuation strategy with Adam Neumann's own brand of bullshit, potent enough to make goop feel like The Economist by comparison. 

It's vital to remember that nothing changed about WeWork's business operations – the company didn't actually run out of cash or see a material downturn in its ability to attract tenants. No one in the media was really surprised that Adam Neumann may have been high as a kite for a substantial portion of his waking hours. What changed was the mindset and risk tolerance of would-be investors, and ultimately that is of far more consequence than a single failed roadshow.

In FreightWaves' view, startups in the freight tech space should have conversations with their investors and board members about how WeWork will change how the private markets value companies. Startups closer to going public should consider how they market themselves in an era when cash-burning unicorns – especially those operating under a marketplace model – have seemingly fallen out of favor. 

Perhaps it's time to think less about growth-at-all-costs and consider the cost of growth. 

Maybe WeWork will allow a new wave of founders to emerge, a fresh cohort who are less idealistic but more pragmatic. At first, these founders will seem coarse and mercenary when they speak of a metric central to capitalism but almost unsayable in a Silicon Valley pitch deck – profit accruing to shareholders.

Photo by Ajay Suresh via Wikimedia