WeWork Adds to Venture Capital’s High-Profile Bankruptcy Busts

WeWork’s Chapter 11 filing adds to a growing list of venture-capital favorites that have gone bankrupt, giving investment firms a fresh reason to more thoroughly vet companies before pouring money into them.

WeWork’s downfall follows other major VC-backed failures, including those of FTX, BlockFi Inc. and Vice Media LLC. Those setbacks will spur venture capital firms to take more time for due diligence before investing, some observers say.

“Theranos, FTX, now WeWork have made VCs realize that they need to be careful to not get distracted by an audacious founder with an audacious story,” Erik Gordon, a professor at the University of Michigan’s Ross School of Business, said.

Though its bankruptcy follows a plummet in in-office work during the Covid-19 pandemic, the company’s failure is a sign backers didn’t fully evaluate their investments, people watching the company’s bankruptcy say.

Now, WeWork’s venture capital backers have low priority in the bankruptcy. The company’s first appearance in bankruptcy court kicked off Wednesday.

“It’s a failure. They’re equity,” Joe Acosta, a bankruptcy partner at Dorsey & Whitney LLP said. “Equity loses in these situations because there’s also debt that these companies take on. They had a high return in mind and they’re lucky if they’re getting pennies returned on the dollar, if that.”

Investors were willing to take on risk in pursuit of profit, and put their confidence and their money on Adam Neumann, WeWork’s charismatic founder. In doing so, investors overlooked weaknesses in WeWork’s underlying business.

“These big, huge funds, they might not have done all the necessary due diligence and thought through the strategy,” Gordon Phillips, a finance professor at Dartmouth College’s Tuck School of Business said.

Much of the investment in WeWork was based on “aggressive assumptions,” Phillips said. Large firms like Softbank Group Corp. had a lot of money to invest and were willing to take risks, he said.

Venture capital firms are less likely to thoroughly vet a deal during boom cycles when they are flush with cash or if they are competing with other firms to invest, Robert Siegel, a lecturer in management at Stanford Business School, said.

Venture capital has an “unrelenting drive to build something, to change something,” Siegel, a venture partner at Piva Capital and general partner at XSeed Capital, said. “That gets rewarded, and we have to remember the venture capital is a game of humongous wins.”

That appetite for risk is already changing as VCs face mounting criticism for their failures, Phillips said.

“At least for a while, people will do more significant due diligence going forward,” he said.

WeWork received major funding from venture capital powers including SoftBank and Benchmark Capital, which helped the company surge. SoftBank has since adopted stricter due diligence.

But that backing overlooked several factors, among them that the company was overpaying for the office space it was leasing to its customers, Phillips said.

FTX, which filed for Chapter 11 protection last year, had significant backing from Sequoia Capital and others, which have been criticized for not doing adequate due diligence. Sequoia, Thoma Bravo and Paradigm face a lawsuit that accuses them of improperly hyping FTX.

‘MTV of Office Share’

Though there were other office-share companies before WeWork, the New York-based firm made the concept popular, Acosta said.

“WeWork was the MTV of office share,” he said.

Neumann, the company’s founder, was a hit in Silicon Valley and an effective fundraiser. Venture capital piled in.

“All of a sudden venture capital said, ‘Oh, we should get on board, we can make a lot of money here,’” Acosta said.

Private equity investment in WeWork was part of a broader hype cycle, where firms bet big in pursuit a big payday, not unlike the dot-com bubble around the turn of the century, said Jonathan Shenson, a bankruptcy partner at Greenberg Glusker. When things were going poorly for WeWork, SoftBank bailed it out instead of walking away, he said.

“I think they just got sold,” Shenson said about WeWork’s venture capital investors.

There are similarities between FTX and WeWork, Gordon said. In Neumann and Sam Bankman-Fried, both firms had “weird founders,” the kind of charismatic outside-the-box thinkers that appeal to venture capital’s desire to pick a big winner, he said.

“They paid too much attention to the story Neumann told them and too little attention to the economics of the business model,” Gordon, who teaches classes on venture capital, said.

Siegel said it’s unlikely venture firms will change their behavior after WeWork’s downfall, or from FTX, which were “things that had incredible hype and then came crashing down.”

That’s nothing new for investors, Siegel, said.

“We’ve seen this in the past and it didn’t change,” he said. “What makes you think it’s going to change in the future?”

The case is WeWork Inc., Bankr. D.N.J., No. 23-19865, 11/6/23.