WeWork is not going to rise from the dead
Its capital structure was always bad
Note: this post is a departure from our standard AI-related fare. I am working on a follow up to my recent post about AI and entertainment, which I hope to have out this weekend.
There’s a lot of founder worship to be had on Twitter, especially among venture capitalists. And yesterday I saw rumors flying around that Adam Neumann was agitating to rescue WeWork from its bankruptcy proceedings. There’s a certain logic at work here which appeals to the venture capitalist mindset: the founder as savior. Only a founder, this line of thinking goes, has the vision to extricate a failing company from the maw of bankruptcy lawyers and creditors. Only a founder can grow WeWork into the global, multi-billion dollar real estate disruptor that is its right.
The logic is appealing, but it is also fatally flawed. Let me explain. WeWork was never going to be a sustainable business because the way cash flowed through its business never made sense. WeWork’s model1 was the following:
Sign long-term leases from office landlords
Sign short-term sub-leases to startups and other small companies
We have here an asset-liability mismatch2. To understand this we need to understand a little bit of accounting. The long-term leases that WeWork signed with office landlords sit on its balance sheet as long-term liabilities. The sub-leases that WeWork signed with startups and small companies sit on its balance sheet as assets. Despite the word “lease” in “sub-lease,” a sub-lease is, from WeWork’s perspective, an asset, since WeWork generates cash from those sub-leases. In other words when a startup signs a sub-lease with WeWork, WeWork will receive cash payments (rental payments) from the startup. Those rental payments, aggregated together, need to be greater than the lease payments that WeWork pays to the landlords from which it leases offices. If rental payments are not greater than lease payments, then WeWork needs an alternate source of cash, namely, from investors.
That is, WeWork’s model required that short-term assets finance long-term liabilities. When demand for offices is high and interest rates are low, this gap can be papered over by a steady supply of new sub-lessors and low interest rates. However, and critically, neither of these two things obtains today: demand for offices is in general lower than it has been in the past, and interest rates are high.
The bottom line here is plain: no founder can resurrect WeWork from the dead, given its capital structure.
Now, I have spoken with some real estate people on Twitter about WeWork’s capital structure problems, and they argue that had WeWork owned the real estate it leased out to startups, it would have had a much different result. Perhaps this is true. I am not a real estate expert, so on this question I’ll defer to other people. However, even if this is true, there is nothing about WeWork’s bankruptcy proceeding which will convey to it ownership of the office buildings it leased from office landlords.
Maybe a WeWork 2.0 with a better capital structure can arise from Neumann’s will. But that’s a bet on accounting and finance knowledge, not on some ineffable notion about founders.
This is admittedly somewhat simplified. WeWork made moves to generate cash in other ways, in part to overcome this asset-liability mismatch, but clearly, given its bankrutpcy filing, these efforts were insufficient.
Incidentally, this mismatch is the same thing that felled Silicon Valley Bank.