The appeal of the company mission
As a millennial, I grew up during the tech era and social media “boom.” Facebook was born in Mark Zuckerberg’s Harvard dorm room in 2004, a story now made famous by the 2010 movie “Social Network.” The first Apple iPhone was launched to market in 2007, after the massive success of the iPod in the half dozen years prior. Uber launched in 2009 as an alternative to expensive and inefficient taxicab options, paired with new technology that made it possible to summon transportation from a cell phone. These companies have changed the way people relate to each other and the world around them.
Growing up in a digital age, the pull of working for the next successful startup has an appeal to many millennials that does not necessarily resonate with prior generations. This is understandable, and something I certainly felt during past job searches. Unfortunately, I never learned to write software code (“One day,” I continually tell myself). Employees of all ages, skill sets, and backgrounds want to feel invested in their company’s mission and know where their efforts fit into the success of that mission. I believe this is amplified for my generation. The issue that this post attempts to explore is what happens when that alluring startup does not turn out to be the next IPO and revolutionary success story as expected.
The background and warning signs of WeWork
WeWork is a startup, founded in 2010, focused on providing shared office and workspace to entrepreneurs and small, growing companies. CEO Adam Neumann’s stated goal in founding it was to replicate the sense of solidarity and community he felt growing up in Israel. This is expressed in the layout and amenities often offered within WeWork locations. The company grew at an explosive pace and by 2019, had expanded to 30+ countries, employed thousands of employees, and was prepared to launch an initial public offering (IPO). However, In the span of months, WeWork went from a lofty $47 billion valuation, to having to shelve their IPO after analysts tore apart the initial S-1 disclosure documents. Softbank, the company’s largest equity investor, bailed the company out with an investment that implied a valuation of roughly $7 billion on 10/22/19. While no one is shedding a tear for WeWork executives and much has been written about the lack of profitability (not just revenue) potential of companies like it, an overlooked piece to the story is the thousands of people employed by WeWork.
RSUs vs. stock options
One of the major risk/reward tradeoffs made by many WeWork employees was accepting a lower salary in return for an equity stake in the company’s future success. This stake can come in a variety of forms but is most commonly paid as stock options or restricted stock units (RSUs) of the company. Both are valued based upon the difference between the exercise or strike price of the option and the market price of the underlying security. Of the two, RSUs are the more favorable and valuable to an employee. This is because RSUs are actual company shares, and though subject to a vesting period, are typically always worth something. Also, they do not require an employee to put up his/her own money to purchase them. Stock options, on the other hand, can be quite valuable but subject the employee to more risk and are commonly purchased with cash or collateral. Employers like WeWork know this, and compensation packages for employees are typically heavily weighted toward stock options as a result.
Golden parachute vs. worthless options
After the much-needed mid-October cash infusion from the company’s largest investor, Softbank, WeWork laid off 2,400 employees, representing almost 20% of its workforce. Turnover is common enough for young startup companies and is often an unavoidable risk in those environments, but even if you were fortunate enough to keep your job, your finances likely took a hit when, as a result of Softbank’s bailout and far lower valuation, an estimated ~80-90% of stock options held by employees became worthless! All of this while co-founder Adam Neumann received a deal worth ~$1.7 billion in exchange for relinquished control, consisting of a $1 billion purchase of his stock, a $185 million consulting fee, and $500 million loan to repay outstanding credit lines he held.
Our goal is not to indict the market environment that facilitated WeWork’s rise, though some amount of criticism is naturally warranted. Rather, we hope to caution employees and equity investors alike of the potential risks that need to be navigated.
Lessons for employees and investors
1. With the potential for high reward comes high risk
For every Apple, Amazon, and Google, there will be the Ubers, Lyfts, and WeWorks of the world, along with thousands of failed startups you’ve never heard of. The success of the former companies is inexorably linked to the risks their founders, management, and early employees took and accepted. There is nothing wrong with this but be aware of the risks should the business falter.
2. Beware of concentration risk and try to mitigate it
A natural consequence of being heavily compensated in employer stock or options is that a large amount of your net worth will likely be tied up and driven by the success or failure of your employer. This can be a great thing – think of Steve Jobs and the thousands of Apple employee millionaires created by his innovation.
It can also go horribly wrong. The failure of Pets.com in 2000 is one prominent example resulting from the early 2000s tech boom. Other examples such as Blockbuster and Lehman Brothers (decidedly not startups) loom large as well.
A common strategy for non-C-suite level employees and founders alike is to await an IPO to cash in on their company equity. The lesson here is that such a strategy has risks. For lower level employees, exercising their options sooner rather than later could be prudent.
3. Liquidity and an emergency fund are critical
What is an employee to do if they knowingly accept the risks described in #1 and #2? Maintaining enough liquidity and an emergency fund of at least 9-12 months of non-discretionary living expenses becomes critical. In ordinary circumstances, we’d typically recommend maintaining 3-6 months of non-discretionary living expenses but given the more volatile nature of employment at a startup and the fickle nature of private valuation, building a larger safety net should be a priority.
Clearly the rise and fall of WeWork has given us all much to consider and reinforces the importance of building a solid financial foundation.