Scale Up or Cover Up?
The company's premise is to offer an unprecedented degree of flexibility into the work space, underpinned by a technology platform using the latest AI to optimise performance. The opportunity is to participate in a $15M round at a valuation of $97M. The company has been going a couple of years so is past startup stage, generating strong revenues and is ready to scale up.
Now imagine your growing excitement as over the following years the company attracts higher and higher valuations - $440M in 2013, $6.5bn in 2014 (unicorn status firmly achieved), $10bn in 2015 and $17bn in 2016. Would you be tempted to exit at this stage, for over 100X? Or would you want to ride the meteoric rise? Your decision to stay invested seems justified when the 2017 valuation tops £21bn and $32bn a year later. What could possibly go wrong?
One problem is that the company has never generated any profits and is absorbing cash. And the other problem is that valuation is based on blue sky thinking by those still prepared to put money in rather than hard scrutiny by analysts. Put the two together and emperor’s clothes come the mind.
Scale up stage businesses are interesting because received wisdom is that they are de-risked compared to early stage companies. Their product is both built and market proven. Well respected investors – who have surely done the groundwork analysis – are now investing so the company takes on the aura of establishment. And as revenues continue to rise, the risk looks to diminish. Once sufficient customer share is obtained, economies of scale and market domination will deliver profit.
And then it turns out that the company never had a profitable model. They bought growth rather than earned it. The much vaunted technology platform cannot overcome the fundamentals of time and space. The valuations were based more on watching what everyone else was doing rather than concentrating on really understanding the business.
Our imaginary business is of course Wework. It filed for IPO in the late summer, potentially the most valuable tech based unicorn, worth $47bn. Then the IPO was pulled, the CEO departed and the valuation went into free-fall as cash ran out. Softbank is looking to double down on its investment but few believe the business should really be a unicorn at all.
Respected investors and funds have lost money. It’s not even like Theranos – reputedly Silicon Valley’s biggest disaster – where start struck investors were hoodwinked by disregarding the science. With Wework the business fundamentals were easy to understand.
So why have so many invested? The suspicion is perhaps that it was less because real value was being created but more in hope that before the emperor was revealed, someone less clever than you would buy you out.
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