December 9, 2019

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What Lessons Can Investors Learn from SoftBank's Investment in WeWork?

Few investments by venture capital or private equity funds have undergone as much scrutiny as the investment by SoftBank in WeWork.  If you have been reading pretty much any business news source, you are aware that SoftBank made a very large investment (a total of $10.65 billion) with almost half of the total being made at a very high valuation ($47 billion) before WeWork’s proposed initial public offering (IPO), and the IPO failed in the most public and spectacular way possible. While there has been a lot of criticism of WeWork’s business model and its founder, Adam Neumann, there has not been as much focus on the many ways that SoftBank’s investment process could have been better from a legal and business perspective.  Here are a few things investors should take note of in order to avoid some of the pitfalls that befell SoftBank.

  1. Do Your Diligence.  Many reports indicated that SoftBank made its investment decision in a matter of hours at a first meeting based principally on a personal attraction to Neumann.  Investors should never fall in love with an investment idea or a founder.  Objective professional diligence of the business model, projections, corporate structure and management are the basic prerequisites to any investment.

  2. Own the Intellectual Property.  Reports indicated that Neumann retained ownership of the trademark rights to “We” and then attempted to sell them to WeWork for $5.9 million.  Investors should always insist that all intellectual property that is important to a company’s business be owned by the company and not by the founder or some related company.

  3. Avoid Related Party Transactions.  Reports indicated that Neumann owned some of the properties that were in turn leased to WeWork.  Investors should insistd that all related party transactions with the founder are eliminated at the time of funding because those transactions result in leakage of value to the founder without any offsetting value to the investors or other stockholders

  4. Protect the Value of Your Investment.  Reports indicated that SoftBank did not avail itself of “full ratchet” anti-dilution protection on its final pre-IPO investment. When an investor is investing funds at a significant step up in valuation in anticipation of an IPO, it is highly recommended that the investor protect the value of that investment in the event that the IPO (or other subsequent financing) do not support the higher valuation.  SoftBank reportedly included “broad-based weighted average” anti-dilution protection but if one looks at most of the late stage investments in so called “unicorns” the investors oftentimes protected their valuation by including “full ratchet” anti-dilution protection, which requires that the investors get the lower valuation for the full amount of their investment if the company raises money in the IPO or any subsequent round at a lower valuation. 

  5. Don’t Give Founders Unfettered Control.  WeWork reportedly had a multi-class voting structure for the company that gave Neumann’s shares much greater voting power than those sold to the investors –often called “super voting shares”.   Super voting shares have been used in a number of technology companies that have gone public in recent years.  The purpose of the super voting shares is purportedly to allow the company to stick to its mission and not be subject to the whims of the public stockholders.  However, allowing a founder to retain voting control over the company when it is private curtails one of the key powers that investors can use to manage a company – remove a founder or other executives that are not performing up to the standards the investors require.  Investors should carefully consider how much management control they will need to properly guide a company in its business objectives, including a successful exit, either through an IPO or a sale.

Investing in growing companies is not for the faint of heart.  Even successful investors can lose money on their investments.  However, avoiding some of the mistakes highlighted above can help an investor improve its chances of a successful and profitable outcome.

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About this Author

Jeremy D. Glaser, Mintz Levin Law Firm, Securities & Capital Markets Mergers & Acquisitions Venture Capital & Emerging Companies Investment Funds Israel
Member

Jeremy serves as Co-chair of the firm’s Venture Capital & Emerging Companies Practice. Jeremy regularly represents technology-based companies principally in the life sciences, software, mobile applications, and clean energy fields. He represents both issuers and underwriters in a wide variety of securities transactions, including IPOs, secondary offerings, and private placements, and represents venture capital firms, hedge funds and their portfolio companies in venture capital and PIPE financings. He has deep experience representing buyers and sellers in acquisitions and dispositions...

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