Since the initial SEC filing of the We Company (also known as WeWork) IPO in mid-August, lots of articles have been published about WeWork’s/We’s debacle. Many of these focus on who is to blame.
In this opinion piece, David Erickson, a senior fellow and finance lecturer at Wharton, writes that SoftBank and its $100 billion-plus Vision Fund may be a good place to start. SoftBank was significantly involved at both the We Company and Uber — two of the most high-profile private companies in recent years that also both had major issues with the founder’s management and governance. This begs the bigger question whether the Vision Fund has lost its ‘Vision.’
Before retiring from Wall Street in 2013, Erickson worked with hundreds of companies globally on strategic and financing issues. Since joining Wharton’s faculty in 2014, he has co-taught the Strategic Equity Finance course, which explores how private and public companies strategically use equity.
So, who is to blame for the We Company mess? While I don’t think SoftBank deserves all the blame, with their $10+ billion of equity invested in the We Company over the last few years and now with their takeover bid of incremental billions of equity and debt, it appears that SoftBank probably should bear a significant burden.
When the SoftBank Vision Fund was introduced in late 2016, it was heralded as a new paradigm for venture capital investing. With $100 billion to invest, its size roughly equaled what all U.S. venture capital firms combined raised in the previous two and a half years. At the time, it was announced that it would be led by $45 billion from Saudi Arabia’s Public Investment Fund (approximately $17 billion would be in a preferred debt form) and $25 billion from SoftBank, with the objective of investing it over the next five years. By the summer of 2019 (less than three years since the original fund was announced), it was reported that SoftBank was talking to potential investors about a comparably sized $100 billion+ for the Vision 2 Fund.
Since the summer, with some of its biggest public investments such as Uber and Slack not performing well and the mess at WeWork, the SoftBank Vision Fund has been under pressure. So the question is, has it lost its vision? What are the Vision Fund’s potential issues?
Potential Issue #1 – Size
While SoftBank (and its founder, Masayoshi Son) has had many substantial investment successes from Yahoo to, more recently, Alibaba and its acquisition of ARM Holdings, it has also had some setbacks over the years. After the dot-com bubble burst in the early 2000s, Softbank’s stock declined by approximately 98%, and Son thought SoftBank would go bankrupt. However, while Son is a long-term thinker and likes to think in terms of 30-, 100- and 300-year increments, the Vision Fund, the largest private equity fund ever, was believed to be Softbank’s first foray into managing private equity funds for investors.
“Who is to blame for the We Company mess? While I don’t think SoftBank deserves all the blame … it appears that [it] probably should bear a significant burden.”
To put the Vision Fund’s $100 billion size in context, the largest venture capital fund as of last year was the $8 billion targeted by probably the most successful venture capital fund, Sequoia Capital; and the largest private equity fund announced as of two months ago was the venerable Blackstone, with its $26 billion Capital Partners VIII fund.
By early 2019, it was disclosed that Softbank had already deployed approximately 80% of the fund in about two and a half years (approximately half the time that they had originally envisioned). So why the rush to deploy? Could it be related to the fund’s structure?
Potential Issue #2 – Structure
Of the $75 billion from outside (or LP) investors such as Saudi Arabia and Abu Dhabi in the Vision Fund, approximately 40% of each LPs investment is believed to be structured in a preferred instrument where LPs get a 7% annual dividend on invested capital plus a percentage of any positive returns. This is a unique structure in the private equity industry where outside investors expect to receive participation in a fund’s performance but not a guaranteed annual dividend. With more than $80 billion invested, this would mean that the Vision Fund owes a dividend of approximately $1.7 billion on the preferred investment to LPs this year.
While this feature was supposedly designed to increase the appetite of potential investors in the marketing process, the need to pay this substantial annual dividend could impact how the fund is managed. Could it have caused SoftBank to potentially deploy 80% of the Vision Fund’s capital twice as fast as originally expected?
Potential Issue #3 – Management
So whom did SoftBank get to run the massive Vision fund – the largest venture capital fund (by a factor of 10+ times) and the largest private equity fund (by almost 4 times)? Would you believe fixed income derivative bankers from Deutsche Bank with no/limited private equity investing experience? They include Rajeev Misra, a former debt trading boss at Deutsche and Colin Fan, Deutsche’s former co-head of trading. As a matter of fact, of the 12 managing partners listed on the Vision Fund website, at least five (including Fan) are former Deutsche Bank traders. In addition to the 12, Son, Misra, and Ron Fisher, vice chairman of SoftBank Group (as well as SoftBank’s representative on WeWork’s board, at the time of the initial IPO filing) are listed as the “Leadership” of the Vision Fund. So, with this group of 15, how does the Vision Fund make decisions and govern the fund, and how do they avoid conflicts with SoftBank Group?
Potential Issue #4 – “Bench”
While the leadership team is obviously critical to success, a fund’s “bench” of investment professionals, operating partners and support personnel are also very important.
In a late October article in The Wall Street Journal titled, “Softbank Fund Dials Down Risk; Staff Struggles with Chaotic Culture,” written about the Vision Fund, it was suggested that:
“In recent weeks, leaders of the fund’s investment teams have been asked to make lists of their weaker employees, possibly a prelude to small staff cuts, according to these people, who also say the fund has deliberately slowed hiring. Both moves are firsts for the fund. Roughly a dozen investment staff have left on their own since the spring of this year, many unhappy about what they see as a toxic culture with competing teams, inexperienced investment executives, and poor communication, as well as a risky incentive structure that, for some, made it less appealing to be at the fund, people familiar with the structure said.”
Toxic culture, inexperienced investment executives, and poor communication are not characteristics that any company wants to be part of its description. That is especially true in this case, describing the $100 billion Vision Fund, where they also have significant stakes and responsibilities in 88 portfolio companies, as disclosed in early November.
Potential Issue #5 – Strategy
As SoftBank states on its website, “To realize its SoftBank 2.0 vision, the SoftBank Group has been constructing a strategic synergy group by investing in innovative technologies and entrepreneurs that are pioneering the future.” While the largest investments by the Vision Fund (WeWork, Uber, NVIDIA, Flipkart, and 20% of GM’s Cruise) seems to fit with that objective, companies like food delivery platform DoorDash, fitness platform Gympass, and dog walking service Wag seem to be more of a stretch. With $100 billion to deploy with a focus on venture-backed technology companies, it appears that the Vision Fund’s investment strategy targets “unicorn” companies that are backed by premier venture capital firms such as Accel, Andreessen Horowitz, Benchmark and Sequoia.
“Toxic culture, inexperienced investment executives, and poor communication are not characteristics that any company wants to be part of its description.”
One tactic the fund has employed is offer a larger size than the company was looking for and “crowding out” other interested venture firms. In the case of Wag, the company was originally looking for $100 million and SoftBank pushed to invest $300 million, crowding out leading venture firms NEA and Kleiner Perkins.
While these tactics have helped the Vision Fund deploy most of its capital quickly, it might be challenging for them to support their 88 portfolio companies going forward. Son has stated that rescuing WeWork was a one-off situation, suggesting SoftBank won’t be doing that for other portfolio companies. As such, it may be difficult for these companies as the economy slows and the private equity financing markets likely get less receptive. This stands in contrast to other private equity and venture firms who leave a certain amount of their fund’s “powder dry” to support their existing portfolio companies. With over 80% of the fund’s capital already deployed, how will the Vision Fund do this?
Potential Issue #6 – Conflicts
In many cases, both the SoftBank Group and the Vision Fund are invested in the same companies. While some of this overlap predates the Vision Fund (such as ARM), the question is how will they navigate these overlapping situations going forward? While the Group is 25% of the Vision Fund, the balance is held by outside investors. With Group leadership such as Son and Fisher also active in the leadership of Vision Fund, who makes decisions, and how, will have to be governed very carefully.
WeWork – The Intersection of these Potential Issues
This brings us to the challenge with the Vision Fund’s most high-profile investment to date (and not in a positive way as yet), WeWork. In the restructuring of their WeWork investment, many of these issues become apparent.
According to reporting by The Wall Street Journal in late October, as part of its recently announced acquisition of WeWork, SoftBank will own 80% of WeWork with an approximate equity valuation of $8 billion. Pro-forma, SoftBank and the Vision Fund will have invested more than $13 billion of equity as well as $5 billion of debt in the company. In addition, the Group will also make a $500 million loan to WeWork’s founder Adam Neumann and pay him $185 million for a consulting contract. SoftBank Group COO, Marcelo Claure (former CEO of Sprint), will replace Neumann as Executive Chairman of WeWork.
“With private equity financing market conditions seeming to get more difficult as the economy slows, it feels like it will be even more important for the Vision Fund to streamline its governance for future decisions.”
As announced in early November, Son said that SoftBank and the Vision Fund wrote down their WeWork’s investments by $4.7 billion and $3.5 billion respectively.
This restructuring transaction and the subsequent disclosure highlight some of the potential issues:
- Who (i.e., at both Group and the Vision Fund) was part of the decision to acquire WeWork?
- How was the decision made to invest the incremental $3 billion of equity, on top of the more than $9 billion of equity already invested, at an approximate equity valuation of $8 billion; and extend a $5 billion loan to the company (assuming that the loan came from the Group)?
- With all 12 managing partners of the Vision Fund available, why was the COO of the Group named executive chairman of the We Company to drive the restructuring?
- If the priorities of the Group and the Vision Fund diverge on their WeWork investment (especially if operating conditions/the economy worsens), how will this be navigated?
What Can the Vision Fund Do to Regain Its ‘Vision’?
Here are a few things they should do:
- Restructure its managing partner group – When you look at the top private equity and venture capital firms, some have a group of four to five managing partners that lead their respective firms; but in most/all of these cases, these partners have worked together for a long time (i.e., multiple investment cycles). I am not sure how the Vision Fund will make decisions with a 12-person managing partner group, especially when many don’t have much private equity investing experience. With the private equity financing market conditions seeming to get more difficult as the economy slows, it feels like it will be even more important for the Vision Fund to streamline its governance for future decisions.
- Get more “hands on” with some of its higher risk/bigger investment portfolio companies – One recent example is the Vision Fund led a $385 million round for short-term car leasing company, Fair, last December. According to Business Insider, the company burned through almost $400 million in the last 10 months. In the last month, in the wake of the WeWork debacle, SoftBank stepped in and replaced the CEO with a SoftBank insider. This supposedly is the first time SoftBank has done that. Identifying which of these companies need more help should probably be “Job One” for the 12 managing partners; and engaging and working with the right team members from the “bench” on these situations should be “Job Two.”
- Get more seasoned executives with “domain expertise” to assist portfolio companies – While Marcelo Claure has been a successful telecom executive and did a good job of restructuring Sprint, leading the restructuring of a high-growth We Company is much different than getting a slow-growth Sprint ready for sale. If SoftBank is willing to pay Adam Neumann $185 million for a consulting contract on WeWork, how much would they be willing to pay a seasoned and successful real estate investor like Sam Zell or Barry Sternlicht for their advice? Unfortunately, while Messrs. Zell and Sternlicht are probably not interested, it might be worth a call. In addition, other seasoned entrepreneurs who have weathered different cycles should be brought on board to advise their portfolio companies.
The Vision Fund’s situation today reminds me of Sequoia Capital’s famous presentation that they gave to their portfolio companies in 2008 to get ready for more difficult times. While I am not suggesting that we are anywhere near the situation of 2008, the bullish cycle we have enjoyed for the last several years seems to be getting long in the tooth. The Vision Fund needs to restore its “vision” soon to survive and thrive over the longer term.