In May 2017, the Tokyo-based telecom company, SoftBank, launched its Vision Fund. Unique in its nature, this fund was able to raise $100 billion to be used to invest in technology startups.
For comparison’s sake, the sum of all American venture capital deals closed in 2017 amounted to $84.2 billion. Despite its success, the Vision Fund’s aggressive investment techniques caused massive inflation in the valuations of startups, particularly with its’ most popular investment, WeWork, and has negatively impacted the future of investments into startups.
SoftBank Investment Strategy: Industry Impact
Most funds tend to follow a similar investment strategy to achieve a high rate of return: identify potentially successful startups and invest to ensure a highly diversified portfolio. However, due to the vast amounts of capital at its disposal, the Vision Fund was able to alter this widely known strategy in their favour.
The sheer size of the fund enabled the Vision Fund to pump money into startups without performing proper due diligence. From their perspective, the number of their investments was more significant than the identifiable stability, success, and accurate valuation of a startup. Quantity over quality. As long as one of their investments managed to obtain a high valuation post-IPO, the venture fund would generate returns.
As an example, in January 2018, the Vision Fund invested in a dog-walking app called Wag. According to Techcrunch, at the time there were a handful of other investors interested. However, all of them dropped out after SoftBank invested over $300 million. At the time, Wags had raised $191.5 million over the course of five funding rounds. Softbank had pushed out competing venture funds through the sheer size of their funding offer. The Vision Fund’s investment into Wag only represented 0.3% of its portfolio, demonstrating that the loss of this investment would be insignificant. On the other hand, this immediate raise in capital resulted in one of Wag’s competitors, being forced to instantaneously raise $125 million, which it would not have had to do otherwise.
The Vision Fund’s large inflow of capital within the sector caused a shift in priorities within the competitive landscape. With a large disparity of capital among competitors, product innovation took a backseat to the pursuit of funding. Success was no longer dependent on a business’ strategy, or its product quality, but instead on a firm’s access to capital.
SoftBank’s intent behind this capital-heavy investment was to drive out competitors and establish a monopoly in the dog-walking industry. Unfortunately for SoftBank, Wag has been experiencing a number of issues including: maintaining a strong client base, and developing effective customer service. The company serves as an example of the flaws that arise with attempting to hijack an industry with nothing but the use of a chequebook.
In addition to the impact the Vision Fund has had on the dog-walking industry, it has also had a larger scale impact on the entire technology startup landscape, with a recent example being WeWork.
Case Study: WeWork
Vision Fund’s investment strategy has been flawed due to the faulty due diligence taken towards the actual startups it invests in. A clear example of this is displayed by SoftBank’s most popular investment, WeWork, an office space leasing company that was worth close to $47 billion in September, and is now worth about $12 billion.
During the due diligence process, the fund’s analysts ignored numerous red flags about its management, especially surrounding Adam Neumann, the co-founder and former CEO of WeWork.
This massive collapse in WeWork’s value was brought on by a myriad of problems within WeWork’s business, starting with the foundation set by the eccentric ex-CEO. One example of Neumann’s contributory behaviour to the downfall of WeWork is demonstrated by his comment, “I need to have the biggest valuation I can, because when countries are shooting at each other, I want them to come to me.”
Along with developing his business on a fundamentally flawed vision that glorifies high valuation over effective business tactics, Neumann consistently engaged in questionable behaviour. The most notable instance of this is shown by his choice to trademark the word “we,” followed by changing WeWork’s name to “We Company”, and pay himself close to $6 million for the company’s name change. Fortunately, after criticism, Neumann was forced to pay back the money. Neumann’s unusual decision making was made known to the public at the launch of WeWork’s IPO, but known by early-stage investors beforehand.
WeWork also faced publicised criticisms on their accounting policies, which is often an issue with startups pre and post-IPO. Any company in the US that wants to open its company to outside investors must follow Generally Accepted Accounting Principles (GAAP). However, if a company is private, or pre-IPO, this is not the case. In the case of WeWork, Alison Griswold of Quartz states, “WeWork devised to measure net income before not only interest, taxes, depreciation, and amortization, but also ‘building-and community-level operating expenses,’ a category that includes rent and tenancy expenses, utilities, internet, the salaries of building staff, and the cost of building amenities.” While disclosing to bond investors, WeWork reported their “community-adjusted EBITDA” to be positive $233 million, while earnings would conventionally be reported at negative $769 million. This allowed WeWork to escape early scrutiny as it was projecting early profitability by using “creative accounting.”
These red flags were overlooked by the Vision Fund. When conversations between Masayoshi Son, the head of SoftBank, and WeWork CEO Adam Neumann began, both of their intentions were vividly displayed by an initial conversation. According to Forbes, Masayoshi tells Neumann “not to be proud that WeWork is growing organically without a large sales force or spending big marketing dollars.” He says to make WeWork, “ten times bigger than the original plan,” and clearly states he believes the company can be worth a few hundred billion dollars. The combination of Adam Neumann’s eccentricities and the deluded support of Masayoshi’s funding offers are direct causes for the failure of WeWork as a startup.
Impact of SoftBank’s Vision Fund
Vision Fund’s investments into Wag and WeWork are clear examples of the capital-heavy fund’s tendency to neglect traditional funding strategies in the technology startup landscape. WeWork is currently being investigated by the Securities and Exchange Commission for possible violations of its rules. Similarly, the Vision Fund is attempting to sell back their initial investment in Wag. As a result, the fund has created doubt about whether or not many well-known startup businesses deserve their high valuations.
As venture capital becomes more and more popular as a means through which technology startups raise funds, venture capital firms should be placed under greater scrutiny, whether in startup valuation, or in the accompanying due diligence practices performed during the investment process.
- 1Osterland, A. (2018, May 24). WeWork Works Bond Market Despite Unusual Accounting Practices. Retrieved from https://www.gfmag.com/topics/blogs/wework-works-bond-market-despite-unusual-accounting-practices
- 2Geron, T. (2019, April 25). Since Receiving SoftBank's $300 Million Check, Wag Has Gained Little Ground. Retrieved from https://www.wsj.com/articles/since-receiving-softbanks-300-million-check-wag-has-gained-little-ground-11556232359
- 3The We Company Form S-1. (2019, August 14). Retrieved from https://www.sec.gov/Archives/edgar/data/1533523/000119312519220499/d781982ds1.html
- 4O'Kane, S. (2019, September 24). WeWork CEO Adam Neumann is stepping down. Retrieved from https://www.theverge.com/2019/9/24/20882034/wework-ceo-adam-neumann-
- 5Chandler, Nathan. How 5G Works. HowStuffWorks, 29 June 2017, electronics.howstuffworks.com/5g.html
- 6Cisco Visual Networking Index: Global Mobile Data Traffic Forecast Update, 2017?2022 White Paper. (n.d.). Retrieved from https://www.cisco.com/c/en/us/solutions/collateral/service-provider/visual-networking-index-vni/white-paper-c11-738429.html
- 7Winck, B. (2019, October 2). The IPO market is rebelling against many of 2019's money-losing unicorns. Here's what's scaring investors away - and what it means for the future. | Markets Insider. Retrieved from https://markets.businessinsider.com/news/stocks/ipo-market-outlook-trends-why-investors-rebelling-against-unicorns-implications-2019-9-1028570687
- 8Eaglesham, J., & Brown, E. (2019, October 7). WeWork Investors Turned Off by 'Sloppy' IPO Filings. Retrieved from https://www.wsj.com/articles/wework-investors-turned-off-by-sloppy-ipo-filings-11570440674
- 9Mohamed, T. (2019, October 7). WeWork is hitting the brakes after its IPO went up in smoke - and landlords could pay the price. Retrieved from https://markets.businessinsider.com/news/stocks/wework-slows-growth-after-ipo-flop-landlords-rents-could-suffer-2019-10-1028580464
- 10Primack, D. (2019, October 8). Why SoftBank Vision Fund is one of the most complex private equity funds ever raised. Retrieved from https://www.axios.com/softbank-vision-fund-complicated-future-0c89673d-7850-47de-8a52-cb49a12cbfc3.html
- 11Marinova, P. (2019, October 9). SoftBank's Risk-Loving Masayoshi Son Now Tells Founders to 'Know Your Limit'. Retrieved from https://fortune.com/2019/10/07/term-sheet-monday-october-7/