The Rise of The Cash Man
A Case Study On The Venture Process
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I think it will surprise no one to find that the best place to start writing about a venture-backed Adam Neumann fever dream is with Disneyland. 😉
While Walt Disney gets credit for doing a lot of different things, one of the most significant undertakings he pursued was building the City of the Future. But the EPCOT (Experimental Prototype Community of Tomorrow) of today is a shadow of what Walt Disney envisioned it to be. A city with layers of living and transportation like nothing we have in any city today.
I've been obsessed with the space-making that Walt Disney built into all his parks since the first time I went to Disneyland. For me, it wasn't the rides or the churros or the characters that got to me. I had an emotional reaction to the space I was in. Walking down Main Street in Disneyland felt like a spiritual experience for me.
Ever since then I've thought often about city building, urban planning, and I’ll read books like Walt Disney and the Promise of Progress City. And Walt Disney wasn't alone. There is something primal about the desire to build the optimal living space. The ideal ecosystem for humans to have community, convenience, and culture that very few cities have been able to nail.
Whether it's Marc Lore building a utopia or Bill Gates building in Arizona. The Saudi Arabian government building a Line in the desert or India trying to retrofit 100 smart cities. A lot of people have this desire to build the optimal living space. And Adam Neumann happens to be the latest one.
And honestly? That's not a surprising vision for what he would try to do next (dramatically less surprising than a blockchain-powered carbon market). Neumann grew up on a kibbutz as a child, an intentional community in Israel. He talked about it often as his inspiration for WeWork and how that expanded his vision into WeLive and WeLearn.
Now? Rather than starting at Work and taking it Home, he's going right to the Home.
The Hot Takes
In case you have no idea what I'm talking about (and if so, bless your soul) Adam Neumann raised $350M from a16z at "over a billion dollar valuation" for his new residential real estate company Flow. And all of this is not just pre-launch, but "before it even commences operations." This also happens to be a16z's largest single check.
Almost immediately the memes and hot takes started rolling in.
But this isn't just a crazy meme story. This is an important opportunity to have a lot of different conversations. It is for moments like these that I appreciate being on Twitter because it gets me out of my echo chamber and exposes me to a lot of different perspectives from both bulls and bears. So what were the most common discussion topics?
"Why does Adam Neumann get to fail up?"
Everyone should read Mandela’s thread. A lot of people rightfully pointed out that in a world where 93%+ of venture dollars go to white men it can feel like a "slap to the face" to those underfunded groups when someone like Adam, who lit $20B on fire, gets a second go at it at such a scale. Does that actually feel like an appropriate allocation of capital?
"This is just going to make the housing shortage worse."
$60B of real estate has gotten snapped up by big PE firms turning everyday people into "perpetual renters." They're pitching Flow as a salve for the housing crisis, but that feels like a stretch. Neumann's existing real estate holdings aren't exactly affordable housing:
"While offering people the ability to gain some sort of equity stake in their apartments could help people build wealth, Flow’s rentals are probably for those who are already relatively rich. The Nashville property Neumann bought, for instance, features a saltwater pool, valet trash pickup, and a dog park."
As a result it starts to feel like more of the same. Big corporate real estate owners who are more focused on squeezing profit from wealthy tenants vs. making an actual dent in solving the imbalance between housing supply and demand.
"This is a fundamental misunderstanding of the residential real estate market"
I love following real estate Twitter (ReTwit) because it keeps me grounded as a VC. What those folks do is very difficult, messy, and gets very little pomp and circumstance. There were a lot of takes from exceptional real estate investors. The best summary I saw was from Moses Kagan; effectively saying “this is hard. And if you try and make it not hard? Then you make it bad."
In the words of an anonymous twitter account (who is both very funny and very grumpy):
"If you want to understand why property management is a tough business go do unit walks for a 300-unit property, and spend two or three days hanging out in the on-site office. I guarantee no one investing in Flow ever did that."
"Marc Andreessen is a hypocrite"
Recently Marc Andreessen came under fire for strongly opposing the building of housing in his hometown of Atherton. One of the biggest causes that exacerbates the housing shortage is wealthy people not wanting more homes to be built in the places people most want to live.
"This is a $350M marketing expense"
Eric Newcomer's take on the bet for a16z as a firm was one of the best articulated in terms of strategic advantage:
"This whole saga has been great strategic positioning for the firm. What Andreessen Horowitz has always understood better than anyone else is that the main audience for their marketing is founders. So even if the masses find investing in Neumann distasteful, this sends a clear message to prospective founders that a16z wants to back the bold. And founders are the ones who can generate the billions in returns for Andreessen Horowitz that the firm needs to be successful."
He even points to one black eye that a16z has in their experience with Parker Conrad when they invested in Zenefits:
"In fact, one of the most compelling Silicon Valley redemption arcs has involved a former Andreessen Horowitz founder. The firm ousted Parker Conrad from Zenefits only to watch Kleiner Perkins, Founders Fund, and Sequoia Capital invest in Conrad’s subsequent company, Rippling. Valued at $11.25 billion in May, Rippling is worth more than Zenefits ever was."
Backing someone like Adam Neumann is no better counter example to what happened with Parker Conrad. The ultimate marketing campaign to reinforce how "founder friendly" they are... whatever that means in this scenario.
"He built a multi-billion dollar business before, didn't he? He can do it again!"
This was my least favorite take. Trying to brush aside WeWorks implosion as "so it didn't work out," is a disservice to the colossal Greek tragedy that it is. They don't make TV dramas about casual startup wind downs. A better framework for evaluating what WeWork was is through the lens of their economic engine.
Some numbers. WeWork raised $12B+ in equity and $9B+ in debt. Over $20B went into that "economic engine." Guess how much is left. $600M. They have $600M in cash on the balance sheet today. So what kind of output came from that $20B input? A business that is (1) declining in revenue growth (dropping from $3.4B to $2.5B in revenue during 2021), and (2) is still to this day losing $4.4B to generate that $2.5B in revenue.*
If you give me $100M and I go pay people $2 to give me $1 in revenue I'd go from $0 to $50M in revenue real quick. Everett Randle at Founders Fund said it even better:
Disclaimers, Caveats, and Concessions
I want to throw out an important level setting: Do I believe that Adam Neumann can build a multi-modal real estate empire that revolutionizes the way we live? No. Would I have invested $350M with the guy who lit $20B on fire? No. Do I believe the investment case I’m about to lay out? No. So why write about this? I think the story and the numbers represent a fascinating opportunity to illustrate "the venture process." There are people who write off venture as largely a "greater fool's" game of passing the bag. There are other people who ask the honest question, "how does something like this happen?" I want to try and help answer that question.
I'm not going to address every aspect and controversy surrounding Adam Neumann, WeWork, and Flow. And I'm certainly not a bull on this investment. I've never found myself typing "Say what you will about..." so many times. I found myself using it over and over again.
"Say what you will about Adam Neumann, but he loves those amenities."
"Say what you will about Adam Neumann, but the man knows how to drive splashy marketing."
Instead I want this to be a case study to walk through how a lot of VCs think. Is the thinking right? Are they making the right decisions? Are they weighing the right variables? Unclear. Time will tell. But this is likely the structure for how some of this process is being justified.
What Are They Thinking?
I don't think I need to defend them much, but it's important to start from a point in saying that the folks at a16z aren't idiots. Far from it. They've been quite successful at investing in generational companies.
So what might the decision making process look like in deciding to give $350M to Adam Neumann?
Granted, there are a lot of aspects I won't touch on. The marketing, the founder support, the "chips on shoulders" mentality of picking a founder to back. All of that is core to a16z's process but none of it am I going to really address.
One VC put it this way:
"I'm not surprised in the slightest. This is squarely in Marc's thesis of investing in repeat founders, especially ones who have a chip on their shoulder and something to prove."
There are lots of bold and optimistic reasons that a16z would make a bet like this. I don’t have qualms with any of those. As VCs you have to constantly be optimistically defying gravity and reality. Because most of the great companies that have gotten built up were completely non-sensical before they became completely obvious.
In fact at large personality-led firms there is often an emotional or high-level reason for doing a deal (e.g. "Marc Andreessen is the boss aka the 'Personality'. He thinks this person is a killer. We're doing the deal. Make the numbers work.") There's an ocean of psychology to unpack in that dynamic. But instead I'm focusing on the process that the other people at the firm go through. How do they "make the numbers work?"
Step One: The Vision
A friend of mine described Adam Neumann as having "golden lips." Right off that bat that phrase feels yucky, but it's undeniable. The guy raised $12B+ and proceeded to light it on fire, and now he's back at it again! I'm gonna go out on a limb and imagine he's a pretty good storyteller.
So... what is Flow? What is Neumann pitching? Here's how a16z puts it:
"Make no mistake, this kind of mission is a heavy lift. Only through a seismic shift in the way industry relationships are structured and the mechanisms through which value is delivered can we hope to address the underlying problems of the current system and build the solution. Doing this requires combining community-driven, experience-centric service with the latest technology in a way that has never been done before to create a system where renters receive the benefits of owners. This means rethinking the entire value chain, from the way buildings are purchased and owned to the way residents interact with their buildings to the way value is distributed among stakeholders. And given the fragmented nature of the ecosystem today, we can only hope to accomplish any of this by bringing every aspect of the living experience together."
A less wordy way of summarizing what is likely getting pitched as the vision for Flow?
“Arpit Gupta, a real estate expert and professor of finance at NYU’s business school, surmises that Flow might try to combine a number of existing things and market them into one. Those include timeshares (flexibility!), co-ops (equity!), layaway financing (access and equity!), and luxury buildings in trendy areas (well-heeled millennials). Perhaps, Flow wants to offer short-term apartments with company-provided financing where you could grow your ownership stake the longer you live there."
So how might you make the investment case for some of those things? And how might the a16z team answer the question, "how do we work this into our model?"
Residential Real Estate Holding Company
According to the New York Times, "Neumann has purchased more than 3,000 apartment units in Miami, Fort Lauderdale, Atlanta and Nashville. Flow will operate the properties Neumann has bought and also offer its services to new developments and other third parties."
That's about the only tangible information we know about Flow. That portfolio of Neumann's properties alone is worth nearly $1B. In the words of another anonymous twitter account, "I bet Andreessen got some protection or equity through his owned assets." As a result of that kind of possible asset-backed equity arrangement you can start to see Flow building up its own property portfolio over time.
What's ironic about this "assets owned by Neumann but managed by his company" dynamic is its exactly one of the things that partially led to WeWork's implosion. When they filed the S-1 we found out things like Adam Neumann trademarked "The We Company" and then had the company pay him $6M for the privilege of using it.
So why wait for the S-1? Be up-front about the conflict of interest.
How do we work this into our model? As anxious as a balance sheet makes most VCs the idea of owning assets can be reassuring here. Worst case scenario you're not just underwater on a ton of leases (ala WeWork). That's assuming you can build any equity in those assets...
Property Management Services
The second piece of that offering in addition to managing Neumann's properties they'll "also offer its services to new developments and other third parties." Often times property management services grow out of first managing owned properties, getting good at the management piece, and then scaling that to non-owned properties.
How do we work this into our model? The idea here is (1) we get good at doing something (e.g. building an office) and then (2) we scale it more quickly by doing it for other people who will pay the big bills. Take a page out of WeWork's attempted ancillary businesses. They started designing offices for other companies. If you get good at property management then you can do it for other property owners.
Subscription Service For Community Experience
In praising Neumann, a16z put it this way:
"Adam is a visionary leader who revolutionized the second largest asset class in the world — commercial real estate — by bringing community and brand to an industry in which neither existed before."
Say what you will about Adam Neumann, but he loves his amenities. The exorbitant spending at WeWork, on everything from a wave pool to endless kombucha, is still haunting the company in the public markets as they try to be as creative as possible in limiting operating expenses.
In 2016 when describing WeLive he painted the picture of the living experience:
“It’s going to be a new way of living, day to day, week to week, month to month, year to year. You will be a global citizen of the world. If you’re a member of one, you’re a member of all of them… This is more like a private club that anyone can join.”
As far as I can tell this feels just as descriptive of what he's trying to create with Flow, "creating a branded product with consistent service and community features."
How do we work this into our model? People love subscription businesses. If we can prove that "subscribing" to a community is even stickier than paying rent, that's worth a higher revenue multiple... probably.
Most of the time a tech-enabled business that pitches their use of "cutting edge technology" is often (1) a better UI, and (2) collecting user data. Yet another page out of WeWork's ancillary attempts at a business model, they touted a data-driven advantage. For the most part that data primarily surfaced insights like "people like sitting by windows."
How do we work this into our model? Tenant data can extend all the way from rental applications to living preferences and beyond. Imagine if every aspect of your living experience was monetizable. Any amenity you identify from "tenant data" can immediately be serviced by the highest bidder.
And Then Some
Crypto wallet? Rent-to-own? Yes, and more. There are plenty of ancillary things that, if they work, can be a meaningful part of the company's future revenue profile.
Some of these "other things that could be meaningful" remind me of Neumann's early pitches of WeLive as a meaningful part of WeWork's business. In 2015 when WeWork was worth $10B (it's worth $4B now) Neumann expected WeLive to generate over $600M of revenue by 2018 (narrator: "it didn't.")
Step Two: The Comps
So you've pulled on all these threads. There's a business model in there somewhere, so what would that eventual amalgamation of parts and products look like? And more importantly, what could it trade for? What are some of the comps?
Holding Company: MidWestOne, Towne (mortgage banks), Mid-American Apartment Communities
Property Management: AppFolio (property management software)
Subscription Community: Q&K International (branded apartments)
Data Business: CoStar (multi-family data company)
Mix in some crypto exposure and you've got a very option-heavy vehicle. Arpit Gupta was right to describe it as probably a combination of any number of existing things that you can then market as one and justify a tech company valuation.
You throw some of those together in a comp sheet and what's the average multiple? 6x forward revenue? Right now that’s feeling like a perfectly good tech multiple. We'll take it.
Disclaimer: I’m not a real estate investor and I was holding my baby while writing this so the best I could do was a quick google for comp names; I’m sure there is a better set of names. Don’t @ me.
Step Three: The Potential
So how do you go about thinking about the future potential for revenue from a company like Flow? One case study is WeWork. For all those people saying, "but Neumann's done it before," let's take a look at what that would look like. If we take some of WeWork's known revenue numbers (the blue numbers) and make some reasonable estimates about what explosive (and expensive) growth can look like you could get a revenue forecast like this (stopping short of the COVID impact).
If this thing were to IPO in Year 9 and be expecting $4B+ of revenue, growing 30%+ that would be a pretty exceptional profile. What would a16z's return look like in that case?
We're making a lot of assumptions here, but a few to call out. We know that Flow's valuation was "more than $1B" so lets assume its $1B pre, putting its current valuation at $1.35B. Pretty generous with a16z owning 25%+. If dilution goes on to be 55%+ that will impact their return (dilution is a rough topic for any Adam Neumann company).
If we assume the company can grow to "WeWork scale" without "WeWork burn" they would be at $4.6B in forward revenue, trade at our comps multiple of 6.4x forward revenue and be a ~$30B company. a16z would have a 10x return on their hand. On $350M that's not a bad day's work. And they don’t need a 10x. When you’re managing multiple billions of dollars you’ll take a 2.5x on $500M-$1B of capital.
Now an important “what if” to address: what if that revenue path falls short? Instead of $4.6B maybe they hit where WeWork is today ($2.5B). And instead of nailing the tech multiple they’re trading like a property management company at 1-2x revenue. And they raised $20B to get there. All the sudden you have WeWork 2.0. That’s the risk you run for the potential outcome.
Your Skepticisms Be Damned
Now for a lot of my FinTwit colleagues I know they’re reeling right now. The amount of assumptions and logical leaps are significant. One friend’s reaction was like this:
“It's like, if I came to you and said ‘I'm going to take over the restaurant industry. I currently have five restaurants, but I'm going to offer every food imaginable. I'll be Le Bernardin, but with Chipotle service, and drive thrus like McDonald’s’”
I don’t disagree that the investment case is really difficult to make. But in a world of music label cabals, do you think a $10B revenue case for Spotify when they started out sounded sane? Or how in 2007 analysts predicted Amazon would have ~$30B of revenue in 2020 and Amazon went on to generate $386B in 2020.
If it works? It will still have sounded crazy. If it doesn’t work? We’ll all jump around saying, “I told you so.” We’ll let the outcome dictate what we “actually” thought.
You can say “a combination of property owner + management services + subscription community worldwide + data monetization? Impossible. I don’t see it.” But venture investing is about attempting to see what other people can’t see. The boldest bets will always be crazy. And the failed bets will always be the most lambasted.
However. For me personally I often look at “is there precedent for such a scale? When you compare this revenue ramp to all these other comps you see a stark contrast with the Flow forecast (the big red line.)
When you get super pragmatic and strike out all the fluff you have a fancy property management company. What does the precedent look like for that? Take Greystar as an example.
They’re a phenomenal business, some of the very best. And that outcome already puts Flow’s valuation underwater. I often quote Mike Tyson in saying, “everyone has a plan until they get punched in the face.” A lot of “visionary” companies have a great plan. But the face punch of reality comes for us all.
Again, for me personally? I don’t buy it. I wouldn’t have made this bet. But I try to avoid raining on anyones hustle (though sometimes it’s hustle and sometimes it’s A hustle.) I know the housing market is incredibly riddled with problems and I would love to see it improved. The idealistic dreamer in me remembers the spiritual experiences I’ve had walking through the ethereal halls of the Disney kingdoms. I would love to see a revolutionary new way of living and connecting with our community. So I wish them the best, and pray they do as little harm to the little guys and gals.
One parting thought from me. I think overall we could do a better job of building companies that meet reality between the atoms and the bits. There are plenty of problems in the physical world that could benefit from digital solutions.
Software is eating the world. But every once in a while some of the people cooking it feel like a millennial hipster who googled "ancient chinese recipe" and are doing their best with what they have in their Brooklyn apartment. And somehow Doritos made it into the meal.
Instead? We could do a better job of understanding the physical world we want to impact before diving in with a “revolutionary” solution. When I look at the “tech-enabled” businesses tackling the real world there are definitely some phenomenal and exciting solutions.
But there are a lot of “slap some software on it” solutions. When they represent a fundamental misunderstanding of the “state of the state” you’ll often not only make bad solutions but hurt a lot of people in the process.
*Plenty of nuance in WeWork's balance sheet but the TLDR isn't pretty.
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