Skip to Content

‘Doesn’t Pass the Smell Test’: Investors Question Recent Developments at WeWork Ahead of IPO

Even in the much buzzed-about realm of private unicorns, WeWork stands out as a lightning rod for attention and conjecture. While the company didn’t invent coworking, it certainly revolutionized and popularized it; its very business model of providing trendy, amenity-laden office spaces on flexible terms has been a disruptive force to the real estate industry and deemed a harbinger of the economy of the future.

The startup-turned-behemoth (which recently announced its rebranding to The We Company) was most recently valued at $47 billion, thanks in no small part to the patronage of Masayoshi Son’s SoftBank Group. It’s branched out from its traditional market of shared workspaces targeting young, millennial-helmed startups, into designing and managing offices for major “enterprise” clients like IBM and Microsoft. And now, it’s braced to tap the public markets via an initial public offering that could come as soon as September.

Yet if recent developments are any indication, WeWork’s public debut could be anything but a straightforward success. While it remains, in essence, a real estate provider, WeWork has long considered itself a tech company—and like many tech unicorns, it has pursued a growth-heavy, cash-intensive strategy that saw its losses double to more than $1.9 billion in 2018 (despite revenues that also doubled, to more than $1.8 billion). 

That’s bad news for dividend-seeking shareholders, and could result in a disappointing IPO akin to that of fellow high-growth, high-loss unicorns Uber and Lyft. Both ride-sharing giants went public earlier this year, and both have seen their stock underperform.

“These large and unprofitable IPOs are problematic for investors, and they have to be done very carefully,” says Kathleen Smith, principal at institutional research firm Renaissance Capital, which provides IPO-focused exchange traded funds (ETFs).

Smith notes that both Lyft and Uber went public below their lofty private valuations, and speculated that WeWork could join that list given that the nine-year-old company is still registering heavy losses—something that may not be of great concern to private investors, but is a trickier sell in the public markets.

“Having a dollar lost for every dollar of revenue does not mean [WeWork] is a mature company; the maturity of a company has to do with how long it’s made money,” she adds. “Profitability is such a key [for investors]. When you’re private and you’re grabbing market share, [unprofitability] is fine; when you’re public, it takes a very unusual company to manage expectations.”

What’s more, an array of financial maneuvers behind the scenes at the company have cast further questions over its corporate governance. As the Wall Street Journal reported last week, co-founder and CEO Adam Neumann has raised more than $700 million from his stake in WeWork, via a combination of equity sales and debt backed by his ownership stake. It is a fairly unusual maneuver for the founder of a company bracing to go public, and one that could easily raise questions about his belief in his company’s long-term prospects. (A WeWork spokesperson declined to comment for this article.)

Additionally, it emerged earlier this month that WeWork is looking to raise up to $4 billion in debt in advance of its IPO—a move designed to continue funding the company’s rapid growth and assuage investor concerns that it could become too reliant on the public equity markets. But it also places more debt on a business that has yet to show an ability to turn a profit, and casts more questions over WeWork’s growth-oriented strategy.

Meanwhile, SoftBank dramatically scaled back a planned $16 billion investment in WeWork earlier this year, revising that figure to significantly smaller $2 billion cash influx that inevitably raised eyebrows given the Japanese conglomerate’s heavy exposure to the firm. 

And Neumann’s corporate governance practices came under further scrutiny after WSJ reported that WeWork has leased space in several buildings that Neumann himself owns—deals that could see Neumann’s properties receive hundreds of millions of dollars in revenues from his own company. It is an arrangement that WeWork will surely have to address in advance of its IPO.

“It just gives the appearance of self-dealing,” Santosh Rao, head of research at Manhattan Venture Partners, says of Neumann’s business dealings. “He’s not doing anything illegal, but it just doesn’t pass the smell test. No founder wants to sell at a low—they always believe that their company is undervalued and the value is going to go up.”

Rao acknowledges that “founders deserve to make money” on their product, and that Neumann could well still be deeply invested in his company via a “sizable stake.” But while Neumann is believed to still be WeWork's largest shareholder, no one will know just how large his stake is until WeWork puts out its public prospectus, and Rao stresses that a CEO like Neumann “cannot give the appearance [to public investors] that you’re cashing out.”

“When you have such a high valuation and people are already jittery, and you see this guy selling [his stake], you begin to wonder if something is going on,” he notes.

That, in turn, draws attention to a matter that’s been speculated about over the course of WeWork’s remarkable rise: whether the company’s business model, which remains heavily reliant on small tenants who have turned to coworking’s flexible office leasing model, can survive the sort of economic downturn that forces startups to tighten their belts, if not go out of business.

“What I worry about from a longer-term perspective is that they’re not cycle-tested,” says Barry Oxford, a senior research analyst at D.A. Davidson who covers the real estate sector. “You’re dealing with [tenants] who were working out of the house and are now looking to add a layer of professionalism to what they were doing.”

“I worry that in a downturn, a certain amount of tenants that WeWork has get flushed out—but [WeWork is] still on a 10-year lease that they signed with the landlord,” Oxford adds, describing the company’s model as reliant on “short-term revenues tied to long-term expenses.”

As a company that emerged in the wake of the Great Recession, it’s true that WeWork still has yet to prove that it can survive an economic downturn. Renaissance Capital’s Kathleen Smith argues that worsening conditions could actually benefit WeWork—given how, in such a downturn, many of its larger corporate clients “are probably more inclined to not want to invest in [long-term leases] and use an on-demand kind of real estate, which is what they offer.”

Smith adds that while there’s “definitely a spot for WeWork in the public markets” given the number of investors interested in growth companies, its unorthodox corporate governance will weigh heavily on the minds of the investors who will consider the company’s IPO. She also speculates that WeWork could deploy a “limited-voting stock” model akin to that of Facebook and Snap—one that has seen those company’s co-founders and CEOs, Mark Zuckerberg and Evan Spiegel, retain significant control over their businesses.

“When we’re looking at investing, we’re looking at whether the company is accountable to shareholders; as an IPO investor, how do you know this company is going to deliver on what shareholders are looking for?” Smith notes. “These kinds of things make it hard for investors who want to see accountability.”

Such questions could dictate whether WeWork’s IPO proves yet another success for Neumann and his company, or a questionable foray that could end up costing the company dearly. We'll find out this fall.

More must-read stories from Fortune:

—Meet the A.I. landlord that’s building a single-family-home empire

—You might have longer than you think to invest for retirement

Facebook’s Libra currency could threaten the global financial system

—The surprising way Republicans used to use immigration to boost the economy

—One of Warren Buffet’s favorite metrics is flashing red. Corporate profits are due for a hit

Don't miss the daily Term Sheet, Fortune's newsletter on deals and dealmakers.