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The Unintended Consequences of WeWork’s Turmoil: Term Sheet

October 22, 2019, 11:51 AM UTC

This article originally ran in Term Sheet, Fortune’s newsletter about deals and dealmakers. Sign up here.

It’s WeWork’s moment of truth. 

After weeks of endless chatter and speculation, we finally have some answers. Fortune has confirmed with sources that WeWork’s board is expected to meet tomorrow to discuss financing options including a takeover by SoftBank that would value the company at as little as $7.5 billion on paper. Let us not forget that WeWork was valued at an eye-popping $47 billion not too long ago.

My colleague Rey Mashayekhi reports that there are two deals on the table that would provide the cash-strapped co-working startup with the liquidity it needs to continue operations in the wake of last month’s disastrous attempt at an IPO. Yet neither option appears to be particularly appetizing for the company’s leadership and investors, who now have a choice between a debt-and-equity proposal that would write down WeWork’s valuation significantly and a bond financing package that would saddle the firm with billions of dollars of high-yield debt.

From the story:

SoftBank’s offer would see the Japanese private equity giant further entrench its position in WeWork, boosting its ownership stake in the firm to over 50% and effectively taking over the company, the Wall Street Journal reported Monday. Yet the deal, which would entail a $1.5 billion equity investment and $5 billion in debt.

The SoftBank proposal would see WeWork’s existing investors—including SoftBank itself—take a serious hit on their investments in the company, since most poured money into the firm when its valuation was at a much higher figure. Yet its success could also be decided by co-founder and former CEO Adam Neumann, who still has outsized influence as one of WeWork’s largest shareholders; on Monday, Axios reported that SoftBank has offered to pay Neumann $200 million to support the private equity firm’s offer, surrender much of his voting stake, and walk away from WeWork’s board of directors.

Yet nothing is decided, as JPMorgan submitted its own debt financing package to WeWork’s board of directors on Monday evening, sources told Fortune. That deal would offer up to $5 billion in secured and unsecured bonds that, unlike SoftBank’s proposal, wouldn’t dilute or devalue the stakes of WeWork’s existing investors. Among the outside investors said to be involved in the debt offering are Barry Sternlicht’s Starwood Capital Group, the WSJ reported.

I want to pause here, and zoom out for a second. Often times, tech reporters tend to steer your attention to the big numbers and the big personalities driving the decisions. But there was one really jarring sentence in The Wall Street Journal report I want to highlight. This one:

“WeWork also is planning to cut thousands of employees, but delayed the layoffs earlier this month because it couldn’t afford the severance costs, people familiar with the matter have said.” In other words, the company needs money because it can’t afford to … lay off its employees. 

I hope you, like me, raised an eyebrow after reading that. WeWork’s tumult has affected dozens of employees who had no input on how the company was structured and what decisions were made at the top.  

I’d like to echo the question Bloomberg’s Shira Ovide asked on Twitter: “How did this board let it get so bad? You can ditch the CEO, but where is EVERYONE ELSE?” I’m wondering the same. 

In situations like this, it’s important to remember that it’s not only deep-pocketed investors who lose out when a bet goes bad. A lot of employees do too — and unlike the shareholders invested in the business, it’s not something they can simply write off and walk away from.

MEANWHILE AT FORTUNE’S MOST POWERFUL WOMEN SUMMIT… 

… There was sympathy for WeWork: Jill Woodworth, the chief financial officer of newly-public fitness equipment maker Peloton, expressed sympathy for WeWork’s management. “I look at WeWork and I have so much sympathy,” she said on a panel at the Most Powerful Women Summit. “When I look at how quickly the market sentiment can change and companies don’t live up to expectations, it’s absolutely gut-wrenching for management.” (Note: She made these comments before the latest WeWork news broke.)

Woodworth explained that there’s a negative bias toward unprofitable companies that hit the public markets, but she hopes that sentiment changes in the long term. She elaborated: “For us, it’s growth—not at all costs—but growth is 100% our priority. If your opportunity is massive, you should just grow as fast as you can.” 

Teri List-Stoll, the CFO of Gap Inc. (which was founded 50 years ago), responded to Woodworth’s comment with a laugh, adding, “Well, that sounds luxurious.” She emphasized that companies must prioritize transparency and over-communication when dealing with investors. “The expectations will be there whether you give guidance or not,” List-Stoll said.

Choosing growth over profitability has become a cliché in tech circles, with founders trying to explain that losing billions of dollars is justified as long as you’re growing. Cisco’s Kelly Kramer, the third CFO on the panel, expressed caution when choosing which metric to prioritize. 

“We’ve been around 30 years, and we have a very long-term investor base,” Kramer said. “Our investor base gives us the top metrics it cares about, and they’re always margin rates and cash flow. The business has to make tradeoffs sometimes, but long-term, we have to explain profitable growth.”

Public market investors have typically expected companies to become profitable within 18 months or so of an IPO. This timeline has been loosened as fast-growing startups make their public debuts with S-1s that warn: “We expect our operating expenses to increase significantly in the foreseeable future, and we may not achieve profitability.” 

Woodworth said she doesn’t feel added pressure for Peloton to become profitable faster now that it’s a public company. Several months ago, she said, an investor asked her the following question: “What will change when you’re public?” 

“And I said, ‘Nothing.’ My job is to help this company build shareholder value,” Woodworth said. “It doesn’t change when you’re public. I’ve seen how market sentiment can shift on you, and the idea of changing your entire strategy based on a market shift is not something we want to do.”

Read more here.

… Private investors urge startups to lose money ‘thoughtfully:’ I moderated a panel with several venture capitalists, whose message came through loud and clear: Tread carefully. 

“It’s great that there’s been a lot of capital,” said Hilarie Koplow-McAdams, venture partner at NEA, began. However, she continued, “Like raising children, if you have no limits you get a wide range of behaviors.”

Another big issue on everyone’s radar: the trade-off between profitability and growth. In recent years in public markets, profitability has been overlooked for growth. That’s resulted in some snafus—the most lurid and late example being that of WeWork’s failed attempt at an IPO. 

“Private markets are heavily influenced by what happens in public markets,” said Patricia Nakache, general partner at Trinity Ventures. “There’s always a pendulum swing in private markets. We have swung way out toward growth at most costs. But now public markets have weighed in and resoundingly said, this has gone too far. We need to clear a path for profitability and we need to recalibrate.”

But the quote of the day goes to TPG Growth’s Heather Smith Thorne, who said: “It’s not about losing money. It’s how you lose the money. So lose it thoughtfully.”

Read the full story here.

VENTURE DEALS

- Instabase, a San Francisco-based platform company for business applications, raised $105 million in Series B funding. Index Ventures led the round, and was joined by investors including Greylock Partners, New Enterprise Associates, Andreessen Horowitz, Spark Capital, Tribe Capital, SC Ventures and Glynn Capital

- IonQ, a College Park, Md.-based startup that uses "trapped ions," or charged particles suspended in a vacuum, as the basis for its hardware, raised $55 million in funding. Samsung and Mubadala Capital co-led the round, and were joined by investors including Amazon, GV, and New Enterprise Associates. Read more at Fortune.

- Blueground, a New York City-based real estate technology company, raised $50 million in Series B funding. WestCap Investment Partners and Prime Ventures co-led the round. 

- Upstream Security, a California and Israel-based provider of cybersecurity for connected vehicles, raised $30 million in Series B funding. Renault Venture Capital led the round, and was joined by investors including Group Venture Capital, Hyundai, Hyundai AutoEver, Nationwide Ventures, Charles River Ventures, Glilot Capital and Maniv Mobility.

- Bayzat, a Dubai-based provider of a platform for human resources, payroll and employee benefits, raised $16 million in Series B funding. Point72 Ventures led the round, and was joined by investors including Mubadala Capital, Elm, Greyhound Capital, Endeavor Catalyst and Tech Invest Com.

- Octave, a San Francisco-based behavioral health practice, raised $11 million in Series A funding. Greycroft led the round, and was joined by investors including Obvious Ventures. 

- GreenPark Sports, a Burlingame, Calif.-based mobile game developer, raised $8.5 million in seed funding. Investors include SignalFire, Sapphire Sports and Founders Fund.

- MediView XR Inc, a Cleveland-based medical device company, raised $4.5 million in seed funding. Investors include Inside View Investment LLC, Plug and Play Ventures and Northwest Ohio Tech Fund.

HEALTH & LIFE SCIENCES DEALS

- Plexium, a San Diego-based biotech company, raised $28 million in Series A funding. DCVC Bio and The Column Group led the round, and was joined by investors including M Ventures, CRV and Neotribe Ventures.

PRIVATE EQUITY DEALS

- AMP Capital agreed to acquire Expedient, a Pittsburgh, Penn.-based computing and data center infrastructure as a service provider, from Landmark Media Enterprises. Financial terms weren't disclosed. 

- SkyKnight Capital made an investment in AeroCare, an Orlando, Fla.-based provider of home healthcare solutions focused on patients with chronic respiratory conditions. Financial terms weren't disclosed. 

- Power Digital Marketing, which is backed by Periscope Equity, acquired Factorial Digital, a New York City-based growth marketing and SEO agency. Financial terms weren't disclosed. 

- Periscope Equity made an investment in Mobile Solutions, a Centennial, Colo.-based managed mobility services provider. Financial terms weren't disclosed. 

- Sverica Capital Management LP made an investment in In Vitro Sciences LLC, Avon, Conn.-based operator of a network of fertility clinics. Financial terms weren't disclosed. 

- Arlington Capital Partners agreed to buy a majority of AEgis Technologies, a Huntsville, Ala.-based provider of advanced engineering and technology expertise to customers in the National Security community. Financial terms weren't disclosed. 

EXITS

- Genpact agreed to acquire Rightpoint, a Chicago-based digital tech-focused consultancy. The sellers include Stella Point Capital. Financial terms weren't disclosed. 

FIRMS + FUNDS

- Founders Fund, a San Francisco-based venture capital firm, is raising $3 billion across two funds. Read more.

PEOPLE

- Ilana Stern joined Peterson Ventures as a general partner.

- Energize Ventures promoted Katie McClain and Juan Muldoon to partner. 

- Next Coast Ventures named Zaz Floreani to principal.