WeRevolt

Here’s a risk factor in the most recent draft prospectus for the We Co.’s initial public offering:

Our future success depends in large part on the continued service of Adam Neumann, our Co-Founder and Chief Executive Officer, which cannot be ensured or guaranteed.

Adam Neumann, our Co-Founder and Chief Executive Officer, is critical to our operations. Adam has been key to setting our vision, strategic direction and execution priorities. We have no employment agreement in place with Adam, and there can be no assurance that Adam will continue to work for us or serve our interests in any capacity. If Adam does not continue to serve as our Chief Executive Officer, it could have a material adverse effect on our business.

It is a common enough risk factor in IPOs of startups run by their visionary founders. I suppose that, if you are one of those founders, putting that risk factor in the prospectus enhances your job security for a while after the IPO. If you mess up and the board calls a meeting to fire you, you can point to the risk factor and say: “Don’t fire me! You just told shareholders that I was essential! If you fire me now, boy will you have egg on your faces!”

This is not really an issue for Neumann at We Co., the parent company of WeWork. “Adam Neumann will control a majority of our voting stock upon completion of this offering,” reads another risk factor. “As a result, Adam will continue to have the ability to control significant corporate activities, including the election and removal of our board of directors and, through our board of directors, decision-making with respect to our business strategy and company policies, and the appointment and removal of our corporate officers.” He is essentially un-fireable: Technically the board could fire him as CEO, but as majority shareholder he could fire the board and put himself right back in office. The voting control—achieved through super-voting stock, not through owning a majority of the company—guarantees his job security.

When WeWork goes public—the IPO has been delayed but is still supposed to happen this year—it will file another revised draft prospectus. Will it include the future-success-depends-on-Adam risk factor? Will it include the Adam-controls-our-stock one? I dunno!

A bloc of WeWork directors is planning to push Adam Neumann to step down as chief executive after a tumultuous week in which his eccentric behavior and drug use came to light and the startup delayed its much-anticipated stock-market listing.

A group including officials tied to SoftBank Group Corp. , the company’s largest investor, wants Mr. Neumann to relinquish his title of CEO of We Co., the parent of the office-sharing company, people familiar with the matter said.

“Directors are expected to raise the prospect of Neumann stepping down as CEO and becoming non-executive chairman,” reports Bloomberg. And Masayoshi Son, the head of SoftBank, is reportedly in favor of the push to move Neumann out. Also the meeting might be happening … now? Two weeks ago I wrote about WeWork’s IPO: “What will happen? Oh I don’t know, probably something weird.” I’m pretty pleased with that prediction.

Well, if they fire him now, won’t they have egg on their faces? To be fair, no one actually bought shares based on the old prospectus; the market took a look at the present incarnation of WeWork, the one in which Neumann is critical, and decided to pass. Still it will require a certain change in positioning. The prospectus refers to Neumann constantly, always by his first name, and his influence is pervasive. WeWork is not just a commercial-real-estate company; it is a projection of Neumann’s charisma. “We are a community company committed to maximum global impact,” says the first real sentence of the prospectus. “Our mission is to elevate the world’s consciousness.” Their mission is to elevate the world’s consciousness and they’re going to fire the CEO for taking drugs on airplanes? Come on!

The thing about WeWork is that it is both a real estate company and a projection of Neumann’s charisma, with a bunch of grandiose claims about being “a state of consciousness” and “a generation of interconnected emotionally intelligent entrepreneurs”; there is a preschool for some reason. As far as the office-rental business goes, it is pretty comprehensible, there are other public office landlords, rent comes in and expenses go out, you could probably find an adequate professional to run it. The state-of-consciousness stuff is a lot more Neumann-specific. If you want to invest in a competently managed shared-office-space company without wild corporate governance problems, Neumann probably seems like a liability and some anonymous professional would be an improvement. If you want to invest in a state of consciousness, Neumann is probably essential to the thesis, and the company doesn’t work, at that level, without him.

Obviously the lesson of the last few weeks is that public-market investors didn’t really buy the state-of-consciousness stuff, so I can see where the board is coming from. Still it feels like there will need to be a comprehensive rethink, and rewrite. “We are a furnished-office company committed to renting people cool workspaces,” the new prospectus might start. “Our mission is to collect more in rent than we spend.” It’s kinda boring? But it’s not like the high-drama approach worked all that well.

Also they could change the name back to “WeWork” while they’re at it, just an idea.

Another pressing problem is, wait, can they fire him? Remember he controls all the votes:

Any attempted coup is a gamble: Mr. Neumann still has allies among the directors and the ability to fire the entire board thanks to shares he controls that carry extra votes. But SoftBank, which has invested more than $9 billion into the company and is represented on the board, has considerable influence too, and We needs the Japanese conglomerate to continue pumping in cash.

Eh I am not sure that gives SoftBank that much leverage. There is an if-you-owe-the-bank-$100-million-that’s-the-bank’s-problem dynamic here; SoftBank needs to continue pumping in cash if it wants to preserve its investment, and it arguably has more at stake than Neumann. (It literally has more at stake—it owns more shares than he does—and has a new Vision Fund to raise.)

No, I think that, if SoftBank and its fellow rebel directors are going to get this done, the only way to do it is to convince Neumann that it’s in his own interests to step down as CEO. The pitch is pretty much: Look, as a shareholder, you own close to 30% of this mess; if it goes public at a high valuation and all goes well, you will be a happy billionaire; if it craters you will have, uh, nothing other than the $700 million you’ve already taken out of the company. It is doubly tricky: The board has to convince Neumann both that it’s in his financial interests to step down—that, despite his successes so far, he is not the right person to take the company public and unlock its value—and that he should prioritize his personal financial interests over his enjoyment of running his own weird company his own weird way. That second part actually strikes me as the hard one; Neumann has hundreds of millions of dollars and all the houses he could ever need, 1  and there is no indication that being CEO has ever interfered with Neumann’s partying, so he might be motivated less by money and more by the joy of continuing to be a whimsical CEO. 

But if you have that conversation and it works, why not go one step further? Why not ask him to give up the super-voting stock? The precedent here is Uber, where founder-CEO Travis Kalanick got muscled out of his super-voting stock (partly by SoftBank!) shortly after being muscled out of the CEO job, and before going public. If you fire your CEO for being too eccentric, and leave him in charge as non-executive chairman and lifetime majority shareholder, you are setting yourself up for trouble. If he keeps voting control, he could always unilaterally fire the board and bring himself back as CEO. He could do it the day after the IPO, if he wanted. If public investors are turned off by Neumann, the real problem is not his title or specific governance provisions, it is that he has absolute ultimate control over the company. If you don’t fix that, there will always be an overhang.

Also I just want to say again: Man, don’t they have egg on their faces! The most straightforward interpretation of recent events is that Adam Neumann is an exceptionally talented unicorn-startup founder who is not suited to take WeWork public. His skill set consists of convincing private investors (convincing Masayoshi Son) that he is running a fast-growing tech company with huge network effects and economies of scale, and getting those investors (that investor) to invest billions of dollars at optimistic valuations. The one-on-one charisma, the ability to spin a grandiose vision, the mission statements about elevating consciousness rather than making money: All of these things stereotypically appeal to private tech investors (to Son) who want to change the world with unicorn investments. 

They do not, apparently, in this particular case, appeal to big public investors. As WeWork goes public, it will need a different skill set, perhaps the skill set of a professional manager who can convince investors that WeWork is a category-leading furnished-office company with acceptable corporate governance. All the “community” stuff, the kooky eccentricities that charmed private investors (Son), are now liabilities.

If that interpretation is right, it’s terrible for SoftBank! The message from SoftBank is pretty much “your job was to extract billions of dollars out of us, and you succeeded at it admirably; now that you’ve served that purpose, we should replace you with a real-estate CEO to salvage the value of your investment and ours.” 

Airbnb

The way employee stock options at startups work is that you pay income taxes when you exercise them. If you get an option with a strike price of a penny, and then five years later you exercise it when the stock is worth $100, you have $99.99 of income and have to pay taxes on it. If you don’t have a lot of cash sitting around, the obvious solution is to exercise the options, sell about a third of your stock, and use the proceeds to pay the taxes. 2  If you can’t sell the stock—because the company is still private and there is no secondary market—then, uh, I don’t know, I don’t really have an ending for this sentence. There are some kludges. Maybe the company will buy some stock back from you if you ask nicely, or lend you money to pay the taxes. If you work at a big enough startup there will be people who offer you strange workarounds that involve (1) lending you money to pay the taxes and (2) taking way more than a third of your stock. 3  None of it is ideal.

Generally the best solution is to wait: Eventually the company will go public and you can exercise the options, sell a portion of the stock to pay taxes, and then either keep the rest or sell it to buy a yacht or whatever. But stock options eventually expire. So there is a limit on waiting; if you don’t exercise the options by the time they expire, then you are throwing away, potentially, the bulk of your compensation for years of work at an early-stage startup. 

Traditionally the options expire 10 years after they’re granted. That basically sets a time limit on unicorns: If your high-flying startup doesn’t go public within 10 years, the employees are going to get antsy. There are other time limits on unicorns: Regardless of option taxation mechanics, early employees are going to want to be able to sell their stock eventually so they can buy the yachts, and venture capital funds tend to have finite lives so will also be pushing for an exit. But the 10 years thing is definitely one limit.

Once upon a time it didn’t matter so much; it only took a few years for most startups to either fail (and make their options worthless) or become worth a few hundred million dollars and go public. If your startup was a big success and your options were hugely valuable, it was probably public, so you could just sell your stock.

But now that every startup wants to be worth at least $10 billion before going public, timelines are being stretched, and the options thing is becoming a problem:

According to interviews with more than a dozen current and former employees and investors, most of whom declined to be identified for fear of retaliation, Airbnb’s 6,000-person work force has become increasingly frustrated by not being able to cash in the company stock that was received in compensation packages. Waiting for the start-up to go public has become a growing source of stress, many said, preventing some from making career changes, starting a family or moving on with their lives.

Questions about going public have risen to the top of an internal message board where employees vote for topics for executives to address every few months, the people said. The discontent has been exacerbated because Airbnb, which has been valued at $31 billion, doled out two tranches of employee equity that are set to start expiring in November 2020 and in mid-2021; those shares will become worthless if the company is not trading publicly by then, they said.

The article describes all the classic weird ways that Airbnb employees are dealing with the options problem: Airbnb “created a program to provide low-interest general-purpose loans of hundreds of thousands of dollars to employees” and “allowed longtime employees who were still at the company to sell portions of their stock,” while some employees “have tried to circumvent the prohibitions by selling their stock on a shadow, or secondary, market” or resorted to prepaid variable share forward contracts, in which investment firms—which “charge as much as a 15 percent fee”—give the employees a non-recourse loan against their shares in exchange for a portion of the upside. 4  (Or one former employee “spent his life savings” to exercise his options and “was returning bottles to buy groceries,” which is not really recommended.)

But there are also less-weird solutions. “Airbnb later began offering a different form of equity compensation, called restricted stock units, which do not need to be bought”; people paid in RSUs rather than options generally do not have this problem. 5  This does not solve the problem for earlier employees who were paid in options. For them, Airbnb came up with the simplest traditional solution: It promised to go public before their options expire. “On Thursday, Airbnb took the biggest step of all: It released a one-sentence announcement saying it planned to go public next year”; a big tranche of options is set to expire next November, so a mid-2020 IPO would fix the problem.

I have spent the last few years saying that private markets are the new public markets and that the IPO is not a central event in a startup’s life the way it used to be. Airbnb CEO and co-founder Brian Chesky has too, by the way; he “has been vocal about not rushing to take it public.” So it is a little embarrassing that he and I are being proven wrong by this dumb options expiry thing.

This is a weird and accidental problem! If you are starting a startup today, there is no particular reason to set yourself up for this problem in 10 years. Like you could just give people 20-year options, or give them RSUs from day one. Or you can keep the options setup and resign yourself to being a little more public while staying private: You can encourage trading on the secondary market, or regularly buy back stock from employees to pay their taxes. We are well into the unicorn boom, although after Uber and WeWork we might be coming to its end. But it still seems to me that, if you want to keep your big tech startup private indefinitely, there are ways to do it. You do have to plan for it though.

Gardening leave drama

The way that gardening leave works at major investment banks is that, if you quit a job at one bank, you are not allowed to start a job at another bank for some period of months (during which the old bank will pay your salary). If you do, you will generally lose deferred compensation and might also get sued for violating your employment contract. Enforcement of this requirement is usually pretty easy: If you start showing up in your new bank’s marketing materials or at big pitch meetings, or if your Bloomberg listing shows you at your new bank, your old bank will find that out pretty easily and you will get in trouble. And so in fact there is a strong norm of abiding by gardening-leave policies, at least at a formal level; you won’t generally get on the payroll at the new job until the gardening-leave period runs. 

On the other hand, if you are a senior enough hire there will be some informal gray areas. You might not show up at your new office for 10 hours every day during your gardening leave, but then, you weren’t showing up at your old office for 10 hours every day either. Sometimes you were showing up at the golf course instead, to keep up your close personal relationships with important clients. (There was some debate about whether Andrea Orcel could go to Davos while he was between jobs—not as a formal business trip, but just because all his friends were there.) If you play golf with a CEO during your gardening leave, does that violate its terms? You’re not there as a representative of your new bank or anything; you’re just there as the CEO’s friend, to play golf. What if you quietly mention, as you are lining up a putt, that your new bank has terrific capabilities in structured finance and suggest that the CEO call you to put a deal together once your new job officially starts? Have you broken the rules? And even if you have, how could anyone find out? It’s not like your old bank would send goons to follow you around everywhere to make sure you’re not breaking the rules, right?

Here’s a fun story out of Switzerland:

A made-in-Zurich banking drama spilled out into the open over the weekend after it emerged that ex-top Credit Suisse Group AG banker Iqbal Khan had been shadowed by the lender, leading to a confrontation in broad daylight in the Swiss financial capital.

The private banker, hired by crosstown rival UBS Group AG last month, was followed by detectives trying to establish if he was attempting to poach ex-Credit Suisse colleagues to join him at the world’s top wealth manager, according to several people familiar with the situation. ...

Khan, on leave before he is due to join UBS as co-head of wealth management on Oct. 1, was followed by unidentified men while driving his car with his wife last week. He eventually noticed that he was being followed and took pictures of his pursuers, which led to a physical confrontation in downtown Zurich when the men tried to take away his mobile phone, according to several people briefed on the events.

Khan filed a police report and the men were arrested; Credit Suisse’s board has opened an inquiry. I don’t know why they tried to take his phone? What is the harm to the detectives, or to Credit Suisse, if Khan established that he was being followed? If you are going to have gardening-leave and no-poach policies, the only way to really enforce them is by instilling some paranoia in your ex-employees; you want them to think that someone might be tracking their every move to make sure they’re not poaching clients or colleagues. This incident is embarrassing for Credit Suisse, sure, but it serves a purpose, and the next senior executive who leaves for a rival will be sure not to take any colleagues with him.

Things happen

Repo Market’s Liquidity Crisis Has Been a Decade in the Making. New York Fed rejects Wall St criticism of response to repo turmoil. Biggest Banks Are Less Likely to Wreck the Economy Than a Decade Ago. What Drove SoftBank’s Vision Fund Up Is Dragging It Down. Citi’s Top Banker in Miami Has Become a Coveted CEO Prospect. Fannie, Freddie Poised to Keep Profits in an Initial Privatization Move. Trading and Arbitrage in Cryptocurrency Markets. Bubble or Nothing. Anna Wiener on ‘Four Years in Startups.’ IEX Exchange to Exit Listings Business. Why Private Equity Is Ripe for Vanguard-Style Disruption. For ‘Recovering Bankers,’ the Restaurant Life Beckons. Man will finally drink 'Sourtoe Cocktail' containing his own amputated toe. What’s Anthony Scaramucci up to?

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1. Yes sure as we discussed last week Neumann has said he wants to be the world’s first trillionaire, so money is still a motivator, but I suspect that that’s not on the table anymore regardless of whether he quits as CEO.

2. Oh also you might need cash to pay the exercise price, though for early-stage options at successful startups that will generally be way less than the taxes. Also you might be able to net-share exercise by, effectively, paying the exercise price in shares.

3. Here is a good post from Dave Kellogg on various approaches, including this one: “For example, one of these (typically very boutique) funds might say: ‘I’ll give you the cash both for the exercise and to pay your tax bill, if you give me the shares. When we eventually sell them, I’ll keep 100% of proceeds until I get my money back, 50% until I get 3x my money back, and 25% after that.’These funds are hard to find and the deals can be very hard to understand.” This is more or less a prepaid variable forward, as we’ll discuss in the next note.

4. Strictly the investor sells the employee aput on the stock, buys back a call, and lends money against the stock plus the put. (“Prepaid variable forward” is, to a derivatives person, a synonym for “collar plus loan.”) If the stock goes to zero, theemployee’s put is in the money and the investor effectively writes off the loan. If the stock goes way up, the investor’s call is in the money and the employee gives up most of the upside on the portion of the shares involved.

5. Because their RSUs generally have double-trigger vesting and thus do not incur taxes until the IPO.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net