WeWork has created a buzz among New York City’s hot tech startups. The office space sharing company's valuation rose and fell dramatically during its first decade. Adam Neumann and Miguel McKelvey founded WeWork in 2010. By 2017, WeWork's valuation rose to $17 billion after SoftBank Group Corp. invested $300 million in the firm. The company was valued as high as $47 billion in early 2019, and its initial public offering (IPO) was highly anticipated. However, WeWork's IPO was ultimately withdrawn amid concerns about the company burning through cash. Adam Neumann resigned as CEO, and the estimated value of WeWork dropped to between $8 billion and $12 billion by October 2019.

How Does WeWork Generate Profit?

Since day one of operation, Neumann said WeWork was operating cash flow positive. Many valuation measures use cash flow multiples. WeWork generates profit through month-to-month memberships, ranging from hundreds to hundreds of thousands in fees, depending on the size and needs of the company. WeWork enters into long-term leases with landlords and offers spots in their hip office spaces at a markup. Moreover, by partnering with third-party providers such as Chase, WeWork offers services such as healthcare and payment processing to members at competitive prices.

WeWork also has developed a form of capacity utilization by leveraging a community atmosphere. Face-to-face interaction between small businesses and entrepreneurs helps members solve each other’s problems, team up for projects, and share physical and human capital. This support network comes at no cost to WeWork. In fact, it may be their most valuable asset.

Should Investors Beware?

When asked if WeWork is a "unicorn," the founders objected, saying that they didn't rely solely on the economy. In 2017, they disagreed that the valuation was inflated. Instead, they projected to grow by thriving off a shift in humanity, unhindered by business cycles or speculation. Investors should not forget past market lessons on technology company valuations.

Since the company rents out long-term leases to its members, they risk being stuck in costly situations if demand were to decrease sharply. Many argue that WeWork would endure the same hardships as office sharing companies HQ and Regus, which struggled with the dotcom bubble. Both HQ and Regus filed for chapter 11 bankruptcy protection. Regus subsequently bought out HQ.

WeWork’s management said that they maintained a cushion in the event of a downturn. They attributed this to their streams of revenue from various supplemental service offerings.

In 2019, a $1.7 billion payout to former CEO Adam Neumann was widely criticized. At the same time, the value of the company had fallen below $12 billion, and employees faced layoffs. The company's new chairman, Marcelo Claure, insisted that there was no risk of bankruptcy.

WeWork’s Market

Some are wary of WeWork's prospects in the event of a tech crash because WeWork attracts many venture-backed startups. If the money dried up, WeWork might lose a majority of its customer base. However, WeWork's members also include large companies, lawyers, and independent freelancers.

WeWork leads amid rising consumer office space companies in New York City, and WeWork offices continue to operate throughout the U.S. and globally. Neumann suggested that WeWork was competing with other coworking spaces and also competing with offices. WeWork's growth relies on the "We Generation." This generation believes in the sharing economy and that they can believe in what they are doing for work.

According to a 2019 survey by the Freelancers Union, freelancers comprise 35% of the U.S. workforce, or 57 million Americans.

How Is WeWork Different?

WeWork is a market challenger, entering a market saturated with shared office companies. When Neumann and McKelvey launched their idea, they started as Green Desk, a green company-oriented shared office space. However, the founders said they saw an opportunity for a bigger idea, a bigger brand. By leveraging community, WeWork aims to do more than a real estate company, creating an experience that helps small businesses thrive and succeed.

Much of the success of WeWork can be attributed to the tech orientation of the company. Behind the scenes, a system is in place for choosing offices, while a live 3-D modeling system works to design the buildings to increase the chance of interaction. Zendesk (ZEN) software runs ticketing and ensures quality service, while their social app connects members virtually.

Investors were also confident in WeWork’s leadership before the canceled IPO and Neumann's resignation. Management looks for “the right people” through a thorough interview process. They make sure employees are connected to their work, offering equity compensation to every employee, even the cleaning staff.

Looking Forward

Although the company may eventually go public, plans for an IPO were shelved in late 2019. Neumann had suggested that an IPO should not be thought of as an exit. However, the canceling of the IPO brought about his own exit. The new chairman, Marcelo Claure, has an impressive track record, but he faces a daunting challenge in restoring investor confidence in WeWork.

The Bottom Line

While many potential investors might be scared away by WeWork's difficulties in 2019, it is useful to remember that many successful companies encountered similar problems. There is always a risk of failure, but investors who buy when there is fear in the market often do better. Buying Apple (AAPL) when it was near bankruptcy or Facebook (FB) several months after its controversial IPO proved to be successful investments. However, the resignation of founder and CEO Adam Neumann probably signals a significant change in direction at WeWork. Ultimately, WeWork's ability to deliver value to its customers will determine its valuation in the market.