Mr. Neumann’s fall from grace last week comes right out of the biblical Garden of Eden (eating forbidden fruit), Greek tragedy (blind hubris) and Dante’s Inferno Ninth Circle (betrayal of trust of family, community and country). There must be a better way to run a closely held company.
The loss of cash anticipated from the failed IPO created a dramatic need for cash to sustain operations. Let’s look at changes in corporate governance and new strategies for crisis management strategies.
Board Duties. In this case, Delaware law governs The We Company’s governance. Decision-making is done by the Board of Directors, appointed and removable by the voting stockholders. The directors have a fiduciary duty to act prudently, a duty of loyalty to avoid self-dealing and a duty of care to justify the reasonableness of exercising their business judgment.
Board Actions. Here, the Board and voting stockholders appear to have been captured and mesmerized by a flamboyant and extravagant founder engaged in self-dealing. The Board approved, or did not discipline, apparent self-dealing of hiring Mr. Neumann’s many friends and family as employees. The Board appears to have allowed but then rescinded a deal for Mr. Neumann’s sale to the company of a trademark registration for $1.6 million or so; however, the timing of discovery and rescission are apparently not public. The Board allowed the purchase of a $60 million private Gulfstream jet for Mr. Neumann’s use. The Board approved dealings where Mr. Neumann, his family and even other members of the Board are the landlord and the company is the tenant. In their risk analysis on SEC Form S-1 filed with the SEC August 14, 2019, the company admitted:
- “We have engaged in transactions with related parties, and such transactions present possible conflicts of interest that could have an adverse effect on our business and results of operations. We have entered into a number of transactions with related parties, including our significant stockholders, directors and executive officers and other employees. … we may have achieved more favorable terms if such transactions had not been entered into with related parties and these transactions, individually or in the aggregate, may have an adverse effect on our business and results of operations or may result in government enforcement actions or other litigation.”
The Board approved spending of over $500 million for acquisitions (arguably, for “diversification” and “synergies”). Such investments generated revenues but arguably were different lines of business that would not build the core business. The investments include WeGrow (pre-school and elementary education), Rise by We (fitness club), WeLive (rentals of dorm-like apartments), Meetup.com (event planning) and Conductor (search engine optimization).
The Board’s actions appear responsible for precipitating a crisis of trust. The Board authorized the IPO documentation that did not provide segmented accounting by line of business. The SEC Form S-1 omitted other information that one might consider “material.” Investors rejected the IPO valuation of $47 billion and complained. The Board has now withdrawn the public offering.
Crisis Management Playbook.
Board Action. Having backed itself into a crisis, the Board took steps to rectify all of its apparent past neglect. It terminated the founder’s employment.
Stockholder Action. The stockholders appointed Mr. Neumann as non-executive chairman of the Board. This action solved a lot of conflicts. It satisfied Mr. Neumann’s need to continue in some form of management. It satisfied the stockholders’ need to remove him from operations while preserving whatever goodwill is associated with his inspirational reputation.
More significantly, the stockholders kept Mr. Neumann’s feet to the “fiduciary fire” so that he would be held responsible for future decisions that he approved. Thus, Mr. Neumann’s personal rights (as stockholder) to complain about future Board decisions would be coopted and any bad decisions he approves henceforth will be subject to his responsibility for participating in and approving them. And he signed a voting agreement that substantially dilutes his super majority voting control.
Action Steps in Crisis Management. The Board’s cleanup crew focused on reform of leadership and cash management.
Nepotism and Cronyism. The Board fired Mr. Neumann’s wife and about 20 members of his family and friends, who held senior positions. A crisis transition will occur, where pending projects will need to be identified, prioritized and terminated or re-adopted under increased Board supervision. A new leader, free of prior association with Mr. Neumann’s entrancement, will guide as CEO.
Board Structure. The Board may be increased to include more directors, who will be assigned to committees. There will be significant changes in the role of directors including independent directors.
Cash Management. Since the IPO documents revealed that expenses were growing as fast as revenues, cash management becomes a priority for survival. SoftBank was reportedly ready to contribute another $10 billion when it was valued at $47 billion, but the valuation is now more in the range of $15 billion according to estimates. Further, SoftBank’s own leadership has undoubtedly been questioned by its investors for having acquiesced in Mr. Neumann’s management “mistakes.” So cash management can be expected to result in significant emergency restructuring. This could involve:
- New scrutiny of all elements of the company’s business to revise:
- its value proposition
- its core business (which incidentally can be reviewed by looking at recent trademark applications)
- its risk management and resiliency plan
- cash flow requirements
- operational reporting for greater transparency
- Mass layoffs of persons not closely tied to the core real estate leasing operations
- Sales of ancillary companies that, while profitable, are not “core” businesses
- Termination of “non-core” projects
- Demands for recovery of expenses incurred by Mr. Neumann and his “oval office” coterie of family and friends that had “no relation” to the company’s business
- Possible renegotiation of lease terms or requiring Mr. Neumann to assign his rights as landlord to a third party where he controls WeWork’s landlord
- Tax audits and amended income tax returns to reflect higher income and reduced deductible expenses from personal projects that a tax auditor might assert was a personal expense
- Slower expansion
- Termination of certain low-performance real estate projects that generate losses
- An increase in the coverage limits for the company’s directors’ and officers’ liability insurance coverages
- A new formulation and new solicitation of private equity, with a “down round” that values the company at less than the valuation agreed when SoftBank had invested.
For other closely held businesses, the lessons are clear. It might be time to restructure your corporate governance with new policies, procedures, practices and internal controls.
1 For history, The We Company, SEC Form S-1 (Aug. 14, 2019) and Elliot Brown, Anupreeta Das and Maureen Farrell, “WeWork to Push Out Staff Close to Ex-CEO,” Wall St. J. Sept. 27, 2019, pp. A1, cols. 4-5, p. A8, cols 3-6; Eliot Brown, “WeWork’s Adam Neumann Runs on Excess,” Wall St. J. Sept. 19, 2019, pp. 1, cols. 5-6; p. A8, cols. 1-6.