The WeWork fiasco is making employees wonder if their shares have been set on fire. We talked to experts who said most tech startup workers are in the dark about how much their equity is worth.

Adam Neumann

WeWork has indefinitely postponed its IPO, and according to media reports may run out of cash by next month.
If the company still eventually goes public, but at a lower valuation than previously expected, it will pay back its preferred shareholders first, leaving close to nothing for employees.
In the event of a bankruptcy and liquidation, employees also get paid last.
Employees at other tech startups may be starting to question their decisions.
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"It's great to be part of a high-flying company. Until it's not."

That's according to venture capitalist Greg Robinson. As managing director at 4490 Ventures in Wisconsin, Robinson has seen too many ambitious professionals join fledgling tech startups, dazzled by the prospect of making it big when the company eventually goes public or gets acquired at a billion-dollar-plus valuation.

Many startup employees, especially early hires, are given equity grants to compensate for relatively low salaries. In a liquidation event (like an IPO or an acquisition), those employees have the chance to exercise their options, snagging a piece of that billion-dollar price.

Unfortunately, it doesn't always work out that way.

Even startups that promise — and seem well-positioned — to become the next Google or Amazon may find their potential was overhyped, after all. And rank-and-file employees, who may have spent years building the business from scratch when they could have been raking it in at a more established organization, can be left in the dust.

WeWork is a prime example of this scenario.

To give a brief rundown of the company's financial situation: In August 2019, WeWork publicly filed paperwork detailing its intent to go public. The company had raised $12.8 billion and was valued at $47 billion by Softbank, its largest shareholder.

But in September, Softbank pushed the company to table the IPO, and WeWork was considering going public at a mere $10 billion valuation, according to media reports. By mid-September, media reports said it had delayed its IPO until at least October.

Meanwhile, cofounder and CEO Adam Neumann was ousted, replaced by two co-CEOs, who began selling off some of WeWork's assets and shelved the IPO indefinitely. By October, Bloomberg reported that WeWork was discussing a $5 billion credit line with lenders led by JPMorgan. Otherwise, the company could run out of cash by November.

For WeWork employees who hold equity in the company, the situation is looking increasingly dire. Business Insider reached out to We for comment and did not hear back by Friday evening.

Preferred shareholders get their money out first — and there may not be anything left for employees

Say WeWork does eventually IPO at a valuation of $10 billion. That's less than the amount of capital that the company has raised, and the first thing WeWork would have to do is pay back its preferred shareholders.

"Preferred shares" is a broad term that simply means shareholders have a different set of rights than common shareholders, which typically include founders and other employees. The vast majority of venture deals involve preferred shares.

Late-stage investors (like investors in a Series D or E round) often request preferred shares as a form of protection in a downside scenario. For example, if the company goes public at a lower valuation than expected, preferred investors will get their money out first.

One common way investors protect themselves in a downside scenario is by using a ratchet mechanism. If the company goes public at a valuation lower than the agreed-upon valuation, the company must issue their preferred shareholders additional shares so those investors don't lose money.

Ratchet mechanisms have become increasingly common in venture deals. According to the law firm Fenwick and West LLP, the rate of technology IPOs that triggered ratchet mechanisms increased from 4% in 2014 to 50% in 2015. (The sample size was 14 companies in 2015 and 27 companies in 2014.)

This increase is likely a result of companies waiting longer to go public, and raising huge amounts of capital in the meantime, Robinson said. It's a way for those companies to "sweeten the deal" for investors, he added. In order to hit a unicorn (or billion-dollar) valuation, which is often viewed as a proxy for a company's success, the company agrees to let investors get their money out first.

Ratcheting is especially common among companies with an unproven business model that are burning through cash quickly, said Steve Sutter, chief financial officer at the software company Egnyte.

According to WeWork's S-1 filing, WeWork's parent company, We, posted a loss of $690 million on $1.5 billion in revenue in the first six months of 2019.

WeWork had a partial ratchet mechanism in its deal with Softbank, its S-1 shows (on page F-115). In fact, in a blog post, the IPO research firm Renaissance Capital projected that if WeWork went public at a market cap of less than $14.5 billion after an IPO, that could result in the world's largest IPO ratchet. Softbank shareholders would be issued more than $400 million worth of additional shares.

In the event of a bankruptcy and liquidation, employees with equity would get paid last

In the event of bankruptcy and liquidation (meaning the business cannot be reorganized and must sell its assets to pay back creditors), employee equity gets paid last.

According to Adam Augusiak-Boro, a senior research associate at secondary-market platform EquityZen, bankruptcy professionals like lawyers, bankers, and consultants typically get paid first. Creditors get paid next, followed by preferred equity holders, and then common.

"In a true liquidation," Augusiak-Boro wrote in an email to Business Insider, "I would imagine the equity gets $0, as all of the creditors will likely eat up all the value of the business." That said, he added, there are many ways to restructure a business that don't involve bankruptcy or liquidation.

For example, Augusiak-Boro said, "WeWork can sell off assets that are non-performing or may not make sense for WeWork's business, and then use those proceeds to pay down debt or fund growth." The result might be a glimmer of hope for employees.

Augusiak-Boro added, "If the asset sales are successful — meaning unproductive assets are converted into cash for either delivering the balance sheet or funding growth of WeWork — the equity value may increase."

Even savvy employees might not know what to ask about their equity grants

The real problem with preferred shares, according to Robinson, is that "these deals are not always communicated perfectly" to everyone in the company — namely, employees.

Generally speaking, Sutter said, investors have more access to financial information about the company than its employees do. And while most employees at tech startups aren't naive, Sutter said, "people get caught up in the emotion of an exciting new technology or business and don't necessarily ask the right questions."

Robinson agreed. Private money can be hard for rank-and-file employees — even savvy employees — to understand, he said. Specifically, they might not know the order in which money is paid in a downside scenario.

When employees hear that the business is now worth half of its previous valuation, for example, they might be "distraught," Robinson said, because they assume that the value of their equity is cut in half, too. What employees might not know is that all of the money the company raised goes back to preferred investors — potentially leaving employees with nothing. "That fuels a notion of, 'I got screwed,'" Robinson said.

Still, employees at WeWork — or at any other high-profile tech startup — may get some money if the company goes public at a relatively low valuation.

According to Augusiak-Boro, the earliest hires have the lowest strike price (the price at which they can exercise their options), so their shares may still be worth something. And after the company goes public, employees may choose to hold onto their shares, in the event that the stock price increases.

Founders should be able to prove to job candidates that their business model is sustainable

In the wake of WeWork's downward spiral (plus other recent tech IPO disappointments including Peloton, Uber, Lyft, and Slack), Robinson anticipates that current employees at tech startups are going to think more carefully about where they're working.

These people are going to start wondering, Robinson said: What's similar between my company and WeWork? What does it mean to raise a lot of money and have a high valuation? Does it reflect the company's potential?

For aspiring tech startup employees, the takeaway is simple.

"Buyer beware," Sutter said. Too often, Sutter added, employees think the company founders and management are smarter than they are.

But if they can't prove to you that their business model is sustainable — specifically, that this company is going to make money — it could be a red flag. "If they can't break the business model into some pretty simple axioms," Sutter said, "you potentially have a problem. It shouldn't be that complicated."

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