The We Company’s postponed effort to raise public capital has generated a storm of controversy.

One columnist even called the proposed stock offering “dangerous,” stating that “the banks that underwrote the IPO will have collected hefty fees. The only losers will be the public investors that allow themselves to buy this overpriced and extremely dangerous stock.”

Why has an office-leasing company generated such heated rhetoric?

Founded in 2010, WeWork, The We Company’s main coworking business, has never had to weather a recession. However, with the August release of its prospectus for its initial public offering, many are wondering if the company will be able to stay afloat when an economic downturn eventually arrives. 

As part of its due diligence disclosures to investors warning them of the risks associated with its business, The We Company’s filing said

While we believe that we have a durable business model in all economic cycles, there can be no assurance that this will be the case. A significant portion of our member base consists of small- and mid-sized businesses and freelancers who may be disproportionately affected by adverse economic conditions.”

Unfortunately, it seems like we might find out the answer sooner rather than later. Recent economic indicators show that a recession may be right around the corner: In August, the yield curve between the 10-year and two-year U.S. treasury bonds inverted for the first time since 2007. Wall Street analysts say that this is a harbinger of a recession that is about 18 months away. 

With that in mind, here’s an in-depth look at The We Company’s business model and the different factors that could affect the industry giant if the economy goes south. 

What’s concerning about The We Company’s long-term stability

Mismatch between lease terms

There’s a fundamental flaw with The We Company’s business model of offering freelancers and small-to-midsize businesses flexibility by providing them with short-term lease options, which often operate through month-to-month agreements.

WeWork’s customers benefit because they don’t assume the risk that comes with signing a long-term lease. With traditional commercial transactions, lessees find the property, finance the improvements, and obligate themselves to a long-term lease. This is both risky and expensive for a new startup. By only paying a monthly fee, small companies can hedge this risk: After all, they can cancel their subscription at any time.

With WeWork’s own lease holdings, however, it’s a different story. The average lease term on the buildings that the company renovates and rents out is 15 years, according to this The New York Times report.

To date, The We Company’s pre-IPO filing revealed that it has paid more than $268.3 million in cash deposits to landlords and used another $183.9 million of surety bonds as a form of insurance on their leases. In addition, $4.5 billion worth of rent payments are backed by corporate guarantees and $1.1 billion are backed by bank guarantees.

That said, those numbers aren’t even a drop in the bucket compared to what the company owes in total for its lease terms. According to Forbes, 71 percent, or $24.1 billion, of The We Company’s operating lease obligations are due in 2024 and beyond. While these long-term lease obligations ultimately allow The We Company to offer cheaper rents, which it can pass on to members in the form of competitive pricing, they could also be the company’s undoing. 

When a recession eventually hits, The We Company will still be locked into these long-term leases, yet there is a strong possibility that it will be unable to sell enough memberships to cover its rental expenses.   

“A recession would be very, very bad news for WeWork,” John Engle, President of Almington Capital Merchant Bankers, told Inman. Almington Capital Merchant Bankers is a venture capital and private equity firm based in Bull Valley, Illinois. “WeWork has thrived by being able to raise billions of dollars from private markets. That’s the only way it can grow and sustain itself.”

Indeed, The We Company has raised billions of dollars to fuel its expansive growth. However, it’s mostly from one investor: Softbank Group, a Japanese multinational conglomerate. To date, Softbank has invested a total of $10.65 billion into WeWork, giving it a 29 percent stake in the company.

While The We Company has been able to land the backing of Softbank, garnering the same type of public support has proved difficult. Amid the scrutiny following the unveiling of its prospectus, The We Company reportedly plans to more than halve its valuation to somewhere below $20 billion — down from an initially optimistic $47 billion.

If would-be investors aren’t buying into The We Company’s business model at a time when the economy is still strong, it’s unlikely they’ll do so when the downturn hits.

As Engle puts it: “[WeWork’s business model] operates under the assumption that there will be billions of dollars worth of fresh capital readily available every few months in order to keep the machine turning over. In a recession, people are much less willing to hand out money and much more fearful of high-risk, high-growth stocks. In that scenario, cash — WeWork’s lifeblood — basically runs out.”

John Heine, a commercial real estate broker in Omaha, Nebraska agrees.

“There is definitely demand from companies to have swing space and the flexibility to move quickly into a short-term lease,” he observes. However, “having a longer primary lease term coupled with short term subtenants in a recession or contracting office space environment may create a challenge for the WeWork model.”

What WeWork is doing to strengthen its business model 

The We Company is working to cushion the blow of an economic slump.

Going after enterprises

In an effort to solve the issue of the lease mismatch, The We Company has started to go after bigger companies. Larger organizations are attractive because they tend to want to sign longer lease terms, bring in more tenants and generate a larger source of revenue overall.

In the prospectus, The We Company says that 40 percent of its membership is currently made up of these so-called “enterprise members,” or companies with 500 or more full-time employees, a number which has doubled in size since March 1, 2017.

However, this past May, Bloomberg reported that The We Company had quietly altered the definition of its enterprise membership to include companies with 500 or more members rather than the original 1,000 or more.

Still, too, the fact remains that even with its enterprise membership under this definition growing to a robust 40 percent, The We Company is still beholden to a majority of freelancers and startups. Until those numbers change even further, investors will continue to call into question its long-term solidity. 

Shifting to co-management deals 

The We Company has also been trying to find additional ways to move away from its mismatched lease term problem. In late 2017, it started shifting from leases to co-management deals with the advent of its Powered By We concept. 

“With [Powered By We] the company comes in and offers WeWork-like services as a property manager,” explains Clelia Warburg Peters, President of Warburg Realty in New York City and a  PropTech Investor. “They’re offering coworking as a service so they don’t have to take on the lease-related risk.”  

The services Powered By We offers include designing and constructing an existing office space to fit in with the We Company’s image with the client paying for these renovations. Once the construction is done, the client buys into a “cultural management subscription” at a yearly fee that gives them access to WeWork’s brand partnerships and onsite perks like coffee and snacks. 

The prospectus points out that Powered By We has generated a revenue increase of $63.6 million at the time of its unveiling. According to a statement that The We Company’s former CFO and managing director of WeWork Asia, Christian Lee gave TechCrunch, co-management and Powered by We are also a major driver behind the company’s expansion in the region. It’s possible that building on this particular income stream could bring some much-needed stability to the brand. However, its initial efforts haven’t been profitable, according to the Wall Street Journal.

Expansion of the We Company Brand

Lastly, the company is taking steps to diversify. Rather than just offering sleekly designed workspaces with kombucha on tap, the We Company has expanded into the following offerings:

  • WeLive: A short-term co-living space aimed at entrepreneurs 
  • WeGrow: An elementary school with a “conscious entrepreneurial” alignment
  • Rise by We: A wellness studio designed to offer “a complete wellness experience”
  • WeMRKT: A retail space, which sells products sold by WeWork’s partner brands 

To Almington Capital’s Engle, these moves into different sectors is as natural next step. “The We Company can’t afford to stop growing at the unprofitable rate that it’s growing,” he believes, “because that would compromise its already tenuous positioning.”

The bottom line

The We Company’s IPO filing has left many people wondering if it will end up like Regus, which is now known as the International Workplace Group (IWG), when the next recession inevitably hits. 

Regus was founded in 1989 with the intent to provide business owners with affordable office space. The business was successful until 2003 when the dot-com bubble burst and Regus’ U.S. holdings collapsed under the weight of its long-term lease obligations, ultimately causing bankruptcy.

While only time will tell if The We Company will follow in Regus’ path, the only clue, as in many cases, will come from the company’s leadership (or lack thereof). As Clelia Warburg Peters puts it: “[In a recession, WeWork’s fate will be] a story about the particular leadership group behind the company and the choices that they’ve made. It is not a story about the lack of interest in this model.”

IWG has come back from the bankruptcy and is now turning a profit. Since the bankruptcy, IWG has reworked its business model to focus on franchising office space, which allows it to generate fees without having those dangerous long-term lease commitments.

Andrew Helling is the founder and editor at REthority in Omaha, Nebraska. Connect with him on LinkedIn.

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