I'm in Venture Capital. What Should I Look For?
Venture capital indeed fills a gap in finance because, when you have a company with great potential that requires a large amount of money to grow, banks primarily lend money based on actual financial data and not on possibility.
Anyone who believes that in Silicon Valley, there are no second chances need only look at what is happening with Adam Neumann, the 43-year-old Israeli entrepreneur who in 2010 co-founded WeWork, the coworking firm of which he was chairman and which came to be valued at $47 billion, and which he was forced to resign in 2019.
Anyone would have thought that was the end of Neumann, both because of the failure of WeWork's IPO and because of his leadership that included frequently renting a plane to go surfing in Hawaii accompanied by an entourage that went with him everywhere, among whom was a stylist for him and his wife.
But Adam is back. Only now does he intend to revolutionize the apartment rental market in the United States, a country where housing is scarce, which is starting to become attractive to venture capitalists. Neumann aims to generate strong neighborhood ties for a generation that believes it is impossible to buy a house when the pandemic has transformed work. Young people no longer have to move to a new city after finding a job. His idea is to reach out to young professionals renting apartments in some of the most vibrant cities, redefining the future of housing.
Since the early 2020s, small companies linked to Neumann have acquired more than 4,000 newly built apartments in several U.S. cities and some suburbs. Nashville, Tennessee, for example, acquired a 268-unit block that has among its amenities a saltwater swimming pool, a special trash collection service, and a private park for neighbors to walk their dogs. Another development, in Fort Lauderdale (Florida), allows renting rooms within its 639 apartments and includes an art area for the enjoyment of neighbors and an outdoor cinema.
Neuman's return is backed by Marc Andreessen, one of Silicon Valley's most important investors, who has backed Neumman's new company, Flow, with an investment of US$350 million, which will begin operations at the beginning of next year.
Andreessen said in his blog: "It's only natural that this is his new venture after WeWork. Adam returns to the theme of connecting people while transforming physical spaces and building a community where people spend most of their time: their homes." He also referred to Neuman as a "visionary leader capable of changing paradigms."
A Little History
Twenty years ago, when Adam Neumann was a student at Baruch College in New York, he pitched an idea called "Concept Living," a communal twist on apartment rentals that sounded like a residence hall for students or urban professionals, to a start-up competition. His professor quickly dismissed it, with the explanation that no entrepreneur could raise enough money to change the way people live.
Neumann abandoned the idea but launched other ventures that were failures, until he founded what he called another kind of physical social network - WeWork, the co-working business whose rise and fall would become synonymous with the hubris of startups.
Neumann caught the attention of investors and the media almost as quickly as his company did. Passionate about his plans to create a work culture that was more than just a place for people to work, he set about creating an advertising concept around the WeWork brand, encouraging people to work hard and party even harder.
His concept brought office rentals the availability of beer, rides, and flexible time, breaking up the monotony of work. WeWork expanded rapidly and soon had more than 50 locations in the United States, Europe, and Israel. With the success of his "We" concept, he began to envision a "universe" in which behavioral patterns would change in gyms, homes, and even schools.
With WeWork, he raised so much money that, in 2016, Neumann revived the idea from his student days, but now under the name "WeLive." The proposition was to offer monthly rentals in apartment buildings with pool tables and communal kitchens, to a generation that only had the best prices outside major U.S. cities.
WeWork's value soared to $47 billion, but Neumann's behavior and the mistakes he made plummeted its value. Among his mistakes, he famously trademarked the "We" brand and sold it to his own company for nearly $6 million, although he ended up returning the money to the company after this deal was revealed during the company's IPO attempt and was subsequently criticized by investors and the public.
In addition to failing to get WeWork to go public because it was so complicated, Silicon Valley and Wall Street investors ended up paying Neumann a huge exit package, worth about $1 billion, as long as he would leave the company.
The New Project
Anderssen's financing for Flow, a company whose most visible presence is a one-page website with a pastel logo and the words "coming 2023," marked by the same ambition that spawned WeWork, carries a valuation of approximately $1 billion.
Referring to this deal in a blog post, Andreessen expressed that what Neumann has planned is nothing less than "a direct hit" to the heart of the world's largest asset class: residential property, amid a crisis that Neumann himself explained as follows: The U.S. has a chronic housing shortage that between 2018 and 2020 went from 2.5 million to 3.8 million homes, and it is not building fast enough. The laws of supply and demand mean that housing prices are rising faster than wages, and at the same time, we are dealing with a young cohort that was once identified as Generation We but "is almost Generation R because they need to rent."
So Neumann invested hundreds of millions of dollars in buying rental apartment buildings in cities like Austin, Miami, and Nashville, whose popularity among that demographic only grew with the pandemic. He saw in them a "tremendous" opportunity to make them more livable for tenants striving for a better quality of life: "I felt there were better ways to operate the buildings. And I felt that, frankly, there was room to make more community."
For his part, Andreessen expressed fears about the loneliness faced by people with little interaction with their neighbors and felt that only a radical change in how real estate operates could solve the problem. He saw Flow as combining "an experience-focused, community-oriented service with the latest technology," as the project considers an app where tenants could make payments and access services and events.
He also hinted that Flow might have a larger goal: to rethink a decades-old rent-to-own model that supposedly makes it easier for tenants to become homeowners but has been plagued by predatory practices. "You can pay rent for decades and still have zero equity, and that's why the entire value chain needs to be rethought, from how buildings are purchased and owned, to how residents interact with their buildings, to how value is distributed among stakeholders."
Andreessen acknowledges that Flow's mission is "a heavy burden," but accepts that the size of its ambition is what attracted him. "Only projects with such lofty goals have the potential to change the world," he said, and Neumann was the only person who had built a global business that "changed the paradigm" while turning a similar industry upside down.
While it is not yet known how Flow plans to engineer that change over the number of properties it will own, nor how Andreessen's investment has been structured, one of the buildings reportedly purchased by Neumann already offers a music room for jam sessions, a "bark park for dogs" and a "trash pickup service"; another building allows tenants to "live the lifestyle they deserve," with a rent-by-the-room system, an outdoor movie theater, and a "lawn art area."
The investment marks Andreessen's second show of support for a Neumann-founded company in a year: in May he invested $70 million in Flowcarbon, Neumann's blockchain-based carbon credit platform, which appears to have no connection to Flow. Interestingly, Andreessen's blog post calls Flow the "first Neumann company since WeWork."
With the VC world awash in cash, the pressure to find bigger and bigger bets has increased, even as the collapse of tech stocks cast doubt on private company valuations and threatened to cut off the flow of new fundraising.
venture capital firms had a record $290 billion to invest, according to PitchBook, up nearly $60 billion from the end of 2021. Andreessen alone has raised a whopping $14.1 billion this year for investment vehicles ranging from specialized cryptocurrency and biotech funds to more traditional venture and growth funds. That's about the same as the previous seven years, according to data compiled by Crunchbase. These numbers make markets as large as housing more tempting for venture capital firms.
Andreessen, who made his name as the inventor of the first Web browser while still a college student, is known for making big bets on bold ideas. He had already made a smaller bet with FlowCarbon, a separately managed company launched by Neumann and his wife Rebekah, whom the former actress once described as her "strategic thinking partner."
Revamping the rental real estate market is not a unique idea. With more than $100 million in venture capital investment, common is a home-sharing company that acts as a property manager for a collection of apartments and houses. Its co-founder, Brad Hargreaves, says, "Venture capital firms (if you can call them that these days) have a lot of capital to deploy, and it's clear that massive change in some industries won't come through light-touch software innovation alone."
Regarding Flow, he expressed that the deal is not likely to be structured as a traditional venture deal, although it is unclear what percentage of the check would be debt financing versus equity financing.
News of the new funding to Neumann also generated views on inequality in venture funding, especially as this year's fundraising figures highlight the continued disparity in investments toward companies whose entrepreneurs are women or come from underrepresented communities.
The deal has also sparked mixed views among early-stage investors, whose job is to back atypical entrepreneurs with a strong chance of success. Some say this is the exact point of the venture asset class - to back bold entrepreneurs - while others point out that Neumann's second chance comes as women and African-American entrepreneurs struggle more than ever to raise seed capital.
Kate Brodock, CEO of Switch and general partner of the W Fund, called the Andreessen-Neumman deal "disgusting:" "This is one of the biggest and most remarkable firms out there, and I just can't understand. It's as if someone woke up and said, how many boxes can I check that just set us back?"
Allison Byers, the founder of Scroobius, a platform that aims to diversify startups and make founders more venture-backed, described feeling a muted rage: "There's an undercurrent of acceptance and almost learned helplessness. Or like a trauma, we've all experienced so much that it doesn't have the same impact anymore." He said, "This all seems new and horrifying to those who have opened their eyes to the systemic problems of Venture Capital funding in the last two years, but we have been dealing with this forever."
Several investors said Flow's substantial funding reflected their industry's bias against minority entrepreneurs. While Neumann has raised hundreds of millions of dollars for his startups despite WeWork's problems under his leadership, many women, African Americans, and Latinos struggle to attract even minuscule funds.
The 90 pre-seed and seed-stage companies founded in the U.S. by black and Latino entrepreneurs that disclosed their funding rounds this year have raised $225 million, with an average round of $2.5 million. Companies with black entrepreneurs in the U.S. also raised just 1.2% of total venture funding in 2022, according to Crunchbase data.
Overall, so far in 2022, U.S. startups raised an average of $4-6 million in seed rounds, according to PitchBook. In this regard, Robert Kazanjian, professor of management and academic director of the Roberto C. Goizueta Center for Entrepreneurship and Innovation at Emory University, expressed that "This is evidence of the challenges facing minority founders. Much of that concern the structure of the personal networks that venture capitalists assemble."
Many critics have expressed that investors often treat minority entrepreneurs as unacceptably risky bets, even compared to other entrepreneurs with not-so-good track records.
Kate Brodock, a general partner at venture capital firm W Fund, said on social media, "Companies like this perpetuate time and time again a traditional system that favors a small, homogenous set of entrepreneurs." For his part, Mac Conwell, managing partner of RareBreed Ventures, wrote on Twitter: "In times of economic downturn, delivery people go back to what they consider safer. You'd get fired faster for investing in underrepresented entrepreneurs than you would for investing in Adam Neumann and his WeWork fame."
Charlie O'Donnell, founder and general partner of Brooklyn Bridge Ventures opines, "They give Adam credit for building a great community at WeWork, even though WeWork was always known for being an uninspiring place to work. They accept a certain reputation that has nothing behind it other than Adam's bragging." He was also skeptical that Flow could meaningfully address the problems with housing, despite Andreessen's ambitions.
Even as more diverse entrepreneurs bemoan the overwhelming sums of VC funding that continue to flow to white, male-gendered entrepreneurs, whatever their past mistakes, Andreessen was touting the value of past failures: "We love to see repeat entrepreneurs build on past successes, growing from lessons learned. For Adam, successes and lessons are plentiful."
And you… What do you think?
If you are a venture capitalist, would you give a new opportunity to an entrepreneur who has previously failed?
If you are an entrepreneur who requires a venture capital investor, what would you give more weight to the purpose of the investment or the expected returns?
Venture capital indeed fills a gap in finance because, when you have a company with great potential that requires a large amount of money to grow, banks primarily lend money based on actual financial data and not on possibility. But, on the other hand, the venture capitalist usually buys a stake in the startup to sell it in the future at a much higher price achieving a great return. What do you think about this? What is your personal experience?
The attractiveness of venture capital funds stems from the high return on investment. On average, in their best quarter, private equity funds have generated returns of 29% over the last 15 years. But it is important to know that the returns of private equity funds vary a lot from one to another, so you have to do thorough research about the fund before investing in it. For example, what level of returns would you like to obtain if you are an investor?
In addition, investing in a venture capital fund is complicated because you have to do it at the time when the fund is set up. The minimum investment is large. Did you know that to invest in a venture capital fund, you must be in the investment or startup ecosystem to invest in a venture capital fund? Keep in mind that they are illiquid funds and that it is a long-term investments.
Remember: if you are a Venture Capital fund, you must consider the purpose of the investments and not only consider the returns when making investments.
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