Is SoftBank Losing Its Vision?

It’s hard to overstate how much SoftBank’s Vision Fund has transformed venture capital. When it was introduced in late 2016, it was heralded as a new paradigm for VC investing. The Vision Fund started with US$100 billion in the bank – with is roughly equal to the sum all US VC firms raised in the previous two and a half years, combined.

By early 2019, SoftBank disclosed that it had deployed approximately 80 percent of the megafund. There were talks about raising a comparably-sized, US$100 billion-worth Vision Fund 2. SoftBank was riding high, with investments in disruptive, high-profile tech companies like Uber Technologies, ARM Holdings, and India’s Flipkart. SoftBank’s forward-thinking founder and CEO, Son Masayoshi, was lauded as a ‘genius’ and an aggressive dealmaker –  as well as being the richest man in Japan.

Then came WeWork’s implosion.

Suddenly, an uncharacteristic wave of introspection flooded the VC market. Investors and banks were taking a good, hard look at many of their supposed high-flying tech startups – and they’re not liking what they see. After WeWork, other startups like connected fitness firm Peloton and online talent agency Endeavor either debuted with disappointing results or scrapped their IPOs altogether.

SoftBank’s aura of invincibility was shattered, resulting in its first quarterly loss in 14 years. This was largely due to its US$9 billion loss at the Vision Fund, exacerbated by WeWork’s car crash and subsequent bailout. Son admitted poor investment judgment, while turning a blind eye to WeWork’s problematic CEO, Adam Neumann.

But SoftBank’s bad year started in May – several months before WeWork’s unravelling. Uber, one of the Vision Fund’s star investments, had a disappointing IPO, as did another one of SoftBank’s investees, Slack Technologies. 50 percent of the Vision Fund’s holdings are in transportation logistics and real estate, making it a poor hedge against market volatility.

All this begs the question: is SoftBank losing its vision?

Strategic Vision?

As SoftBank states on its website, “To realize its SoftBank 2.0 vision, the SoftBank Group has been constructing a strategic synergy group by investing in innovative technologies and entrepreneurs that are pioneering the future.”

The Vision Fund’s largest investments seem to fit that vision: ride-sharing service Uber, smartphone chipmaker ARM, and GM’s autonomous car project Cruise. But some others feel a bit of a stretch, like food delivery platform DoorDash, fitness platform Gympass, dog walking service Wag – and short-term office-leasing firm WeWork.

The deployment of 80 percent of its US$100 billion fund is exceptionally quick, even by VC standards. This could be due to its structure, where all outside limited partners (LPs) are promised a 7 percent annual coupon on their invested capital. This is a unique structure in the private equity industry where outside investors expect to receive participation in a fund’s performance but not a guaranteed annual dividend. Around US$75 billion of the Vision Fund comes from outside LPs like sovereign wealth funds of Saudi Arabia and Abu Dhabi.

SoftBank created the coupon as a marketing tool, knowing it would be difficult to get investors to bite on such an out-sized fund. But it also assumed that the coupon could be entirely paid for via distributions – something that hasn’t yet happened.

As a result, the need to pay this substantial annual dividend could impact how the fund is managed. Partly due to this, the Vision Fund has adopted an aggressive investing strategy hitherto unseen in VCs. No other investor has been as obliging as Softbank in writing massive checks to young companies, giving them the financial firepower to outcompete their rivals while pumping up their valuations – while crowding out other VCs. After all, it has a war chest larger than most VCs themselves are worth.

While these tactics have helped the Vision Fund deploy most of its capital quickly, it might be challenging for them to support their portfolio companies going forward. Son has stated that rescuing WeWork was a one-off situation, suggesting SoftBank won’t be doing that for other portfolio companies. But it may be difficult for these companies as the economy slows and private equity financing markets become less receptive. This stands in contrast to other VC firms who leave a certain amount of their funds “powder dry” to support their existing portfolio companies. With over 80 percent of the Vision Fund’s s capital already deployed, how will it do this?

Existential Questions

Analysts and investors are beginning to question the models on which SoftBank and the Vision Fund have built their reputation: spending big, prioritising growth above profitability, and backing charismatic founders who promise transformative change.

Valuations driven in part by the promise of an unending supply of capital now look increasingly fragile as SoftBank struggles to stem the losses and keep the money flowing. For the companies that accepted SoftBank’s investments, that raises existential questions. But the impact reverberates even further, affecting the entire venture industry and young startups everywhere.

Even other VCs have a complicated relationship with SoftBank. Although the Vision Fund often outmuscled and outspent them, they were beneficiaries of the inflated valuations brought on by SoftBank’s spending. They could mark up the value of their own investments, while still appearing more conservative than SoftBank. They also targeted SoftBank as their exit of choice when they were ready to take profits, since the Vision Fund offered higher valuations than any available in the public markets.

With SoftBank likely to take a more conservative position following the WeWork debacle, the promise of endless capital is likely to end. Following the announcement of its quarterly losses, Son warned, “I want to make it clear that firms that accept SoftBank investment must be self-sustaining.” Consequently, it is expected that valuations will fall, leaving the field open to companies which are able to clearly articulate their financial sustainability.

A Vision for the Future

Son Masayoshi has previously stated a 300-year growth plan for SoftBank. The Vision Fund is Softbank’s first foray into managing private equity funds for investors.

But SoftBank’s models, as stated above all but encourage short term thinking and cash burn to establish ‘growth’. The unusual metrics that SoftBank prioritized at its portfolio companies, such as “gross merchandise value” – a figure which is not recognized by most generally accepted accounting principles – rather than unit economics or cash flow, meant that more disciplined investors looked askance at the balance sheets of many of the startups it backed.

SoftBank’s Vision Fund 2 has already raised around US$2 billion – a healthy amount, but far from the lofty promises made by Son in July where the second iteration of the Vision Fund would be bigger and better than the first. This time around, SoftBank has said it is taking more control, committing US$38 billion of its own capital. Crucially, Saudi Arabia’s Public Investment Fund and Abu Dhabi’s Mubadala Investment Co have yet to commit to Vision Fund 2. (They contributed US$45 billion and US$15 billion respectively to the first fund).

Nevertheless, an element of gambling is in SoftBank’s DNA. When the dotcom bubble burst in the early 2000s, Son and SoftBank were effectively bust. But they were saved by one investment which paid off spectacularly – that in Jack Ma’s Alibaba Group Ltd. Perhaps a few years down the road, when tough times are prevailing, one of the Vision Fund’s beneficiaries will come good. But speculation does not a vision make, thus companies should be judged by the metrics that matter most: profitability, cash flow, sustainability – and a resilient vision.