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Is Due Diligence Making A Comeback?

CNBC asked a simple question last night, "How did WeWork go from a $47 billion valuation to near bankruptcy in just 6 weeks?" The answer is pretty simple as well. Investors aren't doing due diligence. Due diligence is defined as "research and analysis of a company or organization done in preparation for a business transaction."

The signs that WeWork was grossly overpriced all along were obvious to many intelligent observers for a long time. The valuation kept growing, though. The company's revenues and valuation increased at essentially the same rate since 2016, with both metrics approximately tripling. Investors didn't care as they sold it as a technology company, when in reality WeWork is a landlord who loses a lot of money renting office space.

To be fair, WeWork isn't the only company that has been grossly mispriced in the current environment. It's just the biggest and most notable company to be outed thus far. For example, electric scooter startups Bird and Lime keep getting VC money as they have unproven business models. Bird, which just raised money at a $2.5 billion valuation, is said to have lost $100 million on $15 million in revenues during the first quarter this year. A recent analysis showed Bird may be losing much more than $293 per scooter after factoring in various fees.

For VCs and early investors of these money-losing companies, the goal is always a profitable exit, whether that's an IPO or an acquisition. As long as another investor comes along allowing the one before it to get out with a profit, no one will pay too much attention to due diligence. You could even argue taking some of these companies public isn't much different than a Ponzi scheme. The recent flops of high profile IPOs such as Uber, Lyft, Chewy and SmileDirectClub, have shown the final investor, the public markets, are realizing the valuations don't match the economics.

Of course, some of these companies could end up being worth multiples of what they are now. However, the list of companies where the valuation and the ability to generate profits is inversely related continues to grow. With a record 21,380 freshly minted CFAs, we suspect WeWork won't be the last company to have its valuation succumb to due diligence.

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