How Katerra’s Facade Crumbled

The revenue front-loading was one of multiple incidents that pointed to deep problems at the 5-year-old company. Those problems culminated in December when Katerra told investors it was running out of money. It was saved by its biggest investor, SoftBank, who injected money in a rescue financing that wiped out the stakes of other investors and slashed the startup’s valuation by at least 90%, from more than $4 billion to less than $400 million, according to letters sent to Katerra shareholders. Lawyers and venture capitalists said it was one of the most severe financial restructurings they could recall at a significant Silicon Valley startup.

Katerra told shareholders late last year that it had alerted the Securities and Exchange Commission about what it said were “weaknesses and irregularities” in the company’s financial practices, a reference, two people familiar with the matter said, to the revenue maneuver. The total front-loaded amount wasn’t material to the company’s finances, three people familiar with the matter said. The SEC is investigating the matter, a person close to the company said. An SEC spokesperson declined to comment.

Prominent Investors

Katerra’s problems are the latest to materialize at a high-profile company under the purview of SoftBank, the Japanese conglomerate that is the world’s largest technology investor. SoftBank’s reputation for mammoth investments in up-and-coming companies has been damaged by struggles at some of those firms, including the near-collapse of WeWork in 2019.

In an echo of its relationship with WeWork co-founder Adam Neumann, SoftBank was willing to support Katerra CEO and co-founder Marks for a number of years even though the company lacked a clear financial road map for success. SoftBank’s Vision Fund invested nearly $2 billion in Katerra, owned roughly 40% of the company before the recapitalization and had two board seats.

Based in Menlo Park, Calif., Katerra garnered attention by promising to bring Silicon Valley energy and ingenuity to a set-in-its-ways construction industry. By producing walls, roofs and other components in bulk in factories rather than at building sites, Katerra said, it could slash the cost of apartment construction. The Katerra formula also involved relying on centrally procured materials, similar to how Marks had handled the manufacture of products for Dell, Motorola and Microsoft while running electronics maker Flextronics 20 years earlier.

Marks told The Information in 2017 that his lack of experience in the construction industry would help Katerra shake up the status quo in the same way that Amazon changed retail or Airbnb transformed hospitality.

His credentials proved alluring for big-name investors, including SoftBank, as well as Foxconn, DFJ Growth, Greenoaks Capital, Soros Management Fund and Singapore’s sovereign wealth fund, GIC. Marks knew many of the company’s investors from previous business deals and lived close to SoftBank CEO Masayoshi Son in the tony Bay Area enclave of Woodside, Calif.

Katerra declined to make its current chief executive, Paal Kibsgaard, available for an interview. Kibsgaard was named CEO in May after having served as chief operating officer since 2019.

In a statement, the company said, “Katerra leadership is now focused on pursuing sustainable growth and profitability, with the aid of a well-capitalized foundation, reinforced financial discipline, strong execution capabilities, and a new team of seasoned executives.”

Missed Goals

Early on, there were signs that Katerra was promising more to potential customers than it could deliver.

Katerra executives regularly told the property developers who were its prospective customers that it could build apartments faster and for less money than a traditional contractor. Rob Hollister, president of real estate at the Sobrato Organization, a Bay Area–based developer, said Katerra told him in 2018 that it could build a 250-unit apartment building in Sunnyvale, Calif., for about 10% less than a traditional construction firm.

Katerra and Sobrato spent more than six months preparing for construction before the two sides decided to part ways because Katerra determined it wouldn’t be able to build the project for the agreed-upon price, Hollister said. “They were farther off their mark than they thought,” he said.

More recently, Katerra has worked on two projects in the Bay Area for Legacy Partners, a property developer that also invested in Katerra. One of the projects is a year behind schedule, said W. Dean Henry, CEO of Legacy Partners. In his view, Marks “was more of a salesperson than a construction guy.”

Katerra even stumbled in the work it did for the apartment developer run by one of its co-founders, Fritz Wolff. The executive chairman of the Wolff Company, one of the biggest apartment developers in the U.S., Wolff had known Marks for years.

Katerra agreed to build a slew of suburban apartment buildings in 2017 for the Wolff Company, at a 12% discount to current market prices. But with little experience as a builder, Katerra couldn’t lower its own costs enough to make up for the below-market offer to its client.

Problems piled up. Katerra’s factory struggled to get components out the door. Many of them required extensive rework after building parts were trucked to construction sites. Fritz Wolff complained to Katerra employees in meetings about long delays and the fact that the company wasn’t fixing the problems, said a person who was present. He later resigned from the Katerra board. A Wolff spokesperson declined to comment.

Matt Johnson, who worked on financial planning and analysis at Katerra from 2016 to 2020, said the company struggled to implement new accounting software and repeatedly underestimated the costs of construction.

Johnson was part of a group of employees who in late 2018 tried to get a grip on the company’s project cost overruns. “Every time we reviewed it, the costs would go up by a material amount,” he said. “People got too caught up in the vision and not enough on some of the really basic stuff in construction.”

Katerra’s losses hit more than $200 million in 2018, two people familiar with the matter said. The losses represent the amount of money that Katerra spent over the contract price for the property developments, and they don’t include the company’s overall operating costs.

Financial Disarray

Other issues raised concerns among some employees. Some on-the-ground workers were frustrated by what they perceived as wasteful spending at Katerra. Rod Luker left his job running his family’s general contracting business to help manage construction projects for Katerra in 2017. The company’s free-spending culture shocked him.

‘People got too caught up in the vision and not enough on some of the really basic stuff in construction.’

“Everyone seems to have a credit card, and there’s no accountability and people just run amok,” said Luker, who worked at Katerra until last year before deciding to leave. “I had never been a part of that.”

To boost revenue and bring in more-experienced industry hands, Katerra acquired 14 traditional firms involved in construction, design, lighting and renovations. Between spring 2017 and fall 2019, the company’s headcount grew almost sixteenfold, from 550 employees to 8,500.

As Katerra grew, employees felt the burden of the company’s financial disorganization. The company cycled through five chief financial officers in five years. Executives in charge of keeping track of project costs didn’t have financial information about the wall panels Katerra was building or the construction materials it was buying.

Meanwhile, the startup expanded its business globally—setting up a division to build housing in Saudi Arabia, where the government is Vision Fund’s biggest backer, and spending months planning to build an entire city in Indonesia at the behest of SoftBank’s Son before dropping the idea.

Carol Galante, a professor of affordable housing and urban policy at University of California, Berkeley, has been studying prefabricated housing construction and was watching Katerra for years. “I felt this way almost from the beginning—they were trying to do too much too soon. They didn’t understand the business,” she said. “They just went too radical.”

Boardroom Disputes

Yet Marks continually painted a rosy picture to the media. At least once a year, the CEO fielded variations of the same question: When would Katerra become profitable? “This isn’t a business where we have to keep raising money to fund losses,” Marks told The Information in 2017. In each of the next two years, he told reporters that profits were around the corner.

By spring 2019, investors were frustrated that Marks continued to avoid discussing serious business challenges in board meetings. Adam Fisher, a Katerra board member and hedge fund manager who had worked for Soros Fund Management, tried to convene an executive session with other board members to discuss issues with Marks’ management. Marks was furious when he found out about the meeting, a person familiar with the matter said.

Even Marks’ co-founders grew disillusioned. Katerra’s third co-founder, Jim Davidson, along with Fritz Wolff and Greenoaks Capital’s Neil Mehta, complained in board meetings that they weren’t getting complete information from Marks about the company’s performance.

SoftBank also started pushing for changes that year. SoftBank Vision Fund’s board representative, Jeff Housenbold, and other investors urged Marks to bolster his management team by hiring Kibsgaard, who was running oilfield services company Schlumberger, as chief operating officer.

Last spring, directors began agitating for Marks’ removal as the company continued to fall short of financial forecasts. As the board considered replacing Marks with Kibsgaard, Marks pushed back, saying he preferred a different executive. Board members, including representatives from SoftBank and Foxconn, voted to fire Marks last April and elevated Kibsgaard to the position of CEO a month later.

Katerra’s problems helped unravel the relationship among the company’s three founders. Davidson and Wolff no longer speak with Marks, people familiar with the matter said. Marks, along with Katerra’s former technology, marketing and finance heads, joined the venture capital firm he founded, WRVI Capital. Davidson didn’t respond to multiple requests for comment.

In the meantime, another issue was percolating. In early 2020, employees in the company’s renovations division were under pressure to boost revenue. Contractors such as Katerra who are hired by real estate developers typically must record revenue monthly—calculated based on their project costs plus a percentage so they can make money—before they can collect payment for the completed work. This practice is typical in construction and other project-based industries.

To hit revenue targets in the renovations division, employees asked Katerra’s subcontractors—electricians, plumbers and other specialized trades—to submit invoices for work that hadn’t yet been completed, a departure from standard practice. Katerra then used that tally of its project costs as the basis of recalculated revenue estimates that were millions of dollars higher than they should have been at that point in the projects. The work eventually was completed, and Katerra was paid for the work, a person familiar with the matter said.

The maneuver, which involved between 10 and 20 Katerra employees, a person familiar with the matter said, prompted a monthslong internal investigation after employees came forward. Last fall, at least two managers were fired following the probe. Another executive involved had already departed the company. Katerra didn’t find evidence that employees had overcharged customers. The company found that the front-loaded revenue made up less than 1% of Katerra’s total revenue, which was about $2 billion last year, people familiar with the matter said.

The Wall Street Journal previously reported that the company had investigated irregular financial practices and had fired employees as a result. In a note to shareholders last week, Kibsgaard said that in May 2020 the company had identified “potentially improper revenue-recognition practices” within its U.S. renovations business.

Shareholder Losses

By last fall, Kibsgaard had added two restructuring experts to the board. In a deal announced on Dec. 30, SoftBank invested an additional $200 million in Katerra. The deal converted investors’ previous preferred shares into common shares, and then reduced the number of those shares by a factor of 100,000. “That’s insanely draconian,” said Ed Zimmerman, a partner at law firm Lowenstein Sandler who represents startups. “I’ve never seen a 100,000-to-1 split. That zeroes people out in an unbelievable way.”

Some shareholders had extracted value well before the bailout. In 2018, SoftBank bought significant stakes from current and former Katerra executives, as well as earlier investors and co-founders. That same year, Marks sold shares valued at the time at more than $30 million, two people familiar with the matter said.

“Katerra was a bold experiment, and we learned a lot,” Marks said in a statement. “I will be forever grateful to the current and past employees who worked hard to disrupt an industry, and to SoftBank for their investment.”

In a statement, SoftBank said: “While the company’s vision is clear, for a couple years it missed on execution. Now under Paal’s leadership, we believe Katerra is well-positioned to rationalize costs and grow sustainably.”

SoftBank will own the majority of the company in the recapitalization. Other investors have until the end of June to decide whether they want to invest more money at the same price as SoftBank.