About Square

Square is a startup based out of San Francisco that provides Point-of-sale (POS) services across the world. The central premise of Square is to enable small and medium sized businesses to process card based payments at a low and transparent cost. This is achieved through utilizing mobile devices and an app based system. One particular device enabling these services is a credit card reader that plugs into the headphone jack of a cellphone or tablet. Combined with a constellation of compatible devices such as wireless barcode scanners, receipt printers and registers, Square provides a flexible and mobile solution to businesses. Clients utilizing Square’s services are charged 2.75% per transaction for Visa, MasterCard, Discover, and American Express, and 3.5% plus 35¢ for manual entries. Included at no charge are business analytics, digital and physical receipts, as well as an optional inventory management system.

Square additionally provides financing and payroll services for business, as well as a mobile app that allows individuals to send each other money at no cost to themselves.

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Square is the creation of Jack Dorsey and Jim McKelvey who in 2008 came up with the idea for Square. The name is a reference to both the shape of the card scanner as well the expression “To square up one’s debts”. The Current CEO is Jack Dorsey, who is also concurrently CEO of Twitter. On Square’s board are Dorsey and McKevley themselves, former US Treasury Secretary and Harvard University President Lawrence Summers, former CFO of Goldman Sachs David Viniar, and businessman and NBA hall-of-famer Earvin “Magic” Johnson.

 

The Offering

On October 14th, Square submitted an S-1 filing for an initial public offering. The IPO seeks to raise a maximum aggregate offering of $275m from investors.

In the face of Square’s IPO plans, the big question on everyone’s mind is: What is the business really worth? The funding gathered by Square in 2014 implies a value of $6bn. However, embedded in this price and only recently revealed in the S-1 filing, is the promise to the institutional investors of fall 2014 a guaranteed return of 20% in the IPO. The effect of this agreement to past investors is that if the IPO price is below $18.56, they will be compensated with additional stock. This puts the $6bn valuation, based on a share price of $15.50, in a slightly different light, and raises some questions regarding conflict of interest on the investors’ side.

The following is a list of Square’s previous series funding:

• Series A, Nov/2009: $10m (First Round Capital, Khosla Ventures)
• Series B, Jan/2011: $27.5m (Sequoia Capital, Visa)
• Series C, Jun/2011: $100m (Kleiner Perkins Caufield Byers – VC firm, Menlo Park)
• Series C, Dec/2011: $3m (techcrunch.com)
• Series D, Sep/2012: $200m (CrunchFund, Starbucks, Rizvi Traverse Management)
• Debt Financing, Apr/2014: $100m (Barclays, Goldman Sachs, JP Morgan, Morgan Stanley, Silicon Valley Bank)
• Series E, fall 2014: $150m (Goldman Sachs, JP Morgan Chase, Rizvi Traverse Management, GIC)

Despite the stock arrangement previously mentioned, the value has gone up significantly since fall 2014. As of Wednesday’s regulatory filings, the company would offer up to $275m to investors, in an offering expected to be priced at $18 per share, valuing Jack Dorsey’s payment startup around $7.5bn.

 

Valuation

The IPO comes in an unexpected period, when several startups are taking advantage of a huge amount of private capital available and are increasingly worried about stock market fluctuations. For these reasons the market for tech IPOs is not as hot as it was in 2014, with 22 offerings in Q3 2015, compared to 53 in Q3 2014.

Looking more closely at recent IPOs in the industry, taking Square’s closest peers, it’s clear that subscribing the offer can turn out to be a bad deal, given the track record of IPOs in the industry. Market prices of Alibaba, Twitter, Facebook and Zynga all plunged during the first 12 months as public companies.

Businesses that had difficulties in being profitable while private, like Groupon and Zynga, had disastrous performances immediately after being taken public, while LinkedIn, having posted several profitable quarters ahead of its IPO, and Facebook, having been profitable on an annual basis before the offering, have provided good returns to their equity investors. Furthermore, valuations were highly distorted: despite its profitability, the offering size of LinkedIn ($352m) was around half of Groupon’s $700m and a third of Zynga’s $1bn, even if the e-commerce and the developer were constantly reporting losses.

To sum up: investors might be reluctant to invest in Square’s IPO for different reasons:

1. All five large tech IPO of the boom had poor performance in their first twelve months of trading
2. Only companies that were profitable while unlisted (LinkedIn and Facebook) showed satisfying return to investors
3. Square is a company in transition: still losing money but with a double digit growth rate

Square’s recent reports show a revenue surge, coming mainly from point-of-sale services, of 54% in 2014 to $850m, while in 2015 the company has reported H1 sales of $560m, up 51% compared to the same period of the previous year, and will probably exceed $1bn for the full year 2015 figure. Margins are growing as well, with a gross profit margin of 36%. Losses, between 2013 and 2014, grew from $104m to $154m, remaining steady in H1 2015.

 

Conclusion

Despite its innovative character, the business model and the company structure show some relevant risk factors. The growing gross payment volume of around $24bn in 2014 caused growth of frauds as well, which amounted to $6m in the first quarter of 2015, posing a serious threat on the company’s ability to provide effective safety measures. Furthermore, it is uncertain if the company will be able to retain its top executives like Dorsey, whose energy could be entirely drained by Twitter, or if the IPO is just an exit opportunity for the successful entrepreneur.

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