Square Prices Its IPO at $9, giving it a $2.7B valuation | Hacker News Reader

Square Prices Its IPO at $9, giving it a $2.7B valuation

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175 pointsjrbedard175 comments

From a second market type broker who trades private tech company shares (Oct 1st 2015):

''We have only 4000 shares of Square left at $16.50. I believe Goldman is going to price the IPO well north of $25 and the $16.50 is less than the price that Square is granting stock options to employees!''

A good reminder that people are making (and losing) a lot of money behind the scenes of our industry.

A combination of things are responsible - a super old/competitive market (processing), the ever changing risk dynamics and Square's targeting

Let me illustrate points 1 and 2 with an example.

a) Square earns $2 in revenue per $100 of transaction volume b) $0.5 would be their gross margin accounting for expenses i.e. bank/visa fees c) The next biggest line item to subtract would be risk. If there is a fraudulent transaction of $100, then square has to compensate it with 200 transactions of $100 each. (200 txns *0.5 gross margin). Net effect is not only do they have to deal with low margins, they also have to manage risk very well. And this is not something you accomplish overnight especially as you enter new markets. Personal anecdote: I had $120 or so disappear from my Starbucks wallet a couple of months ago and the merchant had to eat the loss.

Lastly, large payment processors get out of this loop because they manage the big (Targets and Walmarts of the world) with the small and over time have fine tuned their risk engine. Square went into it in the reverse order, targeting mom-and-pop stores first (which have low volumes and high acquisition costs) and then trying their hand at large merchants (Startbucks in this case and they lost a ton doing this). In the process they never got risk management right for either segment. And oh, they did not go with an online first strategy which PayPal did in the 90s and the likes of Braintree and Stripe did recently.

My 2c.

Square's fraud loss from their prospectus is 0.1%, which compares favorably to industry based on this Economist article: http://www.economist.com/node/21554743

I'm pretty sure Starbucks, the merchant, would have to cover the costs not square as the processor. I used to work at MBNA and when there was fraud on an card the retailer was responsible.

In this case Starbucks paid for it. But something similar could happen with a Square transaction where they may be held responsible. Was just making a point that there are costly lessons to be learnt in the world of processing.

I suspect it's not quite that simple. Square has a lot of small-to-medium businesses, who's risk profile is higher; which has to have a increased risk on Square, no?

Is anyone willing to give a contrarian take? I'll give it a shot: Square is an ambitious company with some great engineers, stellar UX and a giant total addressable market. Their business loans are interesting and could grow into something important. Square readers are a fashion accessory for hip businesses. No sooner would a coffee shop be seen without a Square reader and an Edison bulb than its yuppie hipsters patrons would be seen without a MacBook or an iPhone. That brand equity might really be worth something.

Coffee shops like Square because it offers one of the lowest rates for tiny under $10 purchases, not because it's "hip". It's a flat 2.75% without any additional $0.10-0.30 fee like some other processors. So a $4 coffee costs the merchant just 11 cents to charge.

Unfortunately this is because Square actually loses money on these sales, which you can confirm by looking at the public available interchange rates for Visa/MC.[1] Credit transactions start at around $0.11-12, and debit is a whopping $0.22.

There's other reasons too like maybe they find their bundled software easy to use or their signup process has less hassles, but they are practical reasons.

[1] https://usa.visa.com/dam/VCOM/download/merchants/visa-usa-in...

Square does high enough volume to negotiate better rates than you'd expect.

The size and strength of our payments and POS business have allowed us to develop a deep understanding of our sellers’ business performance and to build a cohesive commerce ecosystem. As such, we are well positioned to provide financial services and marketing services to sellers efficiently and intelligently. For example, one of our financial services, Square Capital, uses our deep understanding of our sellers’ businesses to proactively underwrite and extend cash advances to them. Although Square Capital is still in its early stages, we have already advanced over $225 million since launching it in May 2014. Square Capital demonstrates how our services can rapidly reach significant scale through a combination of strong demand and our direct, ongoing interactions with our sellers. Although Square Capital currently does not contribute a significant amount of revenue to our business relative to our payments and POS services, our software and data product revenue, including revenue derived from Square Capital, has grown quickly, and we expect these products will contribute a larger portion of our total revenue over time. Marketing services, such as Square Customer Engagement, give sellers easy-to-use tools to help them close the loop between communication with a buyer and ultimately a new sale. We currently see more than 1.5 million monthly feedback communications sent by buyers to sellers through digital receipts. Together, our financial services and marketing services provide sellers with access to capital and access to customers, making it easier for them to accomplish their goals. [0]

Transaction fees is a loss leader, but this isn't their business model. They'll make a majority of their profits on small business loans.

Example:

Local burger shop - I need a $10,000 loan to buy a new stove.

Square - Based on your commercial transaction history, we see you'll be able to pay the loan off in exactly 17.2 months. We'll give you $10,000 at $foo APR for 17.2 months.

[0] - Square S-1 https://www.sec.gov/Archives/edgar/data/1512673/000119312515...

Oh my... merchant account advance loans are the "payday loans" of the small-business world. Much like the 'payday loan' business, the rates usually end up being usurious, but if you are cool with that, there's certainly money to be made.

But... that's completely not what I thought square was doing.

True, but this type of loan has been around a long time in the payments world. These are loans of last resort and the other processors haven't been able to make them into multi-billion dollar businesses so I'm a little skeptical that Square can do it.

Your source, or is this pure speculation? Even Walmart can't negotiate Visa/MC interchange fees.[1] And they do ~400X Square's volume. It's not just a matter of merchant/processor size. Once enough consumers have adopted it as their primary/only card, the card network has an extremely strong position. (This is why AmEx rates are more negotiable; it's usually an alternate card.)

[1] They do lawsuits instead. http://www.reuters.com/article/2014/03/27/us-walmart-visa-la...

That lawsuit isn't about lowering the transaction rate, it's about collusion between credit companies to keep their rates in line with each other.

First hand, I've seen a small ecommerce shop have rates lowered a 1/4 percent doing less than $1m/y.

Second hand, Costco, who in the US and Canada just switch from AmEx to Visa as their accepted card, went through long negotiations that resulted in booting Amex for not matching the discounted rates Visa was willing to offer.

Maybe on credit cards. Probably not on low value debit card transactions, specifically the fixed fee.

No sooner would a coffee shop be seen without a Square reader and an Edison bulb

I'm not so sure about that. I'd agree that they all have "fancy" (for want of a better word) payment systems, but I don't think there's a reason they have to be the fancy ones made by Square.

But more importantly: the US is (finally) moving to chipped and tap-to-pay transactions. That means that pretty much all merchant hardware is going to need to be replaced over time, so the market the Square (and everyone else) currently has is up for grabs. If I were looking at investing in Square that would make me nervous.

I have a quick question about this - there is exactly one business in my area that has actually switched over to chipped cards, and that's Home Depot. Everyone else goes "lol we don't do that, use the magnetic swipe like a normal person" when I try it. I thought that the adoption date was in October, and seeing as how everyone has the machines already... what the hell is going on?

There's an interesting set of incentives at play. The October deadline was actually a shift in liability - now businesses still using swipe transactions will become liable for any losses due to fraudulent transactions, while the card companies will continue to be liable for chipped ones.

Beyond that I don't know too much - maybe the price of the hardware is such that it makes sense to risk it for a little while before buying a chip-capable machine (do people lease them?). The part I really don't understand is that there are businesses with chipped terminals that still insist on you swiping, I can't work out why they'd want that at all.

C&P seems noticeably slower than magnetic stripe at the moment. Possibly due to stores still running their POS on PSTN connections. I wouldn't be surprised if some places were still using stripes to avoid slowdowns at checkout.

Liability was to switchover from the issuer to the merchants' processors (banks) in October, so that was the big push, to off-set liabilities. My experience is about 25% require Chip and PIN.

Some consumers are registering complaints about slow lines due to C&P[1] most of it due to longer C&P processing time.

[1]http://security.itbusinessnet.com/article/One-in-Five-Consum...

Merchants can continue to accept mag stripe transactions but they do so at their own risk. Failing to switch to EMV by the switchover date in October means that any fraud that occurs via a non-EMV transaction is now the merchant's liability. Instead of credit card companies and banks eating the losses from fraud, the individual merchant eats it now.

I was just at a coffeeshop today in SF that had a chip reader and it seemed to be plugged into a Square register.

Square has had chip readers for a little while now and they are pretty cheap too --> https://squareup.com/shop/reader . One of my favorite bars is already using it. Why would someone switch away from square if they are happy with it and there is a cheap upgrade path to support chip readers? Switching services potentially costs time...I can't imagine people wanting to spend that time unless they were inherently unhappy with square.

Square has a habit of wasting a bunch of energy on bad ideas: half the company worked on Square Wallet, which was a dead-end. Half the company worked on the Starbucks integration, which is now known to be a money pit.

I sort of think this means that they're undervalued. All they have to do is stop throwing time and money away and they'll be a lot more productive and profitable.

I sort of agree. Clearly they have some good technical folks. But based on the numbers and the Starbucks deal their management appear to have limited experience in strategy and how to build business cases. So even though the "team" on paper might be good they haven't been able to prove themselves yet.

This isn't helped by having a founder who seems to split his time equally with another large and basically unproven business (Twitter) when you are looking from a financial perspective.

My read on the situation is that the private equity funding options are all exhausted and the company's last option is to IPO otherwise they are a dead duck. That's not a very compelling sales pitch.

I'll bet the share price falls a lot further once they are listed. Perhaps at that time it will present a good buying opportunity if one wants to speculate on the team coming up with the next big thing, but that will be a race against the clock before their bank account runs dry.

Don't forget the Etsy clone, Square Market.

That's a great example. For contra-contrarian reasons: If your coffee is less than $7.75 (debit card) or $4.00 (credit card), square loses money (cf Starbucks).

Their contract with Starbucks is ending soon. Going forward their reader fees will be profitable to the company.

It's not just Starbucks. He did those calculations based on the interchange fees Square pays to Visa/MasterCard/AmEx compared to the flat 2.75% it charges merchants.

To swipe a debit card, Square has to pay at least $0.21 + 0.05% per transaction. 2.75% of any amount less than $7.75 doesn't cover the $0.21 fixed cost. They lose money.

Same deal with credit except it's $0.10+ (and 1-3.5%) instead, so they're only losing money on every swipe under $4.

There's also some amount of markup over interchange going to their underwriting banks (JP Morgan Chase and Wells Fargo) which makes the minimum charges at which there's any profit even a bit higher than that.

Basically, coffee shops are loss leaders for Square.

This is a non-issue. Square has 30-35% margins on its core processing business which is exceptional. The 2.75% rate with no fixed portion was a smart way to attack its core market of small business, low value transactions.

Not always. There is a minimum ticket price that must be met for Square to make money. Square charges merchants a fixed percentage, but Square's costs aren't so simple. There is a reason why tiny corner stores charge extra to process a credit card transaction under $10. or so.

Are people really going to care if their joint of choice changes payment providers?

Do people care how cool their bank and credit card company is?

Id almost certainly guess not.

Hmmm interesting.... I have had in depth conversations about this, and I strongly feel that you are missing something. Sure, in certain areas having a ipad/square reader combo is not necessary. It may actually be detrimental I would imagine. I am not talking about some random small town in Missouri, I am talking about less trendy districts of a city or a coffee shop with a more old school vibe. BUT in large cities and metropolitan areas having a square reader instantly makes your company more trendy and part of an in crowd. This trend will continue to disseminate outward... not with the square reader necessarily, but with some new point of sale system. But already square is at the for front of this movement, we wont continue to use these old POS systems forever. Change will occur.

I disagree - I live/work smack in the middle of Manhattan and I'm not really seeing a Square dominance in coffee shops around me.

Yes, every coffee shop needs their cool iPad credit card processing machine, but anecdotally I'm seeing more non-Square ones than Square ones.

The choice here isn't between "usable iPad thing made by Square" vs. "crappy 90s POS terminal", it's "usable iPad thing made by Square" vs. "other usable iPad thing made not by Square".

I think a huge issue here is that merchants care about the bottom line, and it turns out Square does not have a lock on producing reasonable hardware/software around payment processing. Square may have invented the category but from where I stand they don't look like they own it.

You're lucky if they take cards at all in Manhattan, half the stores are cash only.

Cut me a break. As a customer, I want to buy something and pay for it as easily as possible. If a taxi driver wants me to pay by Square because that makes them more money, I'm cool with that so long as it's straightforward. Whatever. But I absolutely have zero interest in how "cool" a given payment system is.

in San Francisco, I'm starting to see post-Square registers crop up. For example, Revel ( https://revelsystems.com/ ) is also iPad-based.

> Do people care how cool their bank and credit card company is?

The company I work for has built a business based on applying this predicate, and so far we have been successful.

The company being Simple?

Yep. Not the only value that defines us, but definitely a differentiator.

The biggest change I can think of from a consumer perspective is the move to tap payments.

Oh, Square definitely could grow out of its current malaise. I think its biggest problem has been a lack of focus on payments. It basically ceded online payments to Stripe when pretty much all of its merchants need it. It has been extremely slow expanding internationally and bringing out an chip/ApplePay terminal. Instead it has been expanding into various mediocre businesses like scheduling, payroll, food delivery. I'd reluctantly let it keep going on lending since that's hot right now but I don't like it as a core part of its payments business.

I think Jack is capable of leading both companies but I don't think the part-time roles are helping the stock price of either at the moment.

>Square readers are a fashion accessory for hip businesses

Disagree. This is not a consumer electronics market, its a business market.

I have an contrarian view as to why Square seems like a company poised to grow.

All that customers and shopowners care about is simplicity of payment. Square has got that spot on and has pretty good market share which will only grow.

Only tow things can hurt them

1. Existing device that works as card reader. Think of iPhone that can accept payments. 2. Some kind of government regulation.

I dont see that happening. Even Apple's pay p2p thing wont be a threat simply because it probably wont accept a physical card. [Correct me if I am wrong].

A quick survey of the SOMA neighborhood cafes in SF suggests that about half are using some other competitor. The most popular one I see is called Reveal, I think. Your analysis relies too much on cycnicism, IMO.

Erm, nope. So nope. I see how many transactions the lemonade stand on the beach right below my balcony does on Square -- it's an awful lot. Runners, bikers do not need to carry cash just a card. I went with a friend to Burnaby Mountain and between the two of us we would've had problems to buy ice cream from a truck showing up for the three of us for cash but he had Square. It's not "hipsters" it's another nail in the coffin of cash. I hate cash. (And no, I do not have a Macbook or an iPhone, I am a stout believer that Apple should be boycotted for being the leader on the "sanctioned apps only" road)

Not sure where you're living, but I lived in Rochester, NY and just outside Pittsburgh, PA the last two years. The last time I saw a square reader was when I lived in Manhattan, 3 years ago. I'm not sure if I'm just not frequenting the types of places that would use square readers, or if where they're popular is isolated geographically.

I've always used them at Rage Salon, Campbell, CA.

If you're worried about Apple screening the apps you can buy on your phone maybe you should check out what Square doesn't want you to buy:

https://squareup.com/help/us/en/article/5089-prohibited-good...

Those are things Square doesn't want merchants to sell. The difference is meaningful here, because many of those services are regulated and the goods listed are prevented from sale across state lines. Square has an MSB license in all 50 states and are under scrutiny from federal regulators, so they have to abide by the rules.

Have you ever read any merchant account agreement? There are always a whole host of things you're not allowed to sell because it puts you in a different risk category. There are other processors who specialize in being able to handle higher risk categories (say, adult content).

This is brutal. I know someone at Square that exercised his options, and I guess he is underwater by a massive amount now. And since VCs are generally move like flocks of birds, this will likely create a massive chill in terms of funding. Either they are going to take a pound of flesh from the founders coming for their next round of funding, or they will just pull away.

It looks like 2016 is going to see a lot of unicorns take a massive hit. You can bet Stripe and other payment companies are going to take a hit to their valuation, although Stripe seems pretty well-funded at this point.

I assume you are referring to follow up rounds when you refer to a chill? Or do you expect angel/seed funding to be reduced because they are going to lower guesstimated valuations?

Will be Interesting to see if this pattern has an effect of pushing tech companies to IPO sooner.

Is this behavior being replicated cross sector? It seems commonplace for a tech company to write down a valuation of a purchased company (eg every company MS has ever bought), I don't hear about it in health, finance, retail, etc sectors.

You might not have heard about it, but most companies write down the value on acquisitions to some degree.

IANAL, but legally you can be forced to realize tome deprecation on goodwill payments...

https://en.wikipedia.org/wiki/Goodwill_%28accounting%29

With rumors about  device to device payment talks[1], Square is in tough spot.

[1] http://www.wsj.com/articles/apple-in-talks-with-u-s-banks-to...

Confusingly, my browser renders that symbol () as a... square.

Apparently Apple uses U+F8FF, part of the Unicode "Private Use Area", to represent its logo. It's not surprising that it fails to render on non-Apple platforms, given this warning in http://www.unicode.org/Public/MAPPINGS/VENDORS/APPLE/CORPCHA... :

  # The following (1) is for the Mac OS Roman encoding
  # (also used in Symbol & Croatian).
  # NOTE: The graphic image associated with the Apple logo character is
  # not authorized for use without permission of Apple, and unauthorized
  # use might constitute trademark infringement.
  0xF8FF	# Apple logo # Roman-0xF0, Symbol-0xF0, Croatian-0xD8

Additional references: http://hea-www.harvard.edu/~fine/OSX/unicode_apple_logo.html http://www.fileformat.info/info/unicode/char/f8ff/index.htm https://en.wikipedia.org/wiki/Private_Use_Areas

Well, by definition, the Private Use Area is for private use. An OS vendor can put whatever they like there, as can a user.

Chrome, it's a 't' surrounded by italicized parentheses. Unsuccessfully searched for unicode lookup to find the text description of the character.

Edit: at http://www.fileformat.info/info/unicode/char/search.htm?q=%E...

I found: <Private Use, Last>

Not sure what to make of it. Apple decided to assign to a Unicode character their logo. Does anyone have context?

> Not sure what to make of it. Apple decided to assign to a Unicode character their logo. Does anyone have context?

Might be for compatibility with MacRoman, which also had such a character.

In firefow it's a w with two dots over it. Is it just some unicode point that is unstandardized, and so overloaded somewhere with the Apple logo?

My Firefox renders it as an apple with a bite taken out of it. Probably depends on your font.

Chrome Mac renders it correctly.

Since it's a character in Unicode's "private use area," its correct rendering is unspecified. (That code point's "use and interpretation may be determined by private agreement among cooperating users" according to the Unicode standard.)

Correct as in "as the original poster intended", not as in "as the spec specifies".

person-to-person doesn't seem like a win for SMB (yet).

I would actually love to see Apple building a compelling SMB product. Pay your check at a restaurant with your phone, without even opening an app? drools

That would only compete with Square Cash, which Square loses money on anyway.

I'm sorry, what do you mean "though spot"? Just clarifying.

Probably "tough".

Sorry it was a typo.

Anyone have link without paywall? :-)

https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&c...

I've always wondered - why was it so easy to replicate Square's scanning device? Seems like about 6 months after they really started gaining traction, PayPal came out with their copycat triangle one, and then a cascade of copycats.

It went from not being a thing to there being tons of them overnight. I would imagine there would be somewhat of a barrier to entry, but it seems it's a fairly easy device to create?

"The Shakespearean model holds true today. Consider the Square card reader. Square was the first company to do mobile handset credit card processing right. It did the software piece and the hardware piece, and built a brand with the iconic white square device.

Then there was a proliferation of copycat readers. PayPal launched one. They shaped it like a triangle. They basically copied the idea of a simple geometric-shaped reader. But they tried to one-up Square; 3 sides, after all, was simpler than 4.

Before PayPal’s PR people could celebrate their victory, Intuit came out with a competing card reader. It was shaped like a cylinder. Then Kudos came out with its version, which it shaped like a semicircle. Maybe someone will release a trapezoid version soon. Maybe then they’ll run out of shapes.

How will this all end? Do you really want to get involved in making a new card reader at this point? One gets a distinct sense that the companies focused on copycat readers are in a great deal of trouble. Much better to be the original card reader and stay focused on original problems, or an original company in another space entirely." - Peter Thiel, http://blakemasters.com/post/23250566538/peter-thiels-cs183-...

One gets a distinct sense that the companies focused on copycat readers are in a great deal of trouble. Much better to be the original card reader and stay focused on original problems

...I don't see why? PayPal is/was far bigger than Square. If the hardware is easy to duplicate, I'd rather be the larger company with an established presence.

This arguement only makes sense if Shakespeare became wealthy, especially in porportion to his fame. Seeing as we know so little about the man, its impossible to say.

Its easy to be a household name and flat broke. Ask all the washed up movie and rockstars about that. There is of course an amusing "rageingly out of control costs" paralell to startups there.

An additional irony is the claims that Shakespeare was a plagurist...

Intuit's actually predates both Square's and PayPal's: http://venturebeat.com/2009/05/21/intuit-gopayment-lets-you-...

That article just says you type in the credit card number into a web page. Very different.

From the article: "and you can also purchase a card scanner (so you don’t have to type the number in)."

>How will this all end? Do you really want to get involved in making a new card reader at this point? One gets a distinct sense that the companies focused on copycat readers are in a great deal of trouble. Much better to be the original card reader and stay focused on original problems, or an original company in another space entirely." - Peter Thiel

tell that to MS of 198x-199x and actually of 21st century too...

The first generation Square readers were basically the read head from a tape recorder soldered to an audio plug. All of the signal processing was done in software, and even that was pretty simple - magstripes are low bit-density binary, after all. The readers were simple enough that they made the first few hundred by hand, in San Francisco. Once they started mass producing them they were dirt cheap.

Gradually that's changed, though. Pressure from the credit card industry and other payment processors forced Square to start encrypting the magstripe data so that malware on smartphones wouldn't have access to the card numbers (I don't know whether this is a legitimate concern, but the pressure was strong). So Square started putting integrated circuits (and batteries!) into the readers.

Now, with the chip readers coming out, they're starting to be seriously complicated hardware.

Which is why Square's growth has been so impressive. It totally dominates the "dongle" market despite, as you note, the ease in copying it by well-resourced competitors.

Square is also subsidizing massive numbers of small transactions, something that is much more difficult to compete with (who wants to compete with someone willing to lose huge sums of money?).

There are magnetic stripe readers everywhere -- I can't imagine they're that hard or expensive to produce.

I don't imagine they are as straightforward as buying a magnetic reader and putting it in a shell. The interface is somewhat unique after all. It connects through the audio jack. The processing on the software side need to be somewhat custom as well.

Yup, it's as simple as putting a magnetic stripe reader and putting it into a shell. These are a commodity on Alibaba now [1].

The idea of using headphone jack for data transfer has been around since the Commodore PCs [2]

The software side is pretty standard too [3]. It's a standard analog to digital conversion.

[1] http://www.alibaba.com/showroom/headphone-jack-magnetic-card...

[2] http://www.zimmers.net/anonftp/pub/cbm/crossplatform/transfe... And https://en.wikipedia.org/wiki/Commodore_Datasette

[3] http://www.slideshare.net/ShipengXu/data-transmission-throug...

Yeah, a buddy of mine built on from parts at a hackathon on a weekend. Really straight forward.

No, that's exactly what they do. They pipe audio track data through your mic port, like any other reader would. Although they did start encrypting the signal, because people started using these cheap readers for nefarious things.

I don't really care about Square's investors (sunk costs are sunk, plus ratchets and other protections), but what does this do to employee retention (and hiring ability)?

I assume people who joined years ago will still do fine, but what about people who joined in the past 6-12mo? Will they get repriced options? Are cash salaries all people care about? Square has (and still does) have some great people, and it's a "robust job market".

> As recently as September, the company [Square] handed out stock options to staff — one of the main perks of jobs in the Valley — valuing it at $15.39 a share, or more than 50 per cent above what the shares were deemed to be worth only six months earlier.

Source: http://www.ft.com/cms/s/0/6ad992e6-8792-11e5-9f8c-a8d619fa70...

According to crunchbase, they raised money at a $3.25B valuation in 2012.

If they are IPOing at $2.66B now, that means a lot of stock options granted in-between are going to be worthless, unless they were granted at some very different price...

Yes, Square's private per share prices:

Series A: $0.21627

Series B: <$1

Series C: $5.79817

Series D: $11.014

Series E: $15.46345

IPO @ $9 is not great for lots of folks, but mostly late-stage employees (assuming D & E investors have a liquidation preference - though I don't know for sure).

Series E investors got a ratchet guaranteeing $18.56 per share: http://techcrunch.com/2015/11/10/squares-s-1-of-ratchets-and...

what about the common? i think that was the gist of the comment...do the ESOPs pay out in preferred?

edit: below comment mentions using comp rsus

Strike prices on common are almost always far far below what investors are paying for preferred shares.

I thought they were priced at the last round price (which is usually a discount if you interpolate the prce between rounds)

Nah, there's a big discount because preferred shares have downside protection (as well as a few other valuable things general) so common stock is valued lower. Generally a 70% discount or so.

the discount varies by investment round. common shares for early stage companies come with a huge discount. or perhaps it is clearer to say that preferred shares come with a huge premium primarily because the liquidation preference (LP) is so valuable at that stage). preferred shares in later rounds have a much lower premium, because investors don't value the LP as much.

I've had this happen, and it's wrong. The price must be adjusted based on the terms. Common stock has basically no terms, so strike price should be much, much lower than what investors are paying for preferred.

This is for preferred stock though, not for common stock. Employee options would be priced to common stock.

Just went through an IPO and we had a stock split to bring the price down to a number around $14. Square could also be doing a split so that $9 doesn't mean D & E are getting screwed.

That's not how stock splits work. You can't somehow subvert a falling valuation just by creating more shares.

a stock split doesn't account for the lower total evaluation.

The stock options priced is based on the 409a valuation, not on what investors paid in the last round, so they might not be worthless.

what is a normal ratio between the two?

Depends on the stage. Early stages the difference can be 1000-10x. Later stages the difference is much less, 10-1x but usually by then companies start issuing RSU's not options.

RSU's are stock given with the current valuation (eg. you get 10,000 shares, which are worth of $1M with the current valuation). If the company IPO with that valuation, you get ($1M - taxes). If they IPO with less or more, you get less or more.

Difference is that with options you actually have to exercise (buy the stock) with the given strike price.

It depends on the state of the company. In the beginning, the share price between common (employee) and preferred (investor) stock can be very significant (10x or more), but as the company gets closer to IPO, the value between common and preferred stock converges to 1. Some unicorns get around this issue by issuing RSUs that retain some value even if the share price drops.

It can range quite a bit, but you can figure around the 25 - 35% range as a rough estimate for most venture backed companies. Companies that are near-to or are already cash flow positive can move the needle higher.

The S-1 contains a table with number of options granted as well as strike price on various dates since June 20, 2014. Some other data can be determined from the option grants for executives. Here's a rough list:

  Date               Strike ($)
  ==============================
  July 25, 2012       2.73
  May 31, 2013        2.90
  August 27, 2013     3.33
  February 27, 2014   7.25
  June 20, 2014       8.23
  August 16, 2014     9.11
  December 17, 2014  10.06
  March 20, 2015     11.28
  May 14, 2015       13.09
  June 17, 2015      13.94
  July 9, 2015       14.81
  August 11, 2015    15.25
  September 16, 2015 15.39

They'd be smart to hand out some heavy cash bonuses to employees that have been dreaming about $20 per share for years.

Why? The investors get an exit, Jack can cash in his shares, and the general public can inherit the rest. In the near term there will probably be layoffs, as soon as Wall Street realizes that the company had no real direction or traction that can support a multi billion dollar valuation.

Jack can't cash his shares. At least not for a long time.

In my experience incentive stock options that companies give to employees normally are heavily discounted.

It is a bit more nuanced than that. Employees are given options for Common shares rather than preferred shares. Since preferred have voting rights and other perks (like liquidation preferences) they are worth more than common. The value of common stock is determined by a 409a evaluation which takes a lot of different factors into account, but it is not unusual for Common shares to be valued at 1/10th the value of preferred shares.

From my experience it's hard to discount more than ~70% or the IRS starts to complain.

That, plus they've probably been granting RSUs for a while, which do not require being exercised and which cannot be underwater,

Square was granting options as recently as 2-3 months ago for senior eng roles, I don't think many people at Square are hanging on to RSUs.

While they cannot be underwater, they were granted with a target comp in mind and a low enough IPO can put people well below the targeted value.

Sure. I think that's fine; as long as people aren't losing money on taxes or exercise price.

Equity compensation should always be viewed with the appropriate grain of salt—it's an investment, and most likely won't pan out. When the company kills it (Facebook, Apple), it turns everyone into millionaires. Square isn't there yet, though I'm sure a lot of people will have some very nice "bonuses" out of this.

I wouldn't underestimate, if nothing else, the mental impact of being sold on a company with a major piece of comp being RSUs at a price, almost certainly derived from the last round raised, that are then worth a lot less. Obviously nobody will be out-of-pocket on them, but they got a salary much less than they were sold on. This can't work wonders for retention, and makes golden handcuffs more like paper handcuffs.

It's probable the internal, common valuation was much less.

Can someone help me understand...

Let's say an employee was granted 10,000 stock options at $1/share. They're all vested.

Does this mean that each share will be worth $9? So if exercised and cashed out, the employee would essentially earn $80,000 (before taxes)?

Trying to understand how the economics of all of this works.

Also, does this mean there are 300,000,000 shares? (How many shares do start-ups usually start with before funding rounds and what not? Seems like Square must've started with 100,000,000 or something.)

So many questions.

It all depends on the start up. Some start ups have a lot of authorized shares and some have less. This is all reflected in the capitalization table (https://en.wikipedia.org/wiki/Capitalization_table) of the company. The cap table also contains information such as the number of preferred shares and different rounds of preferred shares (Series A, B, ...).

What people sometimes don't realize are the liquidation preferences on the preferred shares. The liq pref is usually 1-3x depending on who has the negotiating leverage. Out in SF, most liq prefs are 1x. This means on an acquisition, the investors get 1x whatever they invested first before any common shareholders get paid. This means that many acquisitions are not successful. A good recent example is Rdio (https://www.crunchbase.com/organization/rdio#/entity). They got acquired for 75M, but investors put in 126M. This means the investors lost money, but common shareholders (shares from stock options) got nothing.

A good scenario would be an acquisition where everyone makes money. A good recently example is Business Insider,investors put in 55M, but the company got bought for 343M easily clearing the investor liq pref (https://www.crunchbase.com/organization/business-insider#/en...). Employees with common shares also probably made a good amount as well.

One thing that also hurts employees are the AMT taxes that are associated with exercising the stock options before a liquidation event. In the examples above, employees have to pay taxes on the spread of the strike price to the fair market value of when they exercised. If an employee had a lot of shares, the taxes could end up quite high.(http://employeestockoptions.com/amttax/)

What you may not realize is that in a qualified ipo the prefs go away. It's basically the one time when prefs turn irrelevant. (there are still other shenanigans like ratchet to min price sometimes).

In practice the qualifier on the ipo means the prefs only vanish on a big (well above the pref stack) ipo number. But still an ipo is at the moment it's done on paper much better for common holders.

I'll answer what I can: First, you're correct on the valuation. If they are exercised and cashed out at the IPO price, the employee would earn $80k pre-tax. However, historically most IPOs are priced to get a "bounce" on opening day also there are usually restrictive covenants around the number of insider shares that can be cashed on IPO day. (This is meant to give investors warm fuzzy feelings about the stock.) In all likelihood the employee will have to wait some more time and will probably cash out closer to $10/share.

The Pricing and Valuation implies 300M shares. However there can be many classes of stock, both common and preferred that grant different rights and ownership. If they have different classes they could have a different number of shares, but the different share types are valued differently.

Shares are just objects granting different rights around the company within certain legal limits. (Ownership, Governance, Profit share, etc.) If you have agreement from the controlling body you can instantiate, remove, or restructure shares at any time. The point is that they could have decided with their bankers that 300M was a good number of shares to have at an IPO and decided to split or reverse split as part of the transaction. It has no bearing on the number of shares today or a year ago.

I guess what I'm getting at is something like this:

If you're given 1% of the company in the form of stock options as an employee, how can one get a grip on what that's worth should a company IPO? Like, if I came in as a high-level hire at Square. Early in the game. Jack gave me 1% of the company in the form of employee stock options. Now I'm vested. What would that mean to me now, after an IPO? How does one even begin to pick that apart if shares can be created or destroyed whenever?

Maybe I'm asking stupid questions. I'm just trying to understand since in my I'm constantly hearing numbers thrown around and, as a non-finance person, it can be hard to know what's really going on. (Which makes it easy to feel like I'm being taken advantage of.)

You would have been given an option to purchase an absolute number of shares, not a percentage. Let's say 10K. That may have been worth 1% when you were granted them, but as more shares are issued in subsequent funding rounds / IPO, your 10K will constitute a smaller percentage of the bigger pie. This is called dilution. You still have 10K shares, though, and they will still be worth $9/share at the moment the company IPOs. (And maybe significantly more or less after that moment. Typically employees have a wait a bit after an IPO before they can sell.)

They cannot be "destroyed" (under normal circumstances) once you are fully vested, although with certain types of options you may need to exercise (purchase) them if you were to leave the company, if you don't want to lose them.

The proceeds from your 10K options is easy to calculate once the company goes public: it's simply the stock price, minus what you have to pay to exercise the option (the strike price). Perhaps the trickier thing to calculate is taxes because of things like capital gains.

What I was saying with the "destroyed" was something like a reverse stock split. (Your proportional ownership stays the same, but your number of shares reduce.) The idea I was communicating that the number of shares itself is not a meaningful judge of anything unless you understand what those shares represent.

If covenants are not in place, you could also "destroy" the proportional ownership of shares by diluting down to a negligible value.

I guess what I'm saying is that people should always be sure they can trust management, ask for a cap table and probably consult a lawyer.

Stock reverse splits don't "destroy" value anymore than exchanging four quarters for a $1 bill. You do not have less value just because you own 1 unit instead of 4, because the value of the unit increased proportionately.

You can dilute proportional ownership, but there you just shifted the meaning of the term "destroy" and are using it in a funny way. Dilution does not decrease value. The reason your percentage of the pie decreases due to dilution is because the pie is getting bigger. You still have the same absolute amount of pie on your plate. Nobody destroyed any pie.

So I think you're mixing up my two points. A reverse split destroys the stock object, reducing the total number of shares but the proportional value remains the same. We both agree on this (per my previous comment).

Destroy can be used in both ways because language is context sensitive and the definition is somewhat broad. You can destroy value through dilution by getting less than you give. Example: If my company is fairly worth $100 and I own two shares and you own one, you own $33 worth of value. I can then issue my friend bob another share because he gave me a great lunch recommendation and I thought it was a big morale boost, something I can do because you don't have a covenant in place. My company is still worth $100, you now own one of 4 shares and only $25 worth of value. I have now destroyed $8 worth of your value. It's an ownership shift relative to the company, but a value destruction relative to you.

Effectively, yes. If an employee has 10,000 options with a $1 strike that means they can purchase 10,000 shares for $1 each. Since the shares are worth $9 the employee can then sell those shares immediately for an $8 profit, or $80,000.

As far as how many shares Square has, it's much more than 300k. That's just what they're offering to the public. That percentage is listed in their S1 filing somewhere

How many shares they started with. Who knows. Doesn't really matter.

I'm seeing reports that Khosla led a Series A round of $10 million at $0.22/share (http://www.cnbc.com/2015/11/09/square-ipo-will-net-big-win-f...). At a $40M valuation.

$40M/$0.22 = ~182 million shares at that point? So they've almost doubled the number of shares they started with if they're IPOing at 300 million shares. Does that sound like a reasonable bit of math?

At a $40M valuation, Khosla got 25% of the company at that time. They have $10m/$.22 shares or ~45M shares of the 182M shares you mention. They're netting $945M (sale)-$10M(invested)=~$409M.

Between Series A and IPO they had roughly 40% of their stake wiped out through dilution. (45M/182M=25%-> 45M/300M=15%) The dilution happened because, during that time Square issued 118M shares to investors in trade for the investor money. The company valuation at each round was determined by: Investment/shares issuedTotal shares outstanding after transaction.

A lot of startups start with 10m or 15m

Feels like an insane amount of dilution for early employees.

Just ignore the extra zeros.

This is the best of all possible worlds for the late-stage investors. They get double the shares from the ratchet and probably a big valuation pop tomorrow too.

> Square Prices Its IPO at 9$

Not a very helpful submission title. Without knowing the number of shares or previous share price, this is meaningless. The market capitalisation would be better. Including the previous projection better still.

It's not really the submitters fault though. In keeping with HN etiquette they posted the title of the article. I'd be criticizing TC here.

Yeah, I can't blame them for following the usual rules.

Just added your suggested figures.

This thread is awesome. For someone sitting afar and looking to invest in Square, the information on this thread is sufficient enough for me to dig deeper on specific points. I wish Wall St analysts did something open like this, rather than just publish some 'post facto' report.

Wow, that's priced at ~2.8x 2015 revenue. So low.

the average P/S ratio of the S&P 500 is at a historic high around 1.8 (http://www.multpl.com/s-p-500-price-to-sales) with long term average at 1.4, so this is still double the long term average. Square's gross margins are very thin in comparison to many other "household name" tech companies, so it deserves a much lower P/S. I've also heard growth is really slowing. This multiple doesn't surprise me at all, and I still won't be buying any of the stock.

If you look at gross profit (164.4 million for the first semester 2015) it's a much more comparable metric to what SaaS revenue would be. The problem with overall revenue in this market it that it's a low margin and more that half of it goes to the credit card companies.

With ~328 profit per year, they are getting about 8X multiple - very comparable to Hubspot, Zendesk which are doing terrific in the public markets.

For anyone getting stock options, expect as much as 6X-8X multiple on revenue if your gross margin is >60% and your year-to-year growth is >70% - the 10X-14X days are gone. Else, if year to year growth is below 70%, or gross margin less that 55%, expect 2X-4X.

Not going to go dig for the SEC filing, but transaction revenue is not something look at, as that is basically booking money they are moving on behalf of someone else. I would suggest looking at EBITA, fraud loss, avg transaction fee schedule and transaction number volume.

Square uses "Gross Payment Volume" to describe that, not revenue. GPV is ~$30 billion.

You can search for GPV in the S-1 to see the specifics: https://www.sec.gov/Archives/edgar/data/1512673/000119312515...

Braintree was doing $12B in GPV when they sold for $0.8B and are now doing ~$50B in GPV. Square is actually doing around $35-45B now (8.8B in most recently reported quarter). Growth is relatively slow though so will be interesting to see what happens in the IPO.

Why did they agree to go public at such a low valuation when compared to recent rounds? Why wouldn't they wait until a time when the capital markets valued their enterprise more favorably?

maybe they were afraid that time is never comming.

Due to a string of bad decisions, including but not limited to the Starbucks deal and the Square Wallet, Square's undervalued. If they can sit up and grow their processing volume, their share price will appreciate greatly and go much higher than $9. They also need to find a way to minimize their losses on low amount payments, since they make losses on some of them. Their small business loans seem like an interesting and propitious part of their overall business going forward.

I think its amazing Square could do an IPO at all - $2.7B is an insane valuation for a company that hasn't proven a scalable business model.

Frankly, its sort of irresponsible and short sighted for VCs to take something like Square public. It will have all sorts of repercussions on real businesses that want to go public in the future.

Agreed. It looks like Square will soon be competing head-to-head with Apple. Both companies want a big slice of the payments business, and they're going to be competing for the same customers. Any investment in Square is very risky, public or private regardless of the price.

It's "$9", not "9$".

Doesn't it make more sense to type it as it's read?

"$" is a modifier, not a word. Otherwise you'd be reading it as "9 dollar sign", not "9 dollars".

Just like we pronounce 9¢ "9 cent sign" right?

Calling it a "modifier" implies that it's something more than a convention. Currency symbols are formatted differently in different countries, according to custom.

Not in this case.

Does Square compensates employees in stock options or RSUs? If options, aren't the employees you joined post Series D completely screwed?

It really depends on the way the shares are distributed. I suspect they aren't "screwed" but they aren't exactly going to get rich from this.

Why would they price it at such a low multiple of revenue? Massive liabilities or something?

Very low margin business. As a multiple of net revenue, it's at the high range of comparable payment processors.

A combination of things - a super old/competitive market (processing), the ever changing risk dynamics and Square's targeting

Let me illustrate points 1 and 2 with an example.

My 2c.

Their net revenue should be about 100 bps, and their loss is 16 bps, at least for 2015.

And revenue growth prospects aren't all that high?

Not when you're competing against every other payment processor.

What were supposed to be Square's differentiating features? What competitive edge is being hyped?

30-35% margins are exceptional in this type of business.

No one feels like subsidizing more of Starbuck's' transaction costs?

Starbucks is almost done moving away from Square for CC processing.

Great article by Bill Gurley that explains some of the factors that drive revenue multiples: http://abovethecrowd.com/2011/05/24/all-revenue-is-not-creat...

Transactions are not revenue.

$9 is a good psychological price. This is going to pop tomorrow.

Just opened at 11.20, already up to 13. The company who helps small businesses accept Visa, Mastercard, Apple Pay at 2.75% of all those transactions. This company makes too much sense to me.

Going to the Blue Bottle coffee downtown SF in front of their office if anyone wants to join me. Pat them on the back.

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