Square has demonstrated the size of the divide between Silicon Valley and Wall Street: about $2 billion, or 33 percent.
That's the gulf between the $6 billion valuation assigned by Square's investors just a year ago and the roughly $4 billion value on the company determined by the IPO stock sale Wednesday evening. The company sold shares to the public for the first time at $9 each, or 40 percent less than the private share sale last year.
Stock market investors, it turned out, didn't care about whatever readings of Jack Dorsey beard trimmings were needed to arrive at Square's valuation when the company was private. The entry to the public markets is the great reckoning. And Square has been judged not worthy of a multiple of a highflying tech company, no matter how many varieties of Kombucha tea are in the company kitchen.
Square had been looking to be valued at an Internet-like multiple of about 10 times the company revenue for the previous year after adjusting for transaction costs, according to an analyst cited by the Wall Street Journal. Instead, public market investors deemed Square deserving of a valuation more in line with dull payment-processing companies like Heartland, Vantiv and Global Payments -- and an unprofitable payment-processing company that targets small merchants, not companies with deep pockets, to boot.
Those payments middlemen are valued at one to just more than three times their sales for the last 12 months. At $9 a share, Square would be valued at less than four times its net revenue for the last 12 months. Square, then, is a payments company. The market judges have spoken.
The funny thing is the stock market investors who smelled sour milk and marked down Square's IPO price are the same types who valued Square at $6 billion in the first place. J.P. Morgan funds were among those that agreed to buy into Square last year at that headline valuation.
Those investment fund types know what they're doing when it comes to valuing companies, even the tech startup variety. So how does this happen?
One big answer is private valuations aren't what they seem. Fictional, really. The last guys into the Square investor boat before the IPO -- including the J.P. Morgan funds and those of investment firm Rizvi Traverse -- received a guarantee of extra shares if the IPO price wasn't at least 20 percent higher than their buy-in price.
These negotiated investor penalties, or "ratchets," essentially make valuations of tech unicorns even more worthless than the paper on which they're written. If you manage to negotiate a can't-lose investment , you're more willing to pay up to get in.
Those investors who negotiated a stock penalty are still ahead in the IPO, even factoring in the loss J.P. Morgan and Rizvi took on Square shares they bought in 2012 that are also below the IPO price. All the other Square stockholders will have to bear the dilution of the 10 million extra shares owed for the ratchet penalty. Still, the earliest investors in Square will make bank, even factoring in the extra shares and the tamped down IPO price.
So it is tough to have sympathy for anyone in this IPO, with the notable exception of those Square employees holding equity that is worth a lot less than they expected. There are no extra stock sweeteners for them. Employees, many of whom were barred from selling their equity when their company was private, are justified to take off work on Thursday in sullen protest. We'll explain it to your boss.
Of course, all this messiness could get cleaned up if Square shares perk up once they start trading on Thursday, or even in six months or a year. Facebook fell on its, um, face in its IPO in 2012. Investors got spooked about Facebook's troubles in mobile advertising. The shares had trouble trading at all.
That all seems like a hazy memory, with Facebook now one of the most valuable companies on the planet. This is the only time a comparison of Facebook and Square will be made. Square is no Facebook.
No matter what happens to Square shares at this point, let the clanging market bell of a sad IPO sale resonate from Sonoma to San Jose. Let it be a warning to people who run private tech companies and those who finance them and work for them. When and if the day of stock market reckoning comes, you too may be judged not worthy.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
This valuation includes Square stock awards to employees and others. As this piece and others have pointed out, Square's reported valuation ahead of the IPO didn't always factor in all the outstanding equity and shares set aside for future stock awards.
The existence of Kombucha tea in Square's kitchen has not been verified.
This particular type of stock penalty appears to be out of favor at the moment. A recent report by Silicon Valley law firm Fenwick & West found the stock penalty ratchets weren't included in any of the 175 third-quarter startup stock sales examined by the firm.
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