The Square IPO, Unicorns and Vanity Pricing

So the Square IPO priced “below the last round.” That’s what the news media reported. In fact, one media story was headlined “Square Flops.” So was yesterday really a bad day for Square? Nope. It was a very very good day – for everyone involved, and much of the news media missed it.

The Square IPO was good for the company because they were able to raise $243 million of much needed cash to keep growing; it was a good thing for employees because the IPO made their shares and stock options liquid (once their lock-up expires); it was a good thing for all shareholders for two reasons: first, most of them didn’t sell; and second, the stock closed up 45% over its IPO price. And that was very good for employees, too. Further, many of the most recent outside investors in Square had a form of downside protection that basically locked in a positive return. It was a very good day for them all. It seems like a lot of the press missed it. And that’s what this post is about.

Square is a super exciting company. They’re behind those small square devices that plug into smartphones and tablets to allow merchants to process payments made by credit and debit cards. It has democratized credit card payments (think Uber for merchants) allowing just about any person or firm to accept card payments. Square has healthy gross margins and tremendous reach. Acquiring customers is one of the toughest things to do in business and Square has acquired plenty. Square has started selling other services into this customer base. Smart money and smart people are backing Square and I suspect Square (and Twitter, also founded by Jack Dorsey) will survive and thrive in the long term.

In many cases – more than just those of the Unicorns – we see headline valuations for financings that are “real” only if the company’s later valuation meets or exceeds expectations. If it doesn’t, then the investors are protected. The exact form of protection varies in different circumstances. Sometimes warrants are involved, sometimes they are entitled to a dividend of additional shares; sometimes its money off the top when there is a “liquidity event,” etc. It doesn’t matter. The point is that the headline price for many financings is often somewhat “notional.” We get it. There’s a certain ego-boost to many when the valuations are high. Founders like it; sometimes the investors like it, too. One big time investor was in our office this week and referred to valuation of some of these young companies as “Vanity Pricing.” That’s ok, as long as everyone understands what is real. And what is not.