Episode 43: The Square IPO

Hosts Ben Gilbert and David Rosenthal of the "Acquired" podcast delve into the 2015 IPO of Square, discussing its evolution from a mobile payment solution to a comprehensive merchant services platform. They examine the company's initial focus on enabling small businesses to accept credit card payments and how it expanded to offer a suite of tools for business management. Despite facing challenges such as a problematic partnership with Starbucks and the complexities of CEO Jack Dorsey leading both Square and Twitter, Square's IPO marked a significant moment. The hosts critique the timing and execution of the IPO, which was priced lower than expected due to market narratives, resulting in a "ratchet" that favored investors from the last private round. Ultimately, they recognize Square's resilience and success in creating a predictable, growing business model with a low churn rate, offering essential insights into the importance of company fundamentals and the impact of strategic decisions on employees and investors.

• Episode 43 covers the 2015 Square IPO.
• Hosts Ben Gilbert and David Rosenthal express excitement about the topic.
• The decision to cover the Square IPO was influenced by listener demand and the hosts' own interests.

"Today we are covering the 2015 Square IPO to much, much demand from a lot of our listeners out there."

• This quote indicates the episode's focus on the Square IPO, chosen due to significant interest from the podcast's audience.

• The hosts conducted a survey and received a lot of feedback.
• They announce a winner for Airpods from the survey participants.
• The feedback suggests listeners enjoy the hosts' approach to topic selection.
• The hosts encourage listeners to leave reviews to help grow the podcast.

"We did our survey and we had a tremendous amount of feedback."

• The quote reflects the podcast's engagement with its audience and the hosts' responsiveness to feedback.

• Statsig is presented as one of the favorite companies of the hosts.
• Statsig's growth and scale are highlighted, including reaching 1.2 billion end users and processing 130 billion events per day.
• Statsig is compared to Visa in terms of transaction processing volume.
• The company has added significant AI companies as customers and expanded its product offerings.
• A special offer for Acquired listeners is mentioned.

(Note: The advertisement for Statsig should not be included in the study notes as per the user's instructions.)

• The origin story begins with Jim McKelvey in St. Louis, Missouri.
• McKelvey was a glassblower and had trouble selling his art due to credit card processing issues.
• Jack Dorsey, who later became a co-founder of Square, was initially an intern for McKelvey's company.
• The story of Square's creation is linked to the difficulties faced by small business owners in accepting credit card payments.

"So Mira, this is again late eighties, early nineties. Initially, they created a product that was a competitor to Acrobat, to Adobe Acrobat and PDFs, but unfortunately Adobe existed and so that didn't work out too well."

• The quote provides context on McKelvey's entrepreneurial background and the challenges he faced, setting the stage for the creation of Square.

• McKelvey and Dorsey had a longstanding relationship that predated Square.
• Dorsey was forced out of Twitter before joining Square.
• The duo approached a professor, Robert Morley, for his expertise in card reading technology.
• Morley later sued Square and settled for $50 million over patent infringement and being forced out at the founding stage.

"And that person's name was Jack Dorsey. Now that's a connection we are reaching way back here at Acquired."

• This quote emphasizes the long-term connection between the co-founders of Square, which played a crucial role in the company's inception.

• Square initially had the name "Squirrel" and an acorn-shaped card reader.
• A meeting with Apple's Scott Forstall led to a name and design change to "Square" with a square-shaped reader.
• The name change was due to an existing company called Squirrel Systems.

"They go to Apple, they go to Cupertino, and they meet with Scott Forestall, who at the time is the most important person besides Steve Jobs when it comes to the iPhone."

• This quote indicates the pivotal moment when the Square founders met with a key Apple executive, leading to a significant change in their branding strategy.

• Square started as a mobile payment system with a focus on serving under-merchant-accounted businesses.
• The initial product was a single dongle that plugged into an iPhone, designed for credit card acceptance on the go.
• Square later evolved into a comprehensive point-of-sale (POS) system, becoming ubiquitous in coffee shops and other retail establishments.
• The company's growth reflects a shift from serving mobile payment needs to dominating the cloud POS market.

"At the beginning of Square, it was more about accepting credit cards on the go and just this single dongle that plugged into your iPhone."

This quote highlights the original concept of Square, which was focused on mobile credit card processing for small businesses or individual sellers.

"They invented this category of sort of cloud point of sale, which is really the big market than they're in now."

This quote indicates Square's expansion from a mobile payment solution to a cloud-based POS system, which is now their main market.

• Square was initially received with excitement by consumers and small business owners.
• It was seen as a novel way to accept credit card payments without being a traditional merchant.
• Users adopted Square for personal transactions, mirroring modern uses of services like Venmo.

"I remember when Square first came out, being really excited and getting a reader myself."

This quote reflects the initial public excitement and personal interest in Square's technology, even from individuals who were not traditional merchants.

• Square's key innovation was enabling anyone to accept payments, overcoming the barrier to entry in the industry.
• The company significantly improved fraud prevention, which was a major concern in the industry.
• Square differentiated itself through design-focused user experience, ease of onboarding new merchants, and fraud reduction.

"The thing that square did that is entirely differentiating is unlocked. A completely new set of people who could accept transactions."

The quote emphasizes Square's innovation in opening up payment processing to a broader range of users, including those previously unable to accept electronic payments.

• Square faced competition from existing players like Intuit's GoPayment and PayPal.
• Competitors struggled with fraud prevention, leading to significant losses and, in some cases, product shutdowns.
• Square's underwriting system and incremental trust-building with merchants set it apart in fraud management.

"Verifone actually shut down their competing product because of fraud losses, because they were taking kind of a 1% loss on every transaction from every customer."

This quote illustrates the challenges competitors faced with fraud, highlighting Square's superior approach to managing and mitigating fraud risks.

• Square's entry into the market unlocked a significant number of new merchants capable of accepting credit cards.
• The company's business model innovation included making the card reader free and simplifying the fee structure for transactions.
• Square's approach contrasted with traditional merchant accounts, which had complex and opaque pricing.

"There were 30 million businesses in the US that had under $100,000 in revenue... but only 6 million of those could accept credit cards."

This quote puts into perspective the market potential Square tapped into by enabling a large segment of small businesses to process credit card payments.

• Square evolved its offerings from a simple card reader to a suite of tools for business management.
• The company's services now include inventory management, employee time tracking, payroll, lending, and appointment booking.
• Square's partnership with Starbucks was a catalyst for expanding and improving its product suite to meet the needs of larger merchants.

"What this deal forced Square to do was become enterprise class in terms of payments and fintech and security really quickly."

This quote discusses the impact of Square's deal with Starbucks, which accelerated the company's development of enterprise-level features and services.

• Square's launch was marked by high-quality design and user experience, setting a standard in the industry.
• The company's rapid growth was fueled by its ability to address the needs of small merchants and by significant venture capital investment.
• Square's success is attributed to its focus on both technology and business model innovation.

"It was like birthed as a perfectly formed product."

This quote reflects on Square's successful launch, emphasizing the immediate impact and polished presentation of its products and services.

• Square focuses on adding value to their channel rather than just selling products.
• They aim to make the lives of small business owners easier, leading to customer retention and mutual success.
• Square's revenue model includes both free and paid services, similar to Amazon Web Services (AWS).
• They acquired Caviar to provide food delivery options for restaurants.
• Square Capital offers loans, generating additional revenue.
• The flywheel effect: as merchants grow their business using Square, transaction volume increases, leading to more revenue for Square and greater adoption of their services.

"So for square, it's not like, what else can we sell through this channel? It's more like, what can we add to this channel? What can we add to make the lives of small business owners easier? So that, number one, they stick around longer and continue to use this product. Number two, their business does better so that we both do better."

• This quote explains Square's customer-centric approach to adding value and services to retain customers and support their growth, which in turn benefits Square.

"It's a flywheel. You know, it's an acquired flywheel. And they do charge, it's like aws, right? Like they charge some amounts of fees for some of their services and some of the services are free."

• The quote describes the flywheel effect in Square's business model, where the provision of both free and paid services creates a self-reinforcing cycle of growth and revenue.

• Square experienced significant growth in payment volumes and revenue, with actual margin dollars being made off transactions.
• They managed to pay down their fixed costs and move towards a financially stable future.
• The Starbucks partnership initially generated good revenue but proved costly in the long run.
• Square renegotiated the Starbucks deal, leading to Starbucks eventually pulling out due to no longer being the exclusive payment provider.
• Despite challenges, Square was close to break-even before their IPO.

"They're growing payment volumes hugely. They're growing revenue hugely, and they're making money off of the transactions."

• This quote highlights Square's substantial growth in payment processing and revenue, indicating a successful business model.

"They did renegotiate that at one point, right? They did renegotiate, but the outcome of the renegotiation is basically that they're just gonna. Starbucks is gonna pull out."

• The quote reveals the outcome of Square renegotiating their deal with Starbucks, which ultimately led to Starbucks withdrawing from the partnership.

• In 2012, Square was valued at $3.25 billion.
• In 2014, Square raised $150 million at a $6 billion valuation from the Singapore sovereign wealth fund and Goldman Sachs.
• The company faced financial strain from the Starbucks deal but was still growing and preparing for an IPO.
• Square's growth was driven by real margin dollars from transactions and a reduction in fixed costs.

"They decide instead to raise a $150 million Series E from the Singapore sovereign wealth fund and Goldman Sachs... at a $6 billion valuation."

• This quote details Square's decision to raise additional private funds at a significant valuation increase rather than going public at that time.

"They were valued, I think at three and a quarter billion dollars in that round."

• The quote provides information on Square's valuation during a funding round, indicating investor confidence and growth potential.

• Square's IPO was considered during a time of financial uncertainty, with a lower than expected share price at $9, valuing the company at $2.9 billion.
• The IPO pricing was below the projected range of $11 to $13 per share.
• The market's negative perception was juxtaposed against Square's strong business fundamentals and growth potential.
• The "ratchet" provision in the last private funding round led to the issuance of additional stock to investors due to the lower IPO valuation.
• Goldman Sachs, as both an investor and the IPO underwriter, faced a potential conflict of interest due to the ratchet provision.

"They go public on November 19, 2015 at $9 a share, which equates to a $2.9 billion valuation."

• This quote provides the specifics of Square's IPO, including the share price and the overall valuation, which was lower than the private funding round valuation.

"So it is, as then got widely reported in the press, it is ratchet time."

• The quote refers to the financial mechanism triggered by the IPO pricing, which required Square to issue additional stock to certain investors due to the ratchet provision.

• Square's business model is based on a zero churn rate on a cohort basis, balancing customer acquisition and retention.
• The company's predictable return on marketing investments and consistent revenue generation from each cohort contribute to its stability.
• Square is not just a payments company but a small business company focused on helping businesses grow.
• The company's success post-IPO is attributed to its ability to bundle services, increase transaction volume, and support merchant growth.

"Square, as we both argued in different ways... they're the most well recognized name in it, and they're doing extremely well in this massive rising tide."

• The quote emphasizes Square's leading position in the cloud POS market and its successful trajectory in a growing industry.

"Square isn't a payments company. Square is a small business company."

• This quote captures the essence of Square's brand and mission, positioning it as a partner to small businesses rather than solely a payments processor.

• Private market valuations often include a preference structure that reduces investor risk.
• In private markets, investors can negotiate preferences that guarantee a return irrespective of the company's sale price.
• Preferences ensure that in a sale, investors recoup their investment before common shareholders.

"So the way that that sort of works is you can say, hey, I'm going to take 20% of this company and give you $200 million and value you at a billion dollars. But if you sell for less than a billion, if you sell for 500 million, I'm still going to take my 200 million back."

• This quote explains how private market investors protect their investments through preferences, ensuring they get their money back even if the company sells for less than the valuation at which they invested.

• High private valuations can lead to a difficult situation when transitioning to public markets.
• Liquidation preferences can inflate private valuations, creating a disparity with public market expectations.
• Companies may face challenges like losing employees or having to go public due to inflated valuations and the need for liquidity.

"You have a lot, a lot of people on that roadshow that you're talking to that are all talking with each other. It's not a small conversation between a CEO and a few partners at a firm. It's much more like it gets pushed down if there's a narrative out there that wants to push it down."

• This quote highlights the difference between private and public market dynamics, where public market sentiment can significantly impact a company's valuation.

• Employees may find their stock options worthless if the company's valuation is too high.
• Overvaluation can lead to employee dissatisfaction and attrition.
• Companies may resort to issuing restricted stock units (RSUs) to address compensation issues.

"So employees are hired in, they're given 25% of their compensation in the form of stock options. But it turns out those stock options have a strike price where the valuation of the company is $6 billion."

• The quote illustrates the problem employees face when their compensation is tied to stock options based on an inflated valuation.

• Valuing companies based on fundamentals is critical, especially for startup investors.
• Founders should be cautious of accepting inflated valuations that may negatively affect employees.

"But when you have your investor hat on, that's why you really need to value companies based on fundamentals."

• This quote emphasizes the importance of basing company valuations on fundamental financial metrics rather than market hype or inflated private valuations.

• Timing the transition from private to public markets is crucial.
• Companies may need to go public earlier to avoid valuation and liquidity issues.
• Public scrutiny and the maturity of the business model are factors to consider when going public.

"Instead of that private round, they could have just tried to go public doing that earlier. Might have been able to do a flatter or up IPO at a higher valuation."

• The quote suggests that an earlier IPO might have avoided some of the valuation and liquidity issues by aligning closer to the company's fundamentals.

• Experience is invaluable in startup management and investment.
• The complexity of investment terms has increased, highlighting the need for experienced decision-making.

"It takes being really hard in the weeds, doing the research on this stuff. Being a venture capitalist, being someone with early stage shares, or being a founder of a company that goes through many rounds of this stuff to really see how this plays out."

• This quote stresses the importance of deep involvement and experience in understanding the intricacies of startup financing and management.

• The timing of product launches and market entry is crucial for startup success.
• Square's timing in disrupting the payment industry is highlighted as a key factor in its success.

"It's so, so rare. I mean, that's like an iPhone style event that happens so rarely where something gets, gets released and just everyone is like, yep, nailed it."

• The quote compares Square's successful market entry timing to that of the iPhone, emphasizing the rarity and impact of such well-timed product launches.

• Grading an IPO involves assessing both the company's performance and the execution of the IPO process.
• The discussion reflects on Square's IPO, considering the timing and financial strategy.

"It's a good idea that was at the wrong time. With terrible execution."

• This quote conveys the sentiment that while the underlying business idea was sound, the timing and execution of the IPO were flawed.