What Square's Down Round IPO Means for FinTech Valuations: Is It VCs vs. Retail Investors?

In the startup world, if you receive $10M as series A funding and if your series B happens at around the same or lower valuation and you are getting $7M funding (say), it is considered bad; it is called the down round. In Square’s case, something similar is happening, although the next round is not a private investor round but a public listing (IPO). In the last few quarters, unicorn market caps have been under pressure. As per BI, most of the big Internet companies have lost at least 25% of their value between April 30 and September 30. I wonder if Square’s IPO valuation is an issue with the company fundamentals or of the IPO market right now. I also think that it could affect other FinTech startup valuations in the future.

Founded in 2009, Square, Inc. was at that time considered to be an innovative mPOS solution provider in the US which was also doing its own merchant acquisition. However, speculations have been rife on the company’s growth and profitability.

After over six years, on November 6, 2015, Square filed the Form S-1 with SEC for an IPO with a price range of $11 to $13. At the upper band, the company is valued at $4.19 billion, significantly lower than their latest funding round valuation of $6 billion in October 2014. While Square looks to raise more funds through the IPO and assist venture capital exits, it is unable to justify the $6-billion valuation to the retail market and has considered a lower valuation. Multiple factors might have led to lower valuations with the most prominent being uncertainty over its balance sheet as the company is growing in both revenues and losses, operating with cash flow negative, increasing competition from new POS startups/platforms like Poynt, Revel Systems and big POS terminal firms getting into mPOS such as VeriFone.

Alongside the company-specific reasons, Square’s IPO comes at a time of uncertainty in the US IPO market with 2015 IPOs being the lowest in six years. According to Renaissance Capital, only 18 US technology companies have gone public so far this year compared to the seven-year high of 55 in 2014. Some IPOs are not getting done because their leaders see how bad the market is, some are not getting done because investors don’t want them at all. Others are getting done when they get done at heavy discounts, said Renaissance Capital’s Co-founder Kathleen Smith. Sequoia Capital's Michael Moritz said that private companies listed as "unicorns" that are valued at $1 billion or above will be the "great, enduring companies of tomorrow." But he added that many "seem the flimsiest of edifices."

Square’s pricing is the latest evidence that unicorns are fetching private funds at higher valuations, which may not be justified in the public market. This phenomenon of lower valuations in the present market is across the startup world where investors have funded at very high valuations and are now finding it difficult to exit from their investments. Furthermore, according to the WSJ, Square’s pricing could serve as a reality check for the more than 120 tech companies with valuations of at least $1 billion.

Largest FinTech IPOs, (Oct. 2014 – Oct. 2015)

The chart above talks about some of the pre and post-IPO scenarios for some FinTech firms. It’s not always bad. First Data has not performed that well but the situation that Square is in can’t be generalized as such, at least in FinTech.

To conclude, while investors and venture capitalists are bullish on the FinTech growth story, some might start exercising caution in the valuation of the startups and their business models. Although, some of their investments are actually protected by the ratchet clause.

The other (broader) way of looking at it is that in the past five years, 10% of VC dollars were invested in FinTech and those companies produced 20% of private companies now valued at $1 b+ (in other words: unicorns).

Notes: 1. Ratchet mechanism/agreement allows/protects one’s investment, in case a company IPOs or sells itself to another company at a lower valuation down the line.