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The Square IPO

Season 1, Episode 43

ACQ2 Episode

August 16, 2017
January 6, 2019

Unicorns and ratchets and lawsuits, oh my! Our heroes dive into the history of Jack Dorsey's famous "other" company, Square. Was the Square IPO a canary in the coal mine signaling doom & gloom for the so-called unicorn companies of the early 2010's, or a mispriced and misunderstood diamond in the rough? Acquired weighs in.

Topics Covered Include:

  • Square's deep origins in the early 90's in St. Louis, MO with the initial meeting of its co-founders, Jack Dorsey & Jim McKelvey
  • McKelvey's side glass blowing business and the "inspiration" for Square that came much later in the late 2000's
  • The complicated involvement of Washington University (in St. Louis) professor Robert Morley, who had worked for years developing payment card reading technology
  • The company's early meeting with Scott Forstall at Apple, and its "significant" impact on the its name and design
  • The real disruptive innovation of Square and its business model (hint: not just building a mobile card reader)
  • Square's massive payments deal with Starbucks in 2012 and its impact on the company
  • The evolution of Square's business from a simple card reader to cloud-based Point of Sale (PoS) system and entire suite of merchant tools & business management services
  • The drama leading up to Square's IPO (including at Jack Dorsey's "other" company, Twitter), dynamics and narratives affecting its pricing, the effect of IPO "ratchets", and the company's performance over the ~2 years since

The Carve Out:


We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Season 1, Episode 26
LP Show
August 16, 2017

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
August 16, 2017


Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

Season 4, Episode 1
LP Show
August 16, 2017

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

Season 1, Episode 11
LP Show
August 16, 2017

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
August 16, 2017

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

Season 1, Episode 23
LP Show
August 16, 2017

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Season 1, Episode 20
LP Show
August 16, 2017

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

Season 1, Episode 7
LP Show
August 16, 2017

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Season 1, Episode 2
LP Show
August 16, 2017

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!


  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben:I also don’t think there’s anything that we want to edit or cut.

David: Oh, it was great.

Ben:We’re getting good at this. [music] Welcome back to Episode 43 of Acquired, the podcast about technology acquisitions and IPOs. I'm Ben Gilbert.

David:I'm David Rosenthal.

Ben:And we are your hosts. Today we are covering the 2015 Square IPO to much, much demand from a lot of our listeners out there from David and from myself living on our Google Doc for way too long. We now have enough distance from it that we feel comfortable retrospectively covering it as an Acquired episode.

David: Yeah. This one is going to be fun. I've been looking forward to this for a while.

Ben:Yeah. We’ve never said that on a podcast intro before.

David: Yeah. Basically, this whole show is just like what Ben and I want to do and what we want to learn about.

Ben:We did our survey and we had a tremendous amount of feedback that said “It seems like you guys just kind of do whatever you want to do” and we hope that you guys like that because that is indeed how this works.

David:Well, that's the best product advice out there, is solve your own problem, right?

Ben:That's right. Speaking of our survey, we promised to you guys that someone would win a pair of AirPods and while they are still shipping because of Apple’s excellent, excellent 6-week delay which congratulations to Apple for creating a product that has that much demand, they’re still in the mail but we’ve got a winner. So a shout-out to Tom who we will leave his last name anonymous, but Tom we have reached out to you over email and congratulations. And thank you to everyone that took the survey. It means a bunch to us.

David:Yeah. Thank you. We got some great data, and not just data but feedback from you guys that hopefully you’ll start to see incorporated in the show.

Ben:We heard you loud and clear. We do not need to do Hot Takes. Got a lot of feedback about the Hot Takes. We’re not doing it. Unless we really need to, we’re not doing the Hot Takes.

David:Like today.

Ben:Yeah. We love reviews. So listeners, if you have a minute right now, you can pause this very podcast, pop open the Apple Podcasts app and you likely are already in it if you are reflective of our analytics, and go and write a quick review. We really appreciate it. It’s how we grow the show, it’s how we bring in more guests and it’s how we do even better content. So thank you for doing that.

We have a sponsor for this episode and our sponsor is Perkins Coie. With us today on the phone, we have Buddy Arnheim. Buddy is a partner in the Perkins Coie corporate law practice. Buddy is based in Palo Alto and has been the first counsel at companies you may recognize such as OpenTable, Trulia, Hotel Tonight, and Cloudera. His team at Perkins represents over 450 other VC-backed companies as well. So very impressive. All right. So Buddy, suppose our listeners aren’t in the market right now for legal services at this exact moment, is there another way that founders, investors, and tech employees should think to interact with Perkins Coie?

Buddy Arnheim:So for folks that are thinking of starting businesses or thinking of getting involved with early-stage businesses, our website has a myriad of resources. We’ve launched this thing about four years ago called The Startup Per Colator. It’s a repository of great information about the early-stage challenges that businesses face. It comes with a bunch of forums to help companies get informed and they can structure through seed financing and bringing on employees and provide them equity in a sense. So there’s a whole bunch of resources at Startup Per Colator that I think folks that are interested in starting companies are getting involved in the early-stage businesses to benefit from.

Ben:Great. Thanks so much. If you want to learn more about The Startup Per Colator or reach out to Perkins Coie, then you can go to StartupPerColator.com. That's Startup P-E-R-C-O-L-A-T-O-R.com. Or if you don’t know how to spell that, you can just Google it like I did. So thanks to Perkins Coie.

David:Thank you guys.

Ben:David, anything else before we dive in?

David:No. Let’s do it. Shall I start with the history and facts? As always.

Ben:As always.

David:Well, today we start not where I think many listeners might think we would start when looking at the Square and the Square IPO, which would be Jack Dorsey, of course, the man most associated with Square.

But we actually start back in 1991 in St. Louis, Missouri with another man named Jim McKelvey Jr. who is a co-founder of Square. Jim had been born in 1965. He was raised in St. Louis and his dad was actually Dean of Engineering at Washington University in St. Louis. And Jim Jr., his dad was Jim Sr., Jim Jr. went there for undergrad. He majored in Computer Science. He also got really into glassblowing while he was in college and he was an artist. He was a budding Dale Chihuly. Shout-out to Northwest artists here, the other University of Washington area. After college. So this is the late ‘80s now. Jim worked for IBM for a couple of years and then he caught the startup bug and he went and he started his own company which was called Mira Digital Publishing.

Now if you’re wondering what all of this has to do with Square and Jack Dorsey, just bear with me for a minute here. So Mira, this is again late ‘80s to early ‘90s, initially they created a product that was a competitor to Adobe Acrobat and PDFs. But unfortunately, Adobe existed and so that didn’t work out too well. But they went at it for a couple of years and then Jim started to realize Adobe was going to win the market. The whole landscape in technology was changing as the internet was coming and so he decided to pivot the company. And this was mid-90’s now, this was 1995. So he wanted to pivot the company into going into publishing actually, into conference publishing. But nobody else in the company really was on board with this idea, with this pivot except for one person. And that was his 15-year-old summer intern who was in high school, and that person’s name was Jack Dorsey.

Ben:Wow. That’s a connection.

David:We are reaching way back here at Acquired. And Jack had also grown up in St. Louis, Missouri many years, after Jim and had gotten a summer job in high school working for Mira. But Jack was totally onboard with the pivot and so he was kind of the first person to get bought in, and that’s how the relationship between the two official cofounders of Square started.

Ben:All right. So they knew each other for years then before the founding of Square, like all the way through Twitter, all the way through even before that obvious. Take us through that.

David:Well, obviously many, many years go by and a lot happens. McKelvey, he pivots the company, they get into conference publishing. But he also kind of rekindles his love of glass blowing and he starts another company called Third Degree Glass Factory. And he starts blowing glass again and he gets really well known for making glass faucets, so like faucets on your sink. They’re really beautiful. We’ll link to it in the show notes. The company still exists today and he makes glass faucets. So this was many years later. This was kind of late 2000s, around 2008-2009. They’re beautiful works of art and so he was selling them, but he couldn’t get set up with all the financial institutions, his bank and credit card companies to be able to accept credit cards. So he had to sell them by cash or check and that was really kind of limiting the amount of $2000 glass faucets that he could sell.

Ben:You got to imagine if just one of those sales falls through, that's a huge deal. Depending on your lifestyle, like if you’re a glass blower and you’re kind of a starving artist and you just have one of those fall through, it changes your whole life.

David:It totally does, right? And not to mention, I mean, you have to do the work, you have to blow the glass. You’re doing all this by hand, putting all this effort into it by yourself before you even try and sell it. And then if you can’t sell it to a lot of your potential customer base because you can’t accept credit cards, that's kind of a problem.

Ben:We live in a Square world now so we’re used to seeing all the food trucks with Square readers. But if you think about the type of business owner who is able to get approved for a merchant account these days, you need to be tremendously established. It was really unfriendly to entrepreneurs and not tech entrepreneurs but like people who were starting these little businesses. And in fact, getting ready for this episode, I talked to someone that had a business that had around 100k of cash in the bank. It was doing like a quarter million dollars in sales a year but was new, it was sort of a few years old and couldn’t get a merchant account with a bank. How insane is that?

David:It's totally insane thinking back on it and now how much Square and other financial startups like Stripe and the online world have changed the way this all works. But even just a few years ago, you needed to be super established doing tons of revenue before the financial system would kind of let you in.

So Jim’s got this problem. He thinks maybe technology can solve it so he calls up a good buddy who just actually, coincidentally, got forced out of his current startup and that was Jack who had been CEO of Twitter famously from 2006 to 2008, and then was forced out of the company. So he’s looking for a job, it’s late 2008 and his old first boss Jim calls him up and says “I've got this problem.”

Ben:I'm thinking back to like my first boss now and imagining ever getting that phone call. I was an umpire and so I’d be the guy that ran the summer umpire’s group, but yeah, I can’t really imagine.

David:Well, you could have started BAMTech.

Ben:That's right.

David:More on that later. So I just told this whole story about the origins of Square. And it’s a great story and it’s the official story. Now, is it the true story? That's a little more complicated.

Ben:David, why have I heard that there was like seven founders of Square?

David:Yeah. So there was a little more going on behind the scenes than that. And impossible to know exactly what. But it is true that Jim was Jack’s first boss and that he called him up in late 2008 right after Jack was forced out of Twitter with an idea to start a new company. It turns out that probably most likely, and Jack’s actually talked about that, that idea wasn’t Square. It was to start an electric car company and compete with Tesla.

Ben:Well that's very different.

David:You know, it’s almost like accepting payments via plugging into your audio jack on your phone, almost. But at some point along the way, a third person gets involved and that person’s name is Robert Morley. Robert or Professor Morley was a professor at Washington University in St. Louis. I believe it was that Jim and Jack initially approached him about potentially helping with this electric car idea. And Morley says “No, that's a terrible idea but I've got this thing in my research that I'm really focused on and I’ve been working on for years, decades. And that's around card reading technology, payment card reading technology and I’ve got this device that you can plug into a mobile phone and it’ll read credit cards.” That, according to Morley’s side of the story, got Jim and Jack really interested in this idea and it was also true that Jim was a glass blower and couldn’t sell his faucets via credit card. So they got really excited, turned them on to the potential of using mobile phones to accept credit cards rather than the super expensive and really clunky and big Point of Sale systems that NCR would sell, National Cash Register or other sort of big fintech companies.

So one way or another, they start working on it. Morley was never kind of officially part of the company. He did in 2014 before they went public, he did sue the company for both patent infringement on the card readers and forcing him out at the founding stage. And Square and the company and he settled in 2016 for $50 million.


David:So Morley got $50 million, everybody’s happy and Square is a great company today.

Ben:Man, so you have to imagine like how does that all go down if you’re Morley. Like it’s based on a lot of his research. He had all these conversations, it seemed like he was in. Presumably they would sign some documents when he parted ways but are you just sitting there thinking like “Well, at some point I’ll get a pay day out of this so I’ll just wait till the right exact time to sue.”

David:Yeah, I don’t know. We didn’t talk to Morley or Jim or Jack for this episode and I doubt they would tell us anyway.

Ben:Yeah. But note, I’ll pull forward a tech theme here that this is not the first time we’ve heard this. There are so many scenarios where right around acquisition, right around an IPO, this lawsuit comes in and it’s around the founding of the company and it’s really messy. And you could take away a lesson that's like, Hey, have your documents all buttoned up from your founding era. But I think the real takeaway is like, Hey, have everyone be fair and equitable.

David:Yeah. At the end of the day, everybody is probably pretty happy here. But I think this also highlights this whole thing, both the official story and the unofficial story. Highlights what I think Jack in particular is really, really great at, like what his super power is – and we’ll talk about this more in the episode. But he gets the power of stories and the official Square origin story is super powerful. Right? Like I'm an artist. I'm making glass faucets and I can’t sell them, but I have to make them upfront and I'm locked out of access to the modern financial industry.

Ben:Yeah, this resonates with so, so many people and I think I’ll put forth another tech theme because we have so many good tech themes that I think it's worth doing these sort of like popcorn ones early. Reinvented founder stories I think are probably more common than actual organic, live-as-it-happened founder stories. Like when you hear the picture perfect, too good to be true entrepreneur post-IPO describing this simple insight that they had when they were... you know, who knows if this one’s actually true and out. But I’ll pick on and say “I don’t have any information.” But with Zillow, you hear Rich Barton talk about how he and Lloyd were both looking for houses after leaving Expedia and they couldn’t believe that it wasn’t online. Like you got to think that it’s much more like, “Hey, we should start a business together. Here’s a few sectors I'm interested in. Let’s assess the viability of this.” I think it looks a lot more like what Travis Kalanick would describe as a jam session between very entrepreneurially minded people that it does this idea popped to me on the head one day.

David:Indeed. It’s a good story though.

Ben:It's a great story.

David:And I think like I was saying, you need a story to communicate. Like it’s not necessarily bad or wrong to create these founding methodologies because that part of how you communicate to your potential customer base, what the company does to the employee base. Like you embody the culture and the values of a company in these stories.

Ben:Yup. And there’s so many great things that fall out of it. Like your engineering, let’s say you’re doing Agile, like your user stories. Like you have your first user story. You have your very first when you’re describing your market, it’s very easy for an investor or a partner or a customer to conjure up to Jim the glass blower in their head.

David:Yup. Well, speaking of stories, we’ve got a couple more before we’re done with history and facts here, and they’re pretty good. So 2009, one way or another the company is off and running. Jack is the CEO. He is either chairman or executive chairman at Twitter but he’s basically like barred from the company. There’s a whole book, the Hatching Twitter all about this which I actually haven’t read. I need to. But I think at one point they shut off his email account. So he’s all in on Square at this point. And Jim is the cofounder and he’s the head of hardware. So they get to work, they have a name. They have a really great name. They have an iconic design for the card reader that's going to plug into phones, iPhones and Androids.

Ben:What’s that name that they have?

David:The name starts with an S and then a Q and then a U. It’s Squirrel. The card reader design also totally iconic and matches the name perfectly. It’s an acorn. So yeah, they go down this path and, fortunately, for the world and for Square, before they launch they go to Apple, they go to Cupertino. They meet with Scott Forstall who at the time is like the most important person besides Steve Jobs when it comes to the iPhone. We’ve talked a lot about Scott on this show. And of course, Jack is he’s been forced out of Twitter but he’s a celebrity so this isn’t just some rinky-dink startup from St. Louis, no offense to St. Louis, but easy to get a meeting with Scott. And Scott points out to them that, hey, they’re having lunch at Apple at the café there and Apple actually uses another company called Squirrel Systems that does their Point of Sale system at the café. So Jack’s like, “Hmm, well, that's not a good idea.” So they change the name to Square and the fortunately they also change the design of the card reader to be a Square.

Ben:And it's worth noting at this point that Square was not a Point of Sale company. So it wasn’t this obvious like you would have searched other Point of Sale systems to realize, “Oh, these are Squirrel Systems.” If you remember at the beginning of Square, it was more about accepting credit cards on the go and just this single dongle to plug into your iPhone. There wasn’t even an iPad app, let alone this ubiquitous every coffee shop on the planet uses Square register as their Point of Sale system. And so you could imagine like you think you’re competing in this category of we’re just working with kind of not the underbanked but like the under merchant accounted right now, we’re providing this new mobile payment system. Mobile is new, it's only two years since the iPhone. You really don’t think you’re going to be competing really in that Point of Sale market of people that stand behind a counter.

David:I remember when Square first came out being really excited and getting a reader myself. I mean, I wasn’t a business. I didn’t sell anything.

Ben:Yeah, me too.

David:I thought it was like, “oh, this is great. When I sell stuff on Craigslist, I can take payment on credit card.” That's what I thought I would use it for.

Ben:In fact, I even used it like what people use Venmo for today because I was so excited. My buddy Andy and I were taking a backpacking trip and we both bought the same backpack and I put them both on my credit card. I was like, “Hey, pay me with Square.” I like, pulled out on the way home, I like pulled out my card reader and accepted his credit card knowing that I was going to take –

David:Oh, man. You’d be paying the fees.

Ben:Yeah. Like I got less money. I paid the fees as the merchant. But it was like too cool not to do it.

David:You wanted to take payment on a credit card on your phone?

Ben:You know, as a person I’ve never been able to do that.

David:I know. It’s pretty cool. That's the end of the fun stories of the history and facts for Square. But I think this is really the key innovation. Part of it is the hardware thing and we talked about the lawsuit and Morley. But part of the innovation was being the technology to accept payments on your phone, but the bigger part of it was enabling anyone to accept payments, like we were talking about. It was this huge barrier to doing so and entering the industry. And what Square was able to do and it also I think was technology innovation, but it was on the backend, they were able to let so many people like you and me, Ben, consumers into this world of accepting payments because they got really, really good at fraud prevention. This was part of the reason why the industry didn’t let anyone in before was protectionism probably, but the stated reason was fraud. That if you let anybody accept payments, you’re just opening the door to tons and tons of fraud happening.  

Ben:Yeah, I think you nailed it. There’s a couple of amazing data points here. So I think you’re right that the thing that Square did that's entirely differentiating is unlocked a completely new set of people who could accept transactions, right? They did it an incredibly design focused way. So every POS system ever has sucked. Right? It’s just been awful and they invented this category of sort of cloud Point of Sale which is really the big market than they’re in now. It’s not as much mobile card reader as much as it is a cloud Point of Sale system. They’re competing with like the micros of the world there that are sort of the tethered to a phone line Point of Sale system and really hard to integrate with. So when you look at the market they were entering, so they did three things really well. They did the incredible, amazing user experience as a merchant. They unlocked new merchants, secondary merchants before, and they did the best job of reducing fraud with this new merchant class.

So when you look at the Square device was revolutionary but it wasn’t the first. I mean Intuit had something called GoPayment that was totally already catching on. It wasn’t even like, “oh well, you can find prior art” or something like that. It was totally happening but Square had a phenomenally better experience.

David:And I think PayPal had a reader too.

Ben:That's right.

David:Afterwards. But it launched pretty quickly afterward.

Ben:And the Square folks called that the triangle because it was shaped like a triangle and was copying Square in a lot of ways.

David:Oh man, that thing was so ugly.

Ben:The interesting data point around this is, both PayPal and I think Verifone was the other one that basically weren’t doing the underwriting in the way that Square does and they were taking huge losses. So they were actually subsidizing payments when they realized, oh crap, there’s this entire new class of merchants emerging. They didn’t have the underwriting system and basically the machine learning system. I mean, that wasn’t all the rage yet but effectively, machine learning system to constantly be learning and constantly basically be re-underwriting that merchant after every transaction.

David:And whether new merchants and existing merchants were going to be fraudulent or not.

Ben:Exactly, exactly. So Verifone actually shut down their competing product because of fraud losses because they were taking kind of a 1% loss on every transaction for every customer. When they shut down, they very publicly accused Square of subsidizing the small businesses. And Square’s like actually a core competency of our business, is we’re really, really good at this. The trick that they were using is a really interesting one and obviously they have this incredibly sophisticated team that does this. But they basically would only take on a little risk at first so you couldn’t do a bunch of transactions and massive transactions at first. They would just say, hey, we’re not going to put you through a bunch of hoops. We’re just going to give you a little bit, basically a little bit of credit. We’re going to let you start racking up your transactions until we trust you and with every time that you completed a transaction and it wasn’t a chargeback and it wasn’t fraud and it wasn’t all these things, they basically gave you a little bit more rope. So that way, they could actually get you started quickly and trust you more over time which was just nothing, it was completely innovative in this industry.

David:Yeah. Just to put a data point around that. When Square started, there were 30 million businesses in the US that had under $100,000 in revenue. That's just businesses, people that had already incorporated a business. But only 6 million of those could accept credit cards. So 24 of the 36 million small businesses in the US under $100,000 in revenue could not accept credit cards. Like that's just unfathomable today.

Ben:Man, if you are like Visa, Mastercard, American Express, you have to be just besides yourself at the market this unlocks for you.

David:Yeah, totally. So 2010, they launch as Square, not as Squirrel and with the square reader, not the acorn reader. And they make the card reader free. So if you want to join Square, you sign up online. You enter some information, it’s pretty easy. You give them your address and then they send you a card reader in the mail for free. Versus like buying a $2000, $5000 Point of Sale system from Verifone or NCR or whomever. It's a game changer.

Ben:Yeah, On top of technology innovation, just massive business model innovation.

David:Totally. And then, once you start accepting payments, it’s a straight 2.75% charge on every credit card transaction which is different from how it worked with large providers at the time. There would be a sliding scale. It would depend on what type of card people were using, if you were using the...

Ben:David, have you ever applied for a merchant account before?


Ben:When I was working on a startup in college, I actually applied for a merchant account. You get this thing that's like maybe 12 or 15 pages thick and it has, I don’t know, 50 to 100 lines on each page and each one is a different scenario where you have a different fee structure for each card. So there’s a zero way that you could ever like put that in a spreadsheet and calculate it yourself and make sure they’re charging you right. Or perhaps model out what your average fee is going to be for your business because it’s literally like, oh, if someone types in their card number versus swiping it, it’s different. If it’s this card that is a Visa Signature instead of a Visa, or it’s underwritten by this bank, or whatever. Every single one is different.

David:Yeah. And if you’re like a retailer or a café or a food truck, like your margin is already super small to begin with. So now you’re just like you can’t even calculate whether you’re profitable on things. It’s just terrible.

Ben:Can we just pause for a minute and say the credit industry is like the biggest fast one pulled of all time. Like, can you imagine, so let’s say we live in a world where the credit card system was never established. Suddenly, this guy’s like, “Oh, I'm going to start a credit card,” and he comes to you as a retailer and he says, “Hey, people can pay with this thing instead of cash and they’re going to want to because it’s going to be really easy, and I'm actually going to take like 3 percent of the entire business.”

David:Yeah, but I'm not even going to tell you how much I'm going to take, like I'm just going to run some voodoo and then you got to trust me.

Ben:Right. Unbelievable. This is a little bit of like the better consumer experience always wins out. Like if somebody provides the way that people are going to pay for services at your business that is the easiest thing and there’s sort of a network effect going on like it’s going to happen – so there’s another tech theme pulled forward – then it’s going to happen. But like just can you imagine how resistant retailers must have been when this first started of like suddenly you lose 3% of your –

David:Yeah, well it took decades. The other thing that this hypothetical shyster named credit card would pull on these business, is not only am I going to take an undefined and calculable percentage of your sales. Rather than when you take cash, then you have cash. Like it’s there, it’s in your cash register.

Ben:By the way, I may take this away from you.

David:Yeah. Well, I may take it away from you, one, via chargeback. But two, even if I don’t take it away from you, I'm not going to give it to you for like 30-45 days. Unreal. So when you took credit cards before, that money wouldn’t show up in your bank account for at least 30 days and if you’re a small business trying to meet payroll, trying to pay off your suppliers, like that's a problem.

So the other big product feature that Square had was they deposit the funds into your bank account within 1-2 business days, which again, was huge compared to the industry at the time.

Ben:Yeah, that's pretty incredible.

David:How they did all this and they launched pretty quickly after they were founded, I don’t know. I mean, that would be a great story of building all this, like this is not easy stuff.

Ben:Okay, so at Pioneer Square Labs we work with these startups and we’ve started 60 and we sort of killed a lot of them along the way and we spun out 6. Every single one whether it's a successful thing that actually launches or an early project you’re working on, like it is so hacked together and the customer experience is so like almost there at the start. You’re just trying to prove that your one insight is true. And I remember when I found out about Square like the first press release, you go to the website and it’s like one of the best designed websites I had ever seen because it’s like a huge tenet for the company and a principle that Jack believes in. In fact, like I was doing web design at that time and web development, and people would just keep pointing back to Square, like, “Oh, make it look like that.” And every iteration for years was like the gold standard of beautiful designed website. And when my Square reader arrived, it was beautiful. The packaging was Apple caliber, like the messaging was all perfect. Like, there was nothing about this company at least as a customer that felt like scrappy or new or at experiment. It’s like it was birthed as a perfectly formed product.

David:Yeah, it will be great. It would be super fun to have somebody if you’re out there who was there in the early days with Square, come on and do a follow-up with us. Like, how did you build all this stuff in 12 months or less? It would be cool. In 2009 and 2010, no less, when it was definitely not as easy as now to build all this stuff.

Ben:Right. And it really speaks to Jack as a product visionary too. I mean, when people referred to him as Jobs-like, I think in the way that Steve Jobs and Jony Ive and those folks could conceive of something and then release it perfectly into market the first time. Square has iterated quite a bit in a very Apple way of small interactions over time and small iterations over time. But amazing how good it was at first.

David:Yeah. So, they launch in 2010. Before they launched, they had raised a Series A from Khosla Ventures in 2009. But they launched and basically they just grew like wildfire. I mean, we’ve talked about all the reasons why this was a complete game changer for small merchants and people that didn’t even accept payments at all before. Launched in 2010, there is a Series B from Sequoia from Roelof Botha who was some partner at Sequoia and had been the CFO of Paypal in 2011. Then a couple months later in 2011, they raise $100 million Series C from Kleiner. 2012, there is another $200 million from Chris Sacca and Rizvi Traverse. Chris had used that vehicle to buy up a lot of secondary shares in Twitter, famously, and then he used the same vehicle to invest in Square. And then simultaneously, well, right after that, then they do this enormous deal with Starbucks in late 2012 and this was such a huge announcement at the time. So Starbucks invested, as part of this round, into Square and committed to moving all of their payments at all Starbucks-owned stores in the US on to Square technology. And up into this time Square was for the customer we’ve been talking about, the sort of small merchants. But the idea that a Fortune 500 retailer would move everything on to Square was just pretty shocking at the time.

Ben:And I actually didn’t dug that much into this deal but to me, it’s shocking that Square was anywhere close enough to feature complete, to make this deal make sense. I mean, I think there’s a lot of discussion we’ll do about this deal, of the financials of it. But from a product perspective, I remember shocked to that like, was Starbucks going to contribute to. I guess Square probably had to do a ton of sort of custom development effort and it probably forced them to enable a lot of the functionality in the Square register that they have today.

David:Yeah. And we talked about this a little bit in the Starbucks episode with Dan. But I think a couple of things. One, Square wasn’t ready; this was a really bad deal. And I joked earlier that the end of the fun story in this episode for Square, at least until the very end of this episode, but this was the beginning of the end of the fun. But I read a lot of things written by Jack and interviews with him looking back on this in preparing for the episode and, you know, he does say and he’s probably right that what this deal forced Square to do was become enterprise class in terms of payments and fintech and security really quickly. They basically had no choice.

Ben:Yeah, that's interesting. And it really also I guess gave them those product features to move a lot more of their business to this point of sale market instead of the mobile card payments. I think the difference is subtle and I mean it’s best simplified as going from iPhone to going to iPad. But they forked the code base. It became Square and then a different app called Register. If you look at the vast majority of their revenue today, they have on a per quarter basis 482 million in transaction-based revenue, and everything else pales in comparison. It’s like 59 million in subscription and services based, hardware revenue. They do 10 million but 14 million of that is a loss. The vast majority of that 482 million is really in the Point of Sale category that is not quite where they started. I mean, they’ve used that as a wedge to get into the merchants that otherwise wouldn’t have been able to get an account, but now they’re in this rising tide of cloud point of sale. I was thinking about this before the episode. A lot of the growth ahead of them is really just this industry of cloud POS growing much more so than Square being able to continue to bring on more people that wouldn’t have been able to be merchants before or perhaps stealing share from other cloud POS providers like Clover or there’s all these other new ones launching that it’s really like they kind of pioneered this category and then really solidified their position in the category by forcing themselves to do all this work, much of it probably from the Starbucks deal and now it’s just like they get to sit on top while that industry accelerates.

David:Yeah. Well, I would agree but I would argue for a slightly different framing of it which is it’s not just cloud POS and I actually think that the software and data products line item of other revenue they have is hugely important. What this really did is it took Square from being just a payments rails system for anybody to accept credit card payments, to a whole suite of a solution for a merchant of any size really but a world-class suite of tools for a merchant to run their business of which payments is probably the most important part that's accessible to anybody from the coffee shop down the street to Starbucks. And that's what I think this deal did. So if you look at the Point of Sale system itself and the Square Register, it’s no longer just about taking payments. It's about managing your inventory, managing your skews, managing your employees, time punching in and out, and then since then, Square has added so many different features. Payroll for employees, Square Capital to do lending against your revenue. Appointment booking. Basically everything you would need if you’re a business to manage and run your business. And I think that all really happened or started because of this Starbucks deal.

Ben:I could see that. I like that framing. It is worth noting and I think it’s another business model innovation that they’re bundling all this stuff in largely for free or for a very reasonable cost and the way they monetize it all is through the transaction. 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.

David:Yeah. Well, it’s a flywheel. It’s an Acquired flywheel. And it’s like AWS, like they charge some amount of fees for some of their services and some of the services are free, like they bought Caviar. And so for restaurants, Caviar food delivery is an option that they offer. Then there’s Square Capital which is loans. And they make money off of those business. But really, the beauty is in helping the merchant grow their business which grows transaction volumes so Square makes more money. And then they use more Square services so they make more money from the ones that they charge for and the whole thing drives itself.

Ben:Yup. Great point. And so this Starbucks thing, it leaves them with a massive hangover, like this is something where – this underscores the point. So I was looking at the investor site earlier and checking out the way they break out revenue and I mentioned subscription and services-based revenue and hardware revenue. There’s actually a fourth breakout which is Starbucks transaction-based revenue and it’s obviously now that the deal is over, it’s 0 but it’s still on all their year-over-year comparisons because it was broken out separately, it was something that they generated good revenue but extremely costly to the business.

David:Well, let’s jump forward and accelerate through the end of history and facts here where we’ll cover all this. So last we left them, 2012, they had raised this huge round, done the Starbucks deal. They were valued I think at $3.25 billion in that round. Remember, this is 2012. The company was founded in 2009. Then, in 2014, kind of rather than go public, they’re toying with going public, they decided instead to raise $150 million Series E from the Singapore sovereign wealth fund and Goldman Sachs. We’re going to come back to Goldman in a minute. And that's at a $6 billion valuation. That round becomes pretty important in a minute.

So, in the meantime, growth is great. They’re growing payment volumes hugely. They’re growing revenue hugely and they’re making money off of the transactions. They’re making real margin dollars off of it. They’re still paying down their fixed cost. But the business is working.

Ben:I think they were coming out of that Starbucks thing and looking toward the IPO, they were close to break even if you look at them today. They just took a $16 million net loss on last quarter but if you look at the way that that's really come down, I mean you’re right, David, on a sort of a per transaction.

David:So they’ve completely paid down their fixed cost and they have a bright future ahead now. So all this is going on. This is throughout 2014. 2015 rolls around. Not a good year for Square. Well, so the first thing that happens, June 2015, Dick Costolo resigns as the CEO of Twitter. And Jack, a Steve Jobs moment, comes back as interim CEO of Twitter, which is also a public company at this point. Square is not public yet but they’re preparing to go public on the back of all this momentum. But during the year they realize this Starbucks deal is a terrible deal and they are financially – now strategically it was great for the company for all the reasons we said, but because of the pricing that they’re giving Starbucks, they’re just losing money on every transaction that they’re handling for Starbucks.

Ben:They did renegotiate that at one point, right?

David:They did renegotiate but the outcome of the renegotiation is basically that Starbucks is going to pull out. Because part of the renegotiation was that Square no longer had to be the exclusively provider for Starbucks for payments and Starbucks could get better pricing elsewhere. So they over time basically just start pulling out of the deal. So that's throughout 2015. Then October of 2015, Square is all working to go public throughout the year, is dealing with all these things and they eventually do go public in November. October 5, 2015 - Twitter announces that Jack isn’t interim CEO, he’s permanent CEO of Twitter and also permanent CEO of Square. So he’s truly like Steve Jobs with Apple and Pixar at this point.

Ben:Was he CEO of Pixar while being CEO of Apple?

David:I think he was, yeah.

Ben:Wow. Parallels in more ways than one but yeah, I totally remember this moment of like, okay so can you do that? Is that... what?

David:Yeah. Is that possible and everybody knew Square, it hadn’t been publicly announced yet but everybody knew they had privately filed to go public. We’re going to do our narrative section that we now do on IPOs in a minute. But let’s just say the narrative was not good in the press. So November rolls around. Square had announced their public filing. They had done their road show all while Jack is also now the new CEO of Twitter and they go public on November 19, 2015 at $9 a share which equates to a $2.9 billion valuation. Now, remember the last round they did was at a $6 billion valuation. So it then got widely reported in the press, it is ratchet time.

Ben:And that $9 a share was below the published range of what they were shooting for, $11 to $13 per share.

David:Yeah. They placed under the range. They said they were aiming to do the IPO at $11 to $13 a share. They end up pricing even under that. Basically, the whole tech world though this is like the first unicorn to die.

Ben:Oh, yeah. This was a moment where everyone thought the music had stopped. Like the doors were closed on the tech IPO market, people were worried about a global financial crisis or at least a recession and Square was trying to tell this other story of like, “no, it’s great. We’re doing better than ever and we’ve got sound fundamentals,” which is totally true but, like, the story that they were telling the world, everyone’s thinking like “Are you crazy? Nobody’s IPO-ing right now.”

David:But they did. And so as a result of it and this got so much press, this ratchet, so at the last round that they’ve done, which remember, Goldman Sachs was a big part of investing into this last round and then Goldman Sachs led the IPO.

Ben:It was like 50 million or so.

David:It was 150 million and I think Goldman invested 50 million. I could be wrong on that.

Ben:Yup, they did.

David:So though the terms of that round were that the company essentially promised those investors in that round a 20% return on their money at IPO. So not just where they get their money back at the same valuation but they would also get a 20 percent return. And the mechanism by which that played out, remember the IPO happened at essentially half of the valuation of that round. So not only did they not get a return, they lost money. The way it played out is the company had to issue additional stock to those investors when the IPO happened, and $93 million of additional stocks. Now that's not terrible. The company had a $2.9 market cap, but it’s a lot. And also, this got issued as stock. So if those investors held that stock, since then the company has basically just killed it because they had sound business fundamentals and lots of growth potential ahead of them and a huge TAM. So now they’re trading at $25.59 as of today, up hugely, almost a $10 billion market cap. And so if those investors had held on to that stock, the stock that they bought in the private round initially and then what they got in the ratchet, they would just be making huge returns right now.

Ben:So let me talk about the conflict here because this blows my mind when we were digging into this and really to get this out. So like the way IPOs work is the bankers get basically banker fees for taking the company public. So Goldman Sachs gets about $10 million in banker fees from this IPO which makes a lot of sense, given where it priced, given all those things. They also get, whatever, $90-something million in that ratchet because they participate in a huge way in that previous round. When you look at this, the incentive for Goldman as the lead underwriter on this IPO is to actually price it lower because their banker fees that they get as a percentage of the valuation of the company is actually significantly less than the amount of money that they would get from it being priced lower. So obviously it's different people and Goldman doing this, but it’s kind of shocking that that’s possible that you would pick Goldman, given their conflict there.

David:It's totally crazy. Banks have long argued that you should let– It’s been kind of like common wisdom in startup world that if you’re thinking about going public and one of the main investment banks wants to participate in sort of a mezzanine round before you go public, you should do that because then you’re going to align incentives with them if they ultimately do take you public where the higher they price the stock, the more money they’re going to make because they’re already a shareholder in your company. But if you have a ratchet like this, then just as you said, Ben, you’ve set up the incentive for them to price the stock lower because–

Ben:It’s perverse.

David:It's totally perverse. And who knows what did Goldman intentionally guide the company to price the IPO too low. Who knows? But here we are. And the facts of the matter are just like you said, Ben, the company has killed it over the last year and a half and the stock is now up almost three times since the IPO.

Ben:Let’s talk about why they’ve killed it. So Square, as we both argued in different ways, I think that they were sort of the creator of this new category of cloud POS and they are the most well-recognized name in it and they’re doing extremely well in this massive rising tide. So they’ll continue to kind of grow with that industry and your point of view that, yeah, and indeed they also were bundling all these other amazing services to make these businesses perform better and make all the card fees on those but also increase the number of transactions that they take a piece of. So great, the company is doing well.

The other magic to this whole thing is this is the sort of business that also has zero churn because for Square, on a per cohort basis, so for folks that aren’t familiar, a cohort is like a whole bunch of people who are becoming new customers in the same time frame. So they would all come in and their net churn was zero. So basically what that meant is the way that this business works is they would lose customers, they would churn out at a certain rate but the amount of money that the customers from that cohort who stayed there would generate from growing their business was approximately equal to the business that Square was losing from these customers that churned out of the cohort. So actually if you look at every new cohort they add, they flatten out over time and make a consistent amount of revenue for the company basically indefinitely. And so it makes a lot of sense for once Square has this cocktail TV ratio where they can figure out, “boy, when we deploy X in marketing spend, we make it back, plus 30 percent or so in less than 2 years, and we’re able to just keep pouring money on to do our marketing efforts and we just keep getting basically zero net churn cohorts that all stack on top of each other forever.” So, very predictable business in an industry that's absolutely a rising tide. It’s something where if you look at it on its fundamentals rather than as like a speculative “who knows if this will actually pan out” thing, it seems like it’s a great growth company.

David:We basically talked about the content of the narrative section here but it’s like a tale of two stories, a tale of two companies here. It was the best of times, it was the worst of times. If you listened to the press around the time of the Square IPO, and I remember lots of investors sort of talking too and chattering them, it was like this is the worst of times, like this is the death knell for all these unicorn companies and Square is like prime example of super overvalued and it turns out that their actual business which is payments is a super crappy business, really low margin, if any margin. And example #1 of that is look at this Starbucks deal, like it sucks. Square is losing so much money on it and that means they’ll never be able to serve large margins. So this company is doomed, right? Like that was the narrative that was so dominating the press cycle and the investor cycle but I think the lesson here is like in any kind of situation like that, you really got to dig into the company’s fundamentals whether the narrative is like this company can do no wrong or whether this company is doomed. And Square’s narrative through the whole thing, you read the IPO or you read the S1, they actually say in the S1 like “we serve small business merchants. We make commerce easy. We make it accessible to everyone, like we’re not a payments company. We’re about helping merchants increase their business.” And because of these flywheel effects, that is good for us too.

Ben:Yup. And boy, it's funny. Not to talk about Rich Barton in every episode now but when you hear him talk and he talks about the name Expedia and the name Zillow, like picking an empty vessel and then you get to fill it with your marketing and you get to fill it with your product and your brand that the value prop to customers, like Square was not a payment word. It’s something that they can choose to fill with whatever they want to be. In the way that Snap is a camera company and we all said, “Oh, Snap is a camera company.” Like, Square is a payments company. Square is a small business company and I think that’s got a lot of power to it.

David:There’s a great interview which Jack, he talks about, and he’s asked sort of like, what is Square? And he’s like, well, there are three things that every business needs. And he says whether you’re Facebook or Twitter or whether you’re a coffee shop, you need access to capital, and capital can be raising money but it can also be sales from your customers, like we were talking about earlier. If you can’t access the capital from the sales you’re making to customers because you’re not going to get for 30-45 days, that's a huge problem. So you need access to capital to build and grow your business. You need to acquire customers and then you need to retain customers and build loyalty. Like what Square has done I think, or at least what Jack would say Square is trying to do, is to help small business, well, businesses of all types, physical businesses do all three of those things better.

Ben:So drifting toward what would have happened otherwise, let’s talk about access to capital a little bit. This will help us guide a little bit of our criteria for grading this toward the end of the episode will be kind of two-fold. One is always did this IPO allow them to do something that they previously couldn’t do before, like was it a good business decision to IPO. The two components of that are the idea of it and the execution of it. So kind of working backwards from them and thinking about access to capital, after the Starbucks thing, they’re left in this place where they’re near cash flow positive, like that is right on the horizon. They know that when they spend marketing dollars, this very predictable thing happens where they are able to get a return on that marketing spend. So it's really about hey, let’s go get some more capital so we can keep taking advantage of scale, getting closer to cash flow positive and pour some dollars on this business. So then you have this decision of do you do that from the private markets like we did our Series D and we did with our Series E, or do we go to the public markets. This isn’t really talked about enough but if you look at sort of liquidation preference in all these venture rounds and all of that stacking on top of each other, the valuations are a little silly because think about it this way. If you’re a public company and somebody says “I will give you a valuation of $1 billion and I will own X shares that are worth 20 percent of the company”, then they actually own X shares that are worth 20 percent of that company. But if a private investor –

David:And if the price goes down or the company gets sold for $200 million, like tough luck.

Ben:Yeah, exactly. You still own exactly 20 percent of that company. Whereas in the private markets, the reason or one of the reasons that we have always inflated valuations is because the risk that the investor takes by putting money in is dramatically reduced by the preference. So the way that that sort of works is you can say, hey, I'm going to take 20 percent of this company and give you $200 million and value you at a billion dollars. But if you sell for less than a billion –

David:For 500 million, I'm still going to take my 200 million back if you guarantee a return like the ratchet. It’s like, nah, I'm going to take my 200 million and I'm going to take a 20 percent return. So founders, employees, rest of the shareholders in the company, you thought you just sold for 500 million but you actually sold for whatever you call it, 200 million at that point.

Ben:In this scenario, you take huge private round on huge private round and you build up all this liquidation preference, all this money that’s going to go to these investors that are happy to say, sure, we’ll give you a higher valuation because it’s lower risk for us. If you want that higher valuation, sure. But if things go south, then we’re going to get the money off the top before any of the common shareholders do. And so, you get yourself into the situation where suddenly have a $6 billion valuation, you start to realize that the public markets aren’t going to give you that $6 billion valuation because it’s a very different climate out there. You have 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. And so, I think depending on the story that's told when you’re IPO-ing, you can really get burned by that and that's what sort of Square was realizing, was uh-oh, we are not going to be able to IPO it at $6 billion or it's looking like we’re not going to be able to. There was like a 9-month period for Square where they’re issuing all these stock options as part of the compensation. 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 that company is $6 billion.

David:And today, the valuation is only 10. I mean, it's $4 billion higher but on a percentage basis, if you’ve got stock options, then it’s relative to the performance of the company and the growth of the company since then. You’re not really being rewarded for that.

Ben:Right. And people started to sort of realize this where they’re hired in, they’re like, “Wait a minute. I'm never going to be able to,” or in any short amount of time, like these stock options that I was given aren’t going to be worth anything and so I'm being undercompensated for my work. So they start losing employees and if they go do another private round it’s going to have to be either a down round or a flat round, or if they go up then there’s even more liquidation preference that goes on top. And so they sort of have to go public in a lot of ways to get all that liquidity and make it so that when you issue the restricted stock units to your employees, like that that’s an option for you. I think they actually started issuing RSUs before they went public, but it was a little bit of like a too little, too late situation where you have all these employees over 9 months to a year whose stock options are worth nothing and realizing it.

David:Yeah. Well, I think for me, this highlights when you’re talking about valuations of companies and investing in companies, and that's actually only part of what we do as startup investors, is as we’re talking on the Opsware episode, the most important thing is helping build companies. But, when you have your investor head on, that’s why you really need to value companies based on fundamentals.

Ben:Which is of course so hard to do in the early stages, right?

David:Totally. But by the time Square was raising these rounds, like it was possible. If you’re a founder in a company too, you also want your company to be valued on fundamentals. Taking a $6 billion valuation because you can get it and it feels good, it's like all nice and well. But you just screwed your employees, you know, if you take it with all this structure.

Ben:And you know, we’re not accusing anybody of doing that because it’s one of these things where like the whole world is telling you yes and it seems like the train is going to keep going and then you’re going to IPO and you’re going to do another up round and it’s all just going to happen. But when you start reasoning from fundamentals, it does get a little scary.

David:I completely agree with you, Ben. Like I don’t know the Square management team personally but I seriously doubt they were actively trying to screw their employees.

Ben:No. They seem like incredible, incredible years and operators. So okay, we’re in What Would Have Happened Otherwise, and in thinking about that, one option and this is I think really hard to expect this of someone, but one option is back when they had I think their Series D that was Starbucks and Sacca was in the neighborhood of 3.5 billion, instead of that private round, they could have just tried to go public and doing that earlier might have been able to do a flatter or up IPO like at a higher valuation or maybe at that 3.5 billion valuation, at least up from their Series C from Kleiner Perkins, and it’s hard to do that because the business wasn’t as mature yet and it’s really hard to want to face that sort of public scrutiny. But as you say, the business was fairly mature then and their model was pretty... the fundamentals of the business has been the same for a very long time.

David:Yeah. It would have been interesting to see if they had gone that path. I wonder though if the Starbucks deal was just too volatile at that point. And if they were still figuring out how bad it was. And again, good from a product and company building in a sense, but bad from a financial sense. I wonder if that's what held them back.

Ben:Right. That's interesting.

David:Well, there we are.

Ben:There we are.

David:That's why machine learning hasn’t come to startup management yet.

Ben:Yeah. It really is. 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. I think you really see the value of experience. Like every time I look into one of these companies, my eyes gets opened by all the different scenarios that happened from staying private longer, from doing huge round, from really doing the math on what are all the possible outcomes. It’s just gotten hairier and hairier. I like the story that the very first term sheet was a two-line piece of paper that said “I will invest in your company for a valuation of this where I get this percent.” Like now, you go into an 8-page term sheet and then 100 pages of definitive docs and all these different terms, and the complexity has just grown exponentially in the last 50-60 years.

David:Yeah. Which is not necessarily a bad thing.

Ben:There’s a lot more at stake. Yeah. There’s tons of real value being created so it makes sense to have all these provisions and carve it all up.

David:But I think you’re right and I think this is actually moving into tech themes. I didn’t have this down but this is a great one which is just like just the value of experience and when it comes to startup management and startup investing and that could be a lived experience or synthetic experience. That's why we do this show.

Ben:David and I are happy to get some synthetic experience at your expense.

David:Exactly, exactly. These decisions have a lot at stake and you can’t just devise an algorithm for the right way to move forward. The only thing you can have is experience and being thoughtful about it.

Ben:Good judgement, great people around you.

David:What else you got for tech themes?

Ben:Boy, I really didn’t save much like I would. I mean, well, one thing that I will say and this might not be a tech theme, but it is incredible facing that tough period that they went through – a good amount of attrition, a CEO splitting his time while being another CEO, massively botched Starbucks deal. Through all this, they’ve really pulled out nicely. Like the company is in a pretty great place right now and it has predictable growth. They’re introducing new products to sell to existing businesses, and who knows, maybe they’ll move into a negative churn or maybe they already are a negative churn, who knows. But it is really a testament to a lot of the things they did right that they’ve got come as far as they have.

David:My tech theme I want to get in quickly is timing. And it’s funny. I feel like the timing of the IPO was so bad. I mean, we’re going to get into grading in just a minute here but man, they really messed up the timing on this one. But the timing of the company and the product, I think this is just a fantastic example of what we talk about a lot on this show of riding waves and timing those waves right. The growth in consumers wanting to pay via credit cards coupled with the growth in mobile devices, and right at 2009-2010 that creating this massive opportunity to disrupt the payments and the merchant industry, merchant services industry.

Ben:And just instant product market fit. Like, it’s so, so rare. I mean it’s like an iPhone style event that happens so rarely where something gets released and just everyone is like, “yup, nailed it.”

David:Yup, nailed it. All right, that's what I got for tech themes. Should we grade it?

Ben:Let’s do it. So I'm going to start from an A because it was like, we’ll start at the top, they needed cash, the future looked bright, they were near cash flow positive. I'm going to knock them down to –

David:Look, from a fundamental perspective, as we talked about, I think it was the right time to go public. They had ironed out the Starbucks deal, the future was bright.

Ben:Then I’ll knock it down to a B because I think they did it a round or two too late. Not only would the climate have been better to IPO but the fundamentals of the business would have justified going public earlier and it's a hard thing to expect of people but that knocks it down to a B for me. The whole Goldman Sachs thing, like unbelievable botch. Oh my gosh. If I was an employee, I’d be so infuriated and I think that for me, it’s a C. It’s a good idea that was at the wrong time with terrible execution.

David:Yeah. Man, I'm so tempted to do like a Facebook IPO style grading here in that like I want to separate out the company and the performance of the company which I think is just fantastic. Truly, I think one of the best tech companies built in the past 10 years, one of the very, very best from the IPO execution. But I do think kind of like what saved the Facebook IPO for me and allowed me to give it two grades was I think they really learned and Mark talks about how like the IPO was a forcing function that really turned into kind of a company-saving event for them and realizing they had this huge problem with mobile. I'm not sure that the same thing happened with Square. I think they just kind of messed things up financially, as you were talking about, Ben. So I'm going to resist the temptation to do two grades although I do want to make it clear I have so much respect for Square as a company and as a company going forward. But I think the IPO process, I'm not going to be as harsh as you because again they probably needed the money and I think had they gone public earlier, they probably hadn’t had the Starbucks deal ironed out enough. That would have been a huge problem. So I'm willing to be a little more generous, but I'm going with B-.

Ben:Well, you know, in this hypothetical world I can predict that it went well and it’s funny how like we only know how the exact reality played out. We don’t know how the alternative reality played out. So it’s not fair really to say that that would have been better.

David:All right.

Ben:I'm glad you didn’t give it two grades because I was going to rip on you pretty hard.

David:I could feel it coming so that's why I pulled back.

Ben:It reminds of that Who’s Line is it Anyway? line where the show where all the facts are made up and the points don’t matter. It feels a lot like that.

David:That's what we do here at Acquired. All right. Speaking of which, I know you all said you hate Follow-ups and so we’re just not going to do them, but in this case we have to say we were right.

Ben:Yeah, we got to brag.

David:We got to brag. Disney acquired a majority stake in BAMTech, exactly as we predicted they would.

Ben:Maybe even sooner. I think we should go back and listen, but I think it was like sometime in the next year or two. But it was 4-5 months later.

David:So good timing, Ben, speaking of timing.

Ben:And that's unbelievable. Like can we just rewind a second and think about like, holy crap, Disney is pulling all their content off of Netflix and doing a Disney-direct offering. It's their own streaming service through BAMTech directly to consumers. I can’t wait to see how this all shakes out.

David:Yeah, seriously. Future episodes to come.

Ben:Well, yeah. Multiple. All right, Carve Outs?

David:Carve Outs. Mine is so perfect for today. It combines everything we’ve talked about. So Nick Bilton who wrote Hatching Twitter, he was at The New York Times, now he’s at Vanity Fair, he has a great new podcast called Inside The Hive and he had Bob Iger, the Disney CEO on. And it was great. We’ll link to it in the show notes. But Bob talks about their M&A strategy and Lucasfilm and Pixar and Marvel and the Disney flywheel. It’s great. You guys will love it. I certainly did.

Ben:Awesome, I got to check it out. So mine is a book that is currently being written but if you guys haven’t check out GitBooks before, it is really an interesting product. It’s like GitHub for books and you can sort of look at the contribution history and the revisions of a book while it’s out there in public. And you know, can be written and revised in real time for people to read it. It's a complete thing that you can go read but it’s interesting as the world changes. It continues to be rewritten. The book itself is called World After Capital and it is written by Albert Wenger of Union Square Ventures. It is so interesting. Like it is one of these things where you often get focused in your own niche or your own work and you read the things that are related specifically to your job, but you don’t think about of like the macro implications of what we’re all doing and it’s a really interesting book where he sort of argues that we’re moving past a world where capital is the expensive and scarce thing and that capital is cheaper than ever and it’s less meaningful than ever before and that knowledge– He talks about attention a little bit but really focuses on knowledge as being the scarce resource, and what does that mean in a world where knowledge is a scarce resource and he talks a lot about AI, machine learning. And if that stuff’s your jam and you like to be a futurist a little bit and have a little bit of sociology bent to it, go check it out. That is a really, really cool book and you can read it in pieces as you would expect from a nice web-based publication.

David:That's awesome. I didn’t know GitBooks existed. I'm going to have to check that out. That's awesome.


David:Well, that's what we got today.

Ben:Thank you so much to you guys for listening. Thanks to Perkins Coie, our sponsor for this episode. Check out the Slack Acquired.fm. We are nearly 900 and would love to have you join us. And lastly, pause this podcast right now and go leave us a review on iTunes. We really sincerely appreciate it. So, thanks everyone.

David:Thanks everyone. We’ll see you next time.

Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

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