Case Questions for Square Inc., IPO

This article discusses the factors that determine when a company should go public, the use of ratchets and liquidation preference in Square Inc. IPO, and whether Square made the right decision in going public.

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Case Questions for Square Inc., IPO
1. What factors determine when a company should go public?
The factors that determine when a company should go public are the following:
When the company and industry has investor appeal – The industry, services,
products are in demand by individual or businesses.
When the company has any of the following investor-attracting properties: A
proprietary product or service; being first on the market; absolute, exclusive control over
a proprietary product or service protected by patents, copyrights, trade secrets or private
formulas
Current regulatory environment – There is an increased cost, amount of time, and
ongoing reporting requirements required to go public after Sarbanes Oxley Act,
decimalization, and Global Research Analyst Settlement. Current regulatory environment
with tax rates, regulations play a part when companies decide to go public
When the company can accurately forecast financial performance – Involves
accurate financial revenue and cost projections. Missed projections impact company’s
valuation and then hurt the company in raising debt or raising equity capital gain.
Accurate forecasting and budgeting functions while operating privately gains credibility
among investors.
When the company has the right executive team in place – It is important to think
about roles, responsibilities, and structures ahead of going public. Can the current team
lead you to the next level of growth?
The company regularly closes its books on time and is audit-ready – The companies
will want to close quarterly financial statements on time before going public as a public
company is subject to accounting audits and has to issue quarterly financial statements.
The company has realistic valuation expectations – When a company goes public, the
company’s valuation is affected by the Price/Earnings ratio of its peers. The valuation
level is determined by the market conditions at the time of going public.
There’s a compelling business case for going public – Raising additional capital helps
out with M&A, R&D, capital expenditures, and capital expenditures and is a major
milestone for any company.
The company has a clear, strategic roadmap – The company has a roadmap and
compelling strategy, operating plan for growing its business and vision for the future.
2. Explain the terms “rachet” and “liquidation preference”. How do these terms come
into play in the case?

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Ratchets are a mechanism used to adjust the respective shareholdings of the
investors and the founders depending on either the company’s performance or the level of
returns on an exit (therefore called an exit ratchet). This technique is principally used to
find a bridge between widely differing views of a company’s value, or to provide
additional incentives/rewards to the founders for delivering excellent returns to the
investors. Also, this technique allows management shareholders to increase their stake if
the company performs particular well. However, they can be complicated in operation
and they need to be carefully thought through due to tax issues and in order to avoid
conflicts of interest between the founders, the company, and its shareholders at a later
date. Ratchets are important to the case because Square’s S-1 filing disclosed an anti-
dilution ratchet provision for Series E investors. The ratchet stated that in the event of
such offering, in which the price per share of the Company’s common stock is less than
$18.55614 (adjusted for stock splits, stock dividends, etc.), then the then existing
conversion price for the Series E preferred stock shall be adjusted so that, as of
immediately prior to the completion of such public offering, each share of Series E
preferred stock shall convert into the number of shares of common stock issuable on
conversion of such shares of Series E preferred stock and an additional number of shares
of common stock equal to the difference between $18.55614 and the public offering price
divided by the public offering share price.
Liquidation preference is a right which can be required by venture capital
investors in recognition of the risk they bear on their capital contribution. While there are
many variations, the liquidation preference typically provides that, in the event the
company is liquidated or subject to a deemed liquidation, the preferred shareholders will
receive a certain amount of the proceeds before any other shareholders. This preference
amount may be equal to the amount of the preferred shareholders’ investment, or a
multiple of it. The remaining proceeds are often shared amongst the preferred and
ordinary shareholders and there are numerous ways in which this may be affected. Also,
the size and structure of the liquidation preference will be negotiated to reflect the risk
inherent in each investment round, therefore the higher the risk, the higher the required
return. Many factors (including the valuation of the company) will be considered in this
calculation. Liquidation preference is important in the case because it would be
mentioned in a company’s balance sheet under stockholders’ equity which represents the
net worth of a company, or the amount that would be returned to shareholders if all the
company's assets were liquidated and all its debts repaid. Square’s stockholders’ equity
noted liquidation preference of $370,967, $520,967, and $520,967 at December 31, 2013,
December 31, 2014, and September 20, 2015, respectively.
3. Did Square make the right decision in going public when it did? Explain your answer.
The company made a good decision by going public because of many reasons. To begin
with, the company had been growing consistently over the past few years. As a result, it
had realistic valuation expectations. The market conditions at the time of the IPO
increased the valuation level of the company’s shares. According to Hall (n.p), going
public was the right decision because going public helped the company gain access to the
capital market and strengthen its capital base from the IPO. It is imperative to note that
Square has the opportunity to raise more capital by selling shares to the public. Using the
capital raised, the company can fund research and development, improve its

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infrastructure, and expand its operations to further expand its operations. Also, the shares
of the company can command higher prices than shares that are not publicly traded. In
turn, this will increase the company’s capital holding, which can help improve the growth
rate of the company (Farley). Furthermore, the going public will go a long way in helping
Square boost its image in the industry. Normally, there is a prestige of being a listed
company on a major stock exchange. In turn, this may also help the company in boosting
its image among its customers, and hence rise above its competitors in the industry.
Consequently, this will help the company increase its sales overtime and grow
sporadically overtime. Furthermore, going public will be beneficial for the company as it
can now be able to diversify its investment portfolios due to the increase in the
marketability of its shares.

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Works Cited
Farley, Tom. The Right Time To IPO. NYSE, 2018. Web. 30 Dec 2018.
<https://www.nyse.com/article/right-time-to-ipo>.
Hall, Mary. What does "going public" mean?. Investopedia, 2018. Web. 30 Dec 2018.
<https://www.investopedia.com/ask/answers/what-does-going-public-mean/>.