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The Four Myths About Square’s IPO Filing

Last year, I spent significant time inside Jack Dorsey’s payments company. What I learned tells us how to read its IPO filing.

The Four Myths About Square’s IPO Filing
[Photo: Flickr user [cipher]]

This week Square filed for its long-rumored and long-anticipated IPO, and the public finally got a look at how Square’s business is actually performing. All the pundits, anonymous sources, and leaked documents could now be considered in light of the actual facts. Did Square’s S-1 prove the press had served up some scolding cups of claim chowder? Not exactly. Square’s story has always been a nuanced one that defied simplistic narratives, and its business can be looked at from a number of perspectives. The company reported revenue of $560 million for the first half of 2015, up 50% during the same period last year, but it also recorded a $78 million net loss, following losses of $154 million in 2014 and $104 million the year prior. It has built out a growing payments processing business but has made product stumbles along the way in trying to expand its portfolio of services and boost margins. Its high-profile deal with Starbucks proved to be expensive, but was it seriously costly? Like most IPO prospectuses, Square’s S-1 presents a portrait of a promising future that could be derailed by significant risks.

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In the spring of 2014, amid rumors of Square burning cash at a dangerously high rate and being an acquisition target for Apple or Google, I had the opportunity to spend time with Square CEO Jack Dorsey, most of his senior leadership team including CFO Sarah Friar, and Square’s board members in an effort to try to understand the company and its future. What I reported in this feature in August 2014–in short, that Square had built a growing payments business, with a lot of promising initiatives, and was not on the verge of collapse despite some dire outside predictions, but also that there were material risks–disappointed Square. But as the last journalist to have that kind of deep access into the company, the insights shared during that time can help inform how to understand the S-1. After reading Square’s filing, I revisited my story and my reporting. Here are four myths to keep in mind about the company as it embarks on the next leg of its journey.

Myth #1: Square is not a payments company

For much of Square’s history, the company has been trying to distance itself from being labeled a payments-processing company. Jack Dorsey, the company’s cofounder and CEO, has said countless times that he doesn’t consider Square a payments company—that he and his team “always knew [payments were] not our core business . . . We knew the real business was around the data.” Board member Vinod Khosla spent time convincing me last year that Dorsey aimed from the outset to build a business around its data, not payments, even pulling up Dorsey’s original deck to prove it to me. “We’ve always looked at the company as this larger thing, and if other people think we’re doing payments, great, that’s a red herring,” he told me. (This perspective continues to evolve depending on who you talk to, and when.)

The problem is, at present, Square’s business is almost entirely dependent on payments revenue. According to its S-1, Square generates around 95% of its revenue from payments and point-of-sale services. There are cogent reasons why Dorsey didn’t want Square branded a mere payments processor. Many industry experts argue that payments are a “commodity game,” as Intuit CEO Brad Smith has said. Though Square collects fees for every transaction it facilitates, that business is subject to fluctuating margins, government regulation, negotiations with larger-scale merchants (like Starbucks), and Square’s evolving relationships with financial intermediaries.

There’s two ways to look at this supposed “red herring.” On the one hand, it signals that Square hasn’t come even close to creating its “core” business by Dorsey’s own definition. This either means that Square has a ton of untapped potential going forward, or the pessimistic view is that it’s been incapable of tapping into this potential to any substantial degree over the past six years.

What I think is far more interesting, though, is that Square managed to build a sleek, beloved brand despite the fact that the company mainly handles payment processing. It speaks to Dorsey’s gifts that he was able to gin up a strong, consumer-facing reputation for Square even though the company would make money from a more enterprise-centric business model. To him, Square isn’t about financial intermediaries and EMV-compliant hardware; it was about reinventing commerce and empowering small businesses. “Proud of what Square stands for: inclusion and empowerment,” Dorsey tweeted this week. This message, along with the company’s glossy design, has given Square a brand that customers love, something traditional payment solutions companies such as NCR and Verifone could never attain.

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Myth #2: Square had its strategy figured out from day one

According to Square’s S-1, more than 2 million sellers account for 97% of its gross payment volume; if Square could upsell these merchants on higher-margin services, such as software to handle analytics or invoices, it could establish a far more lucrative and sustainable business compared to its payments processing. But at this point, it’s all still TBD.

Many of these new products fall under Square’s “software and data” division, and as Jason Del Rey at Re/code writes, this is the “crucial” unit “hiding” in Square’s IPO filing. Jason’s absolutely right: This unit is crucial to Square’s future. But I respectfully disagree that it’s somehow hidden.

Frankly, it’s all Square has been talking about since 2014, if not earlier. The company spent the majority of its time pitching me on the idea that Square wants to be “the central operating system of your business,” as engineering head Gokul Rajaram phrased it. When I found that ultimately unconvincing, Square has subsequently tried to hammer home similar messaging in a feature on BuzzFeed earlier this year, and again in a New York Times profile around that time. The only thing hidden, really, is the revenue from these products; as much as Square has hyped up these small and medium business services, they accounted for just 1.6% of revenue in 2014, and about 4.25% for the first half of this year.

In that sense, thinking of Square right now entirely in the context of these new products, as opposed to the company’s payments business, is a bit like describing Disney by only focusing on its tiny Interactive video game unit, rather than the movie, TV, and parks and resorts divisions that generate the vast majority of its revenue. Square’s new business services are enticing when it comes to their higher margins, but it’s too early to say how they’ll fare in the future. Much like payments processing, Square is entering highly competitive markets with a wide array of old and new competitors. “Incorporating new technologies into our products and services may require substantial expenditures and take considerable time, and we may not be successful in realizing a return on these development efforts in a timely manner or at all,” Square’s S-1 notes. “There can be no assurance that any new products or services we develop and offer to our sellers will achieve significant commercial acceptance.”

Thus far, the company’s product rollouts have been hit or miss. Square Wallet, a digital wallet Dorsey pitched for years, failed to gain consumer adoption; its replacement, Square Order, which allowed consumers to order ahead at local restaurants via an app, was also panned. Square has since killed both products. Its cash-advance program Square Capital and peer-to-peer network Square Cash are both extremely compelling products, yet the former hasn’t yet generated significant revenue from the $225 million its advanced to merchants, and the latter is a money-losing operation, though $1 billion has flowed through the service. There are a slew of other services—Invoices, Open Tickets, Dashboard, Appointments, the list goes on—that are equally as promising, but will they become huge revenue generators?

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While reporting on Square last year, what I found most confusing wasn’t Square’s premise that it ought to offer incremental, value-added services to its merchants. Rather, the problem was that it became increasingly difficult to understand what businesses Square would venture into and which ones it wouldn’t. The company’s thinking felt haphazard, and I kept hearing mixed signals from executives or boilerplate explanations around how Square’s strategy and vision hadn’t changed, only its tactics. I appreciated Dorsey’s transparency and humility when he talked to me about the company’s struggles to figure out whether it should put more emphasis on the buyer or seller side (which played into Wallet’s struggles). I also valued the candor of Square investor Roelof Botha, who didn’t mind acknowledging the company’s see-what-sticks approach. “Are we going to nail every single thing we’re endeavoring to do now? Of course not,” he said. “If you’re batting a thousand in this business, you’re not pushing hard enough.”

Nonetheless, I found it hard at times to parse what the company was selling. When I asked about the rumored Square credit card, which we reported on after hearing from sources that Square decided to cease its development in order to avoid upsetting its financial partners, Dorsey wouldn’t go into details, but he told me that Square would not kill a product because it might be disruptive to its partners. Yet a source very close to Dorsey and the board told me the exact opposite. Square hardware lead Jesse Dorogusker told me the company believes its sellers need assistance with everything from “delivering arugula to keeping the lights on to upgrading their Comcast Internet.” But would Square actually build products to solve these issues? When I asked Khosla how I should interpret Square’s evolving product portfolio, he told me in 2014, “If you ask me, was Square [Capital] on the agenda four years ago? No. But that’s learning. A year and a half ago, would I have said Order was a big business? No.” Khosla also told me at the time that the company wouldn’t do payroll—ZenPayroll already does that beautifully, he said, and Square would partner with them—but by June of this year, the company added a payroll product to its “ever-expanding offerings,” as Forbes reported the news.

Square makes a lot of beautiful and well-crafted products and it’s still figuring out the right mix of which ones its customers want and that will make the company a lot of money. There’s no sin in that approach so long as the company can afford to do so. No need to pretend otherwise.

Myth #3: Square’s deal with Starbucks was a complete waste

If there’s one thing critics pig-piled on after the Square IPO filing, it was the company’s partnership with Starbucks. The deal made Square the processor for credit card transactions at thousands of Starbucks stores, and significantly ramped up Square’s payment volume. But as the S-1 confirms, the deal ended up costing Square tens of millions of dollars in transaction fees, because it agreed to lower rates with the coffee chain that eliminated its margin. The deal has since been described as a “bust” and a “giant money loser,” a partnership that “burned” Square.

While these are fair assessments, none of this is really news. Most of the numbers had been previously reported, and Square knew exactly what it was getting itself into. As we described in our dive into the subject last year, the company fundamentally saw the partnership as a marketing investment for Square Wallet and the Square brand. “It was pretty simple math—everyone involved in the deal knew exactly what the numbers were,” one source told me at the time. “[The] cost was extremely high. But it made sense: Instead of spending X millions of dollars on marketing, the Starbucks deal legitimized this tiny startup. There was a massive push in adoption.”

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If there’s a silver lining in all of this, it’s twofold. First, it’s important to note that investors believed in Square’s potential enough to spend this amount of dough. “All I will say is there was a plan, a conscious decision to do the Starbucks deal, and we decided to place that bet—obviously nobody forced us to do it,” as Khosla told me.

Second, as much as the Starbucks deal hurt the company’s financials, the partnership will soon come to an end, as the S-1 indicates. The company broke out its Starbucks numbers to illustrate how poorly the partnership infected its earnings, but also to show that the infection would eventually clear. “We believe it is useful to exclude Starbucks activity to clearly show the impact Starbucks has had on our financial results historically,” the S-1 statement reads. Once Starbucks transitions to another payments processor, Square’s gross payments volume will shrink, but its business will be healthier.

Myth #4: Square shares no responsibility for what’s written about the company

Just days after we published our feature on Square, the company released a blog post listing the “top 10 myths” about the company. It was a confusing and oddly defensive post that covered everything from Square’s security capabilities to its phone support center. Here at Fast Company, we weren’t exactly sure whether this post was somehow aimed at us, because although we had posted several critical stories, we hadn’t propagated any of these so-called myths. Only one of its 10 bullet points seemed relevant. The myths appeared to respond more to the generally unfavorable coverage the company had received earlier in the year. To this point, the company wrote that it is a myth that “Square’s business is struggling”:

Like you, we’re a growing business. You invest in your future, and so do we. We’re well-capitalized and putting our money to good use: investing in people and new products. Reports that we tried to sell the company, or of a delayed IPO? False. We’re here for the long-term.

Looking back, I’m not quite sure what Square was so sensitive about. There were a lot of legitimate questions about the company’s products (such as Wallet); its deal with Starbucks; and the amount of money the company was burning. If the defensiveness was solely due to The Wall Street Journal‘s report about a potential acquisition of Square, which other outlets reported to varying degrees, then I’m not quite sure why Khosla told me the story wasn’t a big deal. “I don’t think our target market worried about The Wall Street Journal…we haven’t spent a lot of time [on it],” he said. As for its “delayed IPO,” we also didn’t report this, but Square is also splitting hairs, because the company had formed an audit committee and told its finance team to prepare for an IPO. “[CFO] Sarah [Friar] made sure the finance team was ready by the middle of 2013, though no banks were ever hired,” one source close to Friar told me last year.

Legitimate questions remain about Square’s business going forward. Indeed, the S-1 statement includes many more risk factors associated with Square–including Dorsey simultaneously running another public company–than have ever been reported before. Expect the company to face far more scrutiny as a public company than it has as a private one.

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In July, Square communications head head Aaron Zamost wrote a widely shared blog post on Medium about how the narratives swirling around Silicon Valley startups follow a distinct and predictable pattern. Zamost essentially posits that no matter the reality of a company’s business or performance, the ups and downs of its perception in the press, often referred to as the hype cycle, are out of that company’s hands, and rather track along a predetermined arc, forced on by the tech media “like clockwork.” Zamost concludes by offering some helpful advice. He recommends that a company dealing with narrative woes is better off focusing on its customers, remaining humble and not forcing an alternative story arc, and refraining from getting angry or looking defensive. While Zamost warns that “a negative story has nothing to do with you,” he also acknowledges, backwardly, a few paragraphs later that “your company isn’t perfect. You’ve made mistakes. It’s OK to own up to them…if your business is a good one and you know how to manage the clock, your story will take care of itself.”

It’s great advice, and perhaps it’s time for Square to follow it.

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About the author

Austin Carr writes about design and technology for Fast Company magazine.

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