When ServiceTitan filed papers for an IPO last week, aiming to debut by the end of 2024, the tech industry wondered if the stalled IPO market would finally open up.
Unfortunately, probably not.
However, ServiceTitan may actually be a harbinger of something else entirely. That means a series of late-stage companies will be forced to IPO or expose other ugly terms they agreed to after the VC funding market crashes in 2022 and valuations plummet.
“Yes, we will see more of this as ZIRP companies launch IPOs. Hiding these details in the S-1, even if it is hard to understand with the legal text that exists on the S-1. You can't do that,” VC Alex Clayton told TechCrunch, referring to the companies that raised a lot of money in the '00s. Clayton is a general partner at Meritech Capital, a late-stage firm known for its IPO analysis. He and colleagues at Meritech, Anthony DeCamillo and Austin Wang, pointed out the abusive language revealed in Service Titan's S-1 document in an analysis post that went viral over the weekend.
In short, in ServiceTitan's November 2022 Series H raise, the company agreed to give those investors a “compound IPO ratchet structure,” as TechCrunch previously noted.
The ratchet structure of an IPO is that if a company goes public at a lower stock price than the venture investors paid, the company grants more shares to the investors as if the VC had bought it at a lower price. This means covering your losses. As long as the IPO price is higher than what investors paid, there is no problem.
In the case of ServiceTitan, it agreed to a “compound” IPO ratchet structure, as Meritech staff noted. Each time ServiceTitan delays its listing beyond the May 22, 2024 deadline, the company will be obligated to pay Series H investors more shares at an annual rate of 11%, compounded quarterly. .
The stock price for the November 2022 round was $84.57 per share. Currently, Meritech calculates that ServiceTitan would need to debut at a price above $90 per share to preclude paying additional shares to Series H investors. S-1 has not disclosed which investors are holding this period.
Additionally, the staff at stock price experts Meritech currently believes that ServiceTitan's financials justify closer to $72 per share. This takes into account its revenue (paced at $772 per year on a quarter-over-quarter basis, the company says) and growth rate (estimated at 24% on a quarter-over-quarter basis). That's if the IPO price is moderate compared to other software companies.
Regardless of what's happening in the market, further delays mean ServiceTitan's price will have to go even higher to avoid trouble with Series H investors. This will further dilute the holdings of other major investors.
VC Bill Gurley, a partner at Benchmark and a longtime hawk on the IPO process, said: I commented on the situation in X.. “'Composite Ratchet' sounds painful (and it is!). It appears the company agreed to a 'dirty' term sheet,” he wrote. “It's best to avoid investors who demand compound interest altogether.”
Clayton says he doesn't quite agree with the characterization of a company as a “dirty term sheet,” which means founders are being duped by investors. Perhaps ServiceTitan's lawyers knew and understood the term, and executives were willing to take the risk. ServiceTitan has agreed twice to raise terms (albeit not compounded) and was caught up in the stock price decline, the S-1 revealed.
Founders typically agree to such terms to obtain a higher valuation or to avoid a valuation reduction, also known as a down round. After all, the company is agreeing to protect investors from overpaying. Down rounds can be damaging on all fronts, including employee morale, future investment rounds, and media headlines.
However, such conditions are an aggressive strategy.
“You could call this a 'dirty' cliché, but this was a bilateral agreement that followed lengthy legal discussions and was likely about a risk that the founders were willing to take.” said Clayton.
All of this has some meaning. For the founder, Gurley told Xif it's really of value to the company, it's better to simply take a down round than play the valuation term sheet game.
If ServiceTitan had done that, it might not even have gone public today and wouldn't have had to undergo future quarterly financial reviews to go along with it.
“I agree. This IPO seems to be about incentives,” Clayton said, adding that ServiceTitan also “spent a lot of money, so it may have needed the cash as well.”
It also means that the IPO window will not necessarily open. We'll see more of that buried in S-1 disclosures in 2022 as many founders struggle to maintain their previously high valuations, Clayton said. I'm thinking.
That said, if retail investors get excited about the stock, this debut could open the window for an IPO. But some financiers still have doubts. As Miles Dieffenbach, Managing Director of Investments at the Carnegie Mellon Foundation Posted in X,
“ServiceTitan is going public not because the IPO window is “open” but because of the compounding effect of previous rounds. If they had been able to raise clean private funding, I'm sure they would have stayed private! ” he wrote.
ServiceTitan did not respond to requests for comment.