Finance

Investors, Square, and “Ratchet” IPOs

Jason Taylor

“Ratchet” may not be a familiar term in business, but it has a dramatic effect on the common stock sold by a company after issuance. A Ratchet IPO “allows an investor to have his or her percentage ownership remain the same as the initial investment” (Full Ratchet).

As such, whenever a company releases their ratchet IPO, complications arise due to the full public release of company shares for purchase. Just think about it; your company is selling set company shares for others to own and investors want to ensure they keep their percentage of ownership.

In most recent news according to the Wall Street Journal, Square, a US mobile-payment company, paid a $93 million penalty to some of its investors in its IPO. The investor funding round of $150 million came with a “ratchet” term which meant that “the investors were guaranteed additional shares if the IPO price didn’t reach a certain level” (Scott). Square’s public offerings were priced well below the promised threshold to investors. Instead of the expected price of $11-$13, the price was priced below at $9 per share.

These investors have financial interests in the ownership of Square because they are shareholders of the company with their ratchet IPOs. The WSJ article addresses the effect of the ratchet IPOs on these investors.

By definition, shareholders have financial interests in the firm, as they are owners of the shares. As such, they do not have the full rights of Square’s ownership, but they are directly affected by the financial decisions of the corporations. This includes the effects of the IPO price because they participated in a $150 million funding round called a “ratchet.” In simple terms, “investors were guaranteed additional shares if the IPO price didn’t reach a certain level” because they take part in the financials of the company (Scott).

Therefore, the board and managers of Square must manage the effects of the “ratchet” investment. It is their obligatory job because the “ratchet” IPOs are in the interest of the firm as a whole. As a result, Square was responsible in making sure the investors got a proper return on their investments. In the end, Square only paid 10.3 million shares to investors, who initially wanted a 20% return on their investment. There was a huge difference in Square’s IPO priced at $9 compared to the IPO price in the ratchet, at $18.56.

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In turn, there has to be new governmental regulations for the price of IPOs instead of only the decisions made by Square management. In addition to Sarbanes-Oxley Act 2002 provisions, there has to be more rules for the corporation so that there are no delays or severe compromises in the release of IPOs from other companies. These governmental regulations need to be continually improved and updated to avoid corporate financial issues. As a result, there will be set standards on the initial price of IPOs and how this affects investors of the corporation. If applied, this will result in a more uniform and financially correct release of IPO.

In turn, “the IPO ‘ratchet’ could become problematic in coming years if those companies can’t price their shares sufficiently high in public markets” (Scott). As per WSJ, Square has a 32% lower valuation of $4.1 billion compared to last year’s valuation of $6 billion. Altogether, IPO “ratchet” is a major problem because it results in the undervaluing of companies, including Square.

Sources:

Austin, Scott, and Rolfe Winkler. “Square Pays $93 Million Penalty to Some Investors in IPO. Wall Street Journal, 18 Nov. 2015. Web. 20 Nov. 2015.

“Full Ratchet Definition | Investopedia.” Investopedia. Investopedia, LLC, 23 Nov. 2003. Web. 24 Nov. 2015.

 

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