When ServiceTitan filed documents last week for its IPO, hoping to have its debut before the end of 2024, the tech world wondered if a stuck IPO market was unlocking at last.
Alas, probably not.
But ServiceTitan could actually be a harbinger of something else entirely: a series of late-stage companies being forced to IPO or revealing other ugly terms they agreed to after the VC fundraising market tanked in 2022 and valuations plummeted.
“Yes, we will see much more of this as the ZIRP companies start to IPO. You can’t hide these details in an S-1, even if they’re hard to understand in the legalese writing that exists in S-1’s,” VC Alex Clayton tells TechCrunch, referring to companies that raised lots of money during the zero interest rate policy period that ended in 2021. Clayton is general partner at late-stage firm Meritech Capital, known for its IPO analysis. He and his Meritech colleagues, Anthony DeCamillo and Austin Wang, pointed out a wild term, disclosed in ServiceTitan’s S-1 documents, in an analysis post that went viral over the weekend.
To recap, as TechCrunch previously pointed out, with ServiceTitan’s November 2022 Series H raise, the company agreed to grant those investors a “compounding IPO ratchet structure.”
An IPO ratchet structure means that if a company goes public at a stock price that is less than what the venture investor paid, the company will cover the loss by granting the investor more shares, as if the VC bought at the lower price. If the IPO is priced above what the investor paid, there’s no problem.
In ServiceTitan’s case, as Meritech’s crew pointed out, it agreed to a “compounding” IPO ratchet structure. For every quarter ServiceTitan delayed going public after a deadline of May 22, 2024, the company would owe the Series H investors even more stock: 11% annually, compounding quarterly.
The stock price for that November 2022 round was $84.57 a share. Currently, Meritech calculates that ServiceTitan would have to debut at above $90 per share to negate paying its Series H investors more stock. The S-1 did not disclose which investor(s) hold this term.
Furthermore, the Meritech crew – who are stock pricing experts – believe that ServiceTitan’s financials currently justify closer to about $72 a share. This given its revenue (on pace for $772 annually, based on its last quarter, the company says) and growth rate (implied at 24%, based on the last quarter). That’s if the IPO prices around the mid-range of its comparable to other software companies.
More delay, no matter what’s going on in the market, would mean that ServiceTitan has to price even higher to avoid the gotcha with the Series H investors. This would also further dilute the holdings of the other major investors.
VC Bill Gurley, who was famously a partner at Benchmark and has been an IPO-process hawk for years, commented on the situation on X. “A ‘compounding ratchet’ sounds painful (it is!). Looks like company agreed to ‘dirty’ term sheets,” he wrote. “Best to steer WAY, WAY clear of investors asking for compounding ratchets.”
Clayton says he doesn’t quite agree with the “dirty term sheet” characterization, which implies a founder getting duped by an investor. Chances are ServiceTitan’s lawyers knew and understood the term and executives were willing to take the risk. ServiceTitan had agreed to ratchet terms (albeit not compounding) twice before, and got caught with lower share prices, the S-1 disclosed.
Founders typically agree to such terms because it gets them a higher valuation and/or avoids a valuation cut, also known as a down round. After all, the company is agreeing to protect the investor from overpaying. Down rounds can be damaging in all sorts of ways – employee morale, future investing rounds, media headlines.
But such terms are a kick-the-can-down-the road tactic.
“You can call it ‘dirty,’ which is the cliche term, but it’s an agreement between two parties with lengthy legal discourse and is just likely about risk the founders were willing to take,” Clayton said.
All of this means a few things. For founders, Gurley said on X, it’s better to just take a down round if that’s what a company is really worth, rather than play valuation term-sheet games.
Had ServiceTitan done that, it might not even be going public now – and taking on the future quarterly financial scrutiny that comes with that.
“I agree. This IPO seems to be about incentives,” Clayton says, adding that ServiceTitan “has also burned a ton of money, so they might have needed the cash too.”
It also means that the IPO window isn’t necessarily opening. Because 2022 saw a lot of founders struggling to maintain their previously high valuations, Clayton believes we’ll likely see more such things buried in S-1 disclosures.
Then again, if retail investors go wild for the stock, this debut might open the IPO window. But some financiers remain doubtful. As Miles Dieffenbach, Managing Director of Investments for Carnegie Mellon’s endowment posted on X,
“ServiceTitan isn’t going public because of the IPO window being ‘open’, but because they have a compounding ratchet from their last round. If they could’ve raised clean private capital, I bet they’d stay private!” he wrote.
ServiceTitan did not respond to a request for comment.