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Amid rumors of a buyout and reports of cash crunch, is Square all boxed in?

Amid rumors of a buyout and reports of cash crunch, is Square all boxed in?


The payments prodigy has gone from IPO to uh oh in the span of just six months

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Not so long ago, Square was flying high. Its CEO, Jack Dorsey, was being called the next Steve Jobs and bankers were reportedly salivating at the prospect of taking it public. But in the last few months its prospects seemed to have soured, at least according to the press. A recent report from the Wall Street Journal said that Square is running low on money and engaged in talks with multiple companies about possibly getting acquired.

Its CEO was being called the new Steve Jobs

So is the situation really that dire? Square has vehemently denied that it’s looking to sell, both to the WSJ and in a discussion with The Verge. While that particular detail is in dispute, there are a few salient facts about Square that might help to explain why it's suddenly being framed as a troubled startup getting shopped around.

Early this month Square took on $100 million in debt funding from Goldman Sachs, Morgan Stanley, and JP Morgan Chase. Banks are typically late-stage investors when it comes to tech startups. They are happy to extend a loan like this to a company that will soon greatly increase its valuation, either through another round of financing or an IPO. Facebook and Twitter both raised debt before going public.

Debt financing can also be a bad sign, however. When Foursquare took on $41 million in debt it was seen as evidence that the company was struggling to attract new investment without deflating its valuation, not that it was about to offer an IPO.

So it makes sense when the WSJ reports that "during the first quarter of 2014, a Square executive told a potential acquirer that the company had nine months before it would hit a predetermined 'cushion' of funds set aside as a last resort." That would mean Square likely has nine months of venture funding left before it digs into its $100 million in credit. While the WSJ casts this as a bad sign, for a startup to have between one and two years of runway before it runs out of cash is fairly typical.

Profits aren't necessary in the bizzaro world of startups

All of this assumes of course that Square isn’t profitable, something Dorsey has admitted publicly, but again that’s not necessarily a negative in the bizzaro universe of high growth tech startups. Plenty of companies, from Twitter to Box, have gone public or announced IPOs without any profits to speak of. Even Amazon, a well established tech titan with massive annual revenues, often invests in growth to the point where it produces little or no profits.

While Square processes billions of dollars for merchants each year, Square has very thin margins on this revenue. Every time customers swipe their credit card through a Square reader, whether it's at a flea market or a Starbucks, Square takes a 2.75 percent fee on the cost of the transaction. But 70–80 percent of that ends up going to the credit card companies and toward fraud prevention, leaving Square with less than 1 percent of gross revenues. Even if it was processing $10 billion a year, in other words, Square would get to keep less than $100 million.

The margins on Square's core business are razor thin

Though those thin margins are an issue, the major problem for Square seems to be that it’s struggling to grow the side of its business that could one day be quite profitable. Square has been trying to break into the higher-margin business of consumer services. It launched its Square Wallet App, which lets people pay with their phones, and it rolled out Square Cash, which makes it easy for people to transfer money to their friends or family. So far, however, neither of those have found mass adoption.

That brings us back to the rumors of an acquisition. Payments is a two-sided market: to succeed, a company needs both merchants and customers on the same system. Square has done a good job attracting small merchants and proved that it's capable of handling a customer as big as Starbucks. It’s been less successful getting consumers to use its wallet app.

Square is good fit for a tech titan with cash to spare

Big players like Apple or Google, both of whom were reportedly considering purchasing Square, have a ton of consumers using their phones, consumers who have already shared their credit card numbers. Acquiring Square would mean that apps like Google Wallet or some future version of Passbook would suddenly work in many more stores. So it’s not surprising these companies are at least making overtures about possibly acquiring it.

In today’s startup environment, it can be hard to judge a company’s health. Square has taken on debt, lacks profits, and is being discussed as a possible acquisition by some of the bigger companies in tech. Six months ago those signals meant it was preparing for an IPO. Today they're interpreted as signs of a struggling company looking to sell. Either way, as is so often the case with high-flying startups, it needs a dramatic win to get its public narrative moving in the right direction again.