ServiceTitan’s IPO paperwork submission last week, aiming for an appearance by the close of 2024, stirred curiosity in the tech industry about whether a dormant IPO scene might be awakening.

Unfortunately, it seems not.

Yet, ServiceTitan might signal a different trend: a wave of mature firms compelled to go public or disclose unfavorable conditions they accepted due to the 2022 venture capital funding slump and declining valuations. 

“Indeed, this is just the beginning as ZIRP firms start to debut on the market. In an S-1, you can’t hide these specifics, despite their complex legal language,” shares VC Alex Clayton with TechCrunch, mentioning companies that gathered considerable funding during the zero interest rate policy era that concluded in 2021. Clayton is a leading partner at Meritech Capital, a firm well-regarded for its IPO evaluations. Over the weekend, a significant clause identified within ServiceTitan’s S-1 filing caught viral attention in a post authored by him and his Meritech teammates, Anthony DeCamillo and Austin Wang. 

To summarize, as reported earlier by TechCrunch, ServiceTitan agreed in its Series H fundraising in November 2022 to provide investors a “compounding IPO ratchet setup.” 

An IPO ratchet arrangement implies that if a firm’s public offering price is below what the investor originally paid, the firm will compensate the difference by issuing more shares to the investor, as if the investment was made at the reduced rate. However, if the IPO price exceeds the investor’s original cost, no adjustment is necessary.

For ServiceTitan, as Meritech noted, it consented to an “increasingly compounding” IPO ratchet structure. Should ServiceTitan defer its public launch beyond the May 22, 2024 cutoff, the company is obligated to allocate additional shares to the Series H investors, escalating at an annual rate of 11%, compounded quarterly. 

The per-share price during the November 2022 funding round was $84.57. At present, Meritech estimates that ServiceTitan needs to enter the market above $90 per share to avoid providing Series H investors additional shares. The S-1 did not specify which investor(s) hold this condition. 

Moreover, the Meritech team — who are specialists in stock pricing — suggest that ServiceTitan’s current financial state validates a price nearer to $72 per share. This estimate is based on its revenue, anticipated at $772 million annually per its latest quarter, and a growth rate projected at 24%, as per the same timeframe. This assumption holds if the IPO valuation is aligned with similar software firms.

Continuing postponements, irrespective of market conditions, would necessitate ServiceTitan setting an even higher price to circumvent complications with the Series H investors and would additionally dilute the shares of other significant stakeholders.

VC Bill Gurley, notably a partner at Benchmark and a longstanding observer of IPO processes, spoke on X regarding the situation. “A ‘compounding ratchet’ is painful (indeed it is!). Seems like the company committed to ‘unsavory’ term sheets,” he noted. “It’s wise to keep FAR, FAR away from financiers demanding compounding ratchets.”

Clayton, however, disputes the “unsavory term sheet” label, suggesting it implies an entrepreneur deceived by an investor. Most likely, ServiceTitan’s legal advisors were aware and accepted the terms, as did the executives by taking on the risks. It’s known that ServiceTitan has twice accepted ratchet arrangements before (though not compounding) and faced lower share prices previously, as per the S-1.

Entrepreneurs often agree to these clauses as they provide a means to either achieve a greater valuation and/or avoid a valuation reduction, or down round. Essentially, such terms are mechanisms to safeguard investors from overpayment. Down rounds can be damaging in various manners — affecting employee satisfaction, future investment opportunities, and public perception.

Yet, agreeing to these terms typically serves to delay the inevitable.

“While you might label it ‘unsavory,’ being the common term, it represents an agreement between two parties, involves extensive legal discussion, and indicates the level of risk founders were prepared to accept,” Clayton explained.

All this implies a few aspects. From Gurley’s perspective on X, it’s more prudent for founders to accept a reduction in valuation if it’s warranted, instead of engaging in evaluation term-sheet maneuvering. 

Had ServiceTitan chosen this route, they might not even be considering a public listing now — and could avoid the ongoing quarterly financial evaluations that accompany such a move. 

“Indeed, I concur. This IPO appears driven by incentive objectives,” Clayton mentions, observing that ServiceTitan “has also expended a substantial amount, possibly necessitating the cash.”

Additionally, it indicates that the IPO market isn’t necessarily on the verge of resurgence. Considering 2022 witnessed many company leaders battling to preserve their lofty valuations, Clayton anticipates more such instances hidden within S-1 disclosures.

Still, if retail buyers show fervent interest in the shares, this launch might actually open the IPO floodgates. However, certain funding experts remain skeptical. As Miles Dieffenbach, the investment director for Carnegie Mellon’s endowment, remarked on X:

ServiceTitan isn’t taking the public route due to the IPO window being ‘open’, it’s due to their compounding ratchet from the last financial round. Presumably, if private equity was available, they’d remain private!

ServiceTitan has not responded to a solicitation for comment.