Casper’s IPO is imminent, but did the company hit snooze when it came to employee shareholders?
Last Monday, the so-called “unicorn” direct-to-consumer mattress company Casper filed its S-1 ahead of its upcoming IPO—with an expected valuation at debut well below the $1.1B valuation it had previously set in its Series D financing. While most coverage has so far focused on the drop itself and the reasons for the lower-than-expected stock price, it’s important to discuss the implications for existing shareholders and option grantees.
Equity is a common incentive for employees, but determining the value of a grant is very difficult in pre-liquidity situations. For most equity holders, an IPO (or another exit) is the first time their shares have the potential to turn from abstract, maybe-valuable paper into actual money. Employees who previously had no mechanism to understand or value their grants can finally do the math and see what they’ll be worth.
From public filings, we can pretty faithfully recreate Casper’s existing cap table, along with the strike prices and dates of its various option plans and fundraises. While we hope Casper’s employees do their own homework before making any decisions—and this is by no means legal or financial advice—we wanted to take a look at how this IPO might pan out for all the employees who have acquired equity in the company since it was founded in 2014.
Like most early-stage startup employees, Casper’s team has probably all been dreaming about an eventual IPO, but they can now stop counting sheep and start counting shares.
Which of Casper’s employees (and investors) will actually make bank? And for those who stand to lose out, what’s next?
Casper’s reported valuation
Valuations for private companies serve a number of functions, and are rarely straightforward. Companies and funds work with valuation specialists like us to set the strike price of option exercises, report the value of a position to external investors, or facilitate tender offers. Valuations shift more often than companies fundraise. But, while the company is private, the number that the public sees is usually set by a fundraising round. Casper’s February 2019 Series D fundraising included a $100M priced round at $31.24715 per share, which had set the post-money valuation of the company at just north of $1 billion.
That’s why industry watchers’ eyebrows raised in response to Casper’s IPO announcement. The S-1 reports that the September 2019 pro forma weighted average number of shares used in computing net loss per share attributed to common stockholders, basic and diluted (“Shares”) is 39,178,344. With the IPO valuation of $17–$19 per share, the public markets are estimating Casper’s equity valuation to be between $666M–$744M. We’ll be using a mid-point $18 per share for the rest of this analysis ($18 referred to as “IPO Price”).
Given the IPO range, will Casper actually go public?
The $18 IPO Price is below the Preferred Series B and Preferred Series C/D purchase prices of $23.12 and $31.25, respectively. The S-1 notes that the holders of the Preferred investment will be issued additional shares of common stock. Based on a study by the law firm Fenwick & West, 30%–40% of IPOs in the past 4 years included such blocking rights, i.e. the ability to block the public offering if the IPO price is not at least as high as (or greater than) the last priced round. Private investors commonly receive blocking rights to protect their investments, but employees or option-holders rarely do.
WeWork is a prominent example of blocking rights in action. WeWork filed its S-1 with the Securities and Exchange Commission on August 14, 2019. Within weeks, it became clear the public markets did not support WeWork's valuation, so under investor pressure, the company pulled its IPO and pushed its CEO out.
Casper and its bankers should, and almost certainly do, keep WeWork in mind during the run-up to the IPO. It’s possible that Casper was way ahead of this possible downside and had incorporated in its deal structure, or is getting in front of these problems by issuing its investors additional shares:
The terms of our Series B preferred stock, Series C preferred stock and Series D preferred stock provide that the ratio at which each share of such series converts into common stock in connection with this offering will increase if the initial public offering price is below $23.1229 per share, $31.24715 per share and $31.24715 per share, respectively, which would result in additional shares of our common stock being issued upon the Preferred Conversion.
As of this writing, it does not seem that the investors will block the public listing. To that end, we’re waiting to see the dilution impact of the above additional issuance on all other shareholders, namely, the employees.
How are Casper's employees doing?
Let’s rewind. It’s December 2017, and only 2.3M Casper options have been granted, at an average exercise price of $6. At an $18 IPO, the average employee is going to receive a 3x return on their share price, or 2x gain—$28M in value captured overall.
Fast forward to 2018, when Casper grants 2.5M shares with an average exercise price of $14.20. The average employee in this group will make about 27% above the cost of their shares, or around $9.5M altogether.
Then in the nine-month period ending September 2019, the company grants 2.2M shares at $18.65. However, at the point of IPO, these shares will be underwater. These grantees will just have to hope volatility or later gains put them in the money.
As noted above, the Series B, C, and D investors who had price per share above the IPO Price are now getting additional shares to compensate for this downside.
The question becomes: What about the employees? Should they also have such downside protection? More importantly, why was the strike price set so high? Did the 409A valuation provider assess market fundamentals, or did they solely look at the Series C and Series D investments to determine value?
More simply, had you joined the company prior to the Series C financing (circa Q2 2017), you would have done quite well. During 2017 and 2018, fairly well, and if you joined in 2019 and later, you are underwater and should be re-priced.
With these numbers in mind, let’s see who we estimate would “win” in an $18/share Casper IPO.
Winners: Jonathan Truppman and the secondary / tender offer sellers of September 2017
In September 2017, the Company facilitated a tender offer whereby an affiliated entity (possibly a previous investor) purchased shares of common stock from a number of common stockholders (i.e. the “Tender Offer”), with the S-1 specifically naming Casper’s General Counsel Jonathan Truppman as one of the sellers. The sellers sold 83,468 shares of Common Stock at a price per share of $28.1225 / share (or exactly a 10% discount to the most recent round of financing of $31.24716). This sale was clearly a win, as it is much higher than the $18 IPO price.
The total value recouped in this exchange came in at about $2.35M. While that was a haircut off the preferred at the time, we now know it’s about an $800k net gain over waiting for the IPO. Truppman and the other participants locked in their profits by taking advantage of the privilege of acting early.
Losers: Emilie Arel and the Tender Offer buyers
Emilie Arel, Casper’s President & Chief Commercial Officer who joined in July 2019, was granted 570K shares (25.9% of all the 2.2M options granted in 2019). These options, however, were granted at a strike price of $19.65. Theoretically, the “value” of a company should substantially increase at an IPO, given the company’s better access to the capital markets and liquidity. However, almost eight months after the grant, these options are out of the money.
All else equal, the tender offer buyers from the 2017 transaction we discussed are not doing great either: at the IPO Price, they’re looking at a ~64% loss.
What to learn from Casper’s IPO valuation
Allowing certain employees to participate in tender offers and liquidity programs is an admirable way to allow for early employees to diversify risk and “take chips off the table.” However, in the current (perhaps inflated) private valuation environment, the common stock pricing rule of thumb, “10% or 20% discount to the last round of financing,” seems to be a bit antiquated—companies have enough information to be more precise with their valuations, and using that information can protect them from creating overvalued liquidity in these situations. Proper consideration to risk of the common stock vs. the preferred stock and market and company fundamentals should be considered in the valuation process, and claw-back clauses may need to be introduced in the transactions.
Furthermore, setting valuations high while a company is private (to decrease the dilution effect of a round of financing) may be unnecessary if these investors have downside protection, and would take the same dilution upon future financings, including an IPO. Plus it could result in a 409A valuation that ignores market fundamentals and will result in employee strike prices (and alternative minimum taxes) that are higher than they should have been. Casper employees who exercised their options during 2018 may have unnecessarily been subjected to higher alternative minimum taxes because of the 409A valuation.
Said differently, a 409A valuation specialist should consider market and company fundamentals—not just preferred financings, which may have downside protection. The audit community should make announcements that encourage and require fundamental analysis above and beyond reliance on the last round of financing.
Companies should have programs and written policies in place to compensate employees in a downround, especially if there are mechanisms that protect investors in a downround. For equity to function properly as an incentive, employees need to trust that leadership won’t hang them out to dry if the IPO is a snoozefest.