Square’s Next Round Could Swipe a $4 Billion Valuation

Square is seeking to raise a fresh round of capital at a massive valuation of up to $4 billion, according to multiple sources familiar with the situation.

If the company is successful, it will have quadrupled its worth since raising $100 million at a $1 billion valuation only 10 months ago.

While that would be astonishing for a three-year-old company, it’s important to note that negotiations continue, and that investors could ultimately value the company at a slightly more modest number (hmm, like $3 billion?!).

A Square spokesman declined to comment.

Square, which was founded by Twitter inventor Jack Dorsey, has quickly made accepting credit cards via a mobile phone into a mainstream and affordable concept for small merchants.

Over the past year, it has quickly expanded beyond handing out magnetic-swipe readers to offer more robust experiences for both consumers and merchants, including software on the Apple iPad that acts like a register, and software on the iPhone that is a virtual wallet.

The payments method has received a warm reception from mostly small businesses, including taxicabs, food trucks, coffee shops and even lawyers and accountants.

The rumors of Square looking to raise more capital started spreading after Owen Thomas, formerly of the Daily Dot, noticed that Dorsey and Square’s COO Keith Rabois were in Boston and Baltimore, where many institutional investors are based. Thomas called Legg Mason, which confirmed it was looking at the San Francisco company.

Previous investors in Square’s three rounds, totaling roughly $137 million, include Kleiner Perkins Caufield & Byers, Tiger Global Management, Sequoia Capital, Khosla Ventures, Visa and well-known entrepreneur Richard Branson.

The big question is whether Square will be able to demand such a hefty valuation.

To determine that, based on what is known about the company, I did some back-of-the napkin calculations to come up with its annual revenue.

Last month, the company said it is now processing $4 billion in annual transactions. Since we know that Square charges 2.75 percent per swiped transaction, and 3.5 percent plus 15 cents per keyed-in transaction, we can start to get a better picture of its finances.

Let’s assume that a quarter of the company’s transactions are keyed in — which demands the higher rate. That would mean the company’s revenue would total nearly $83 million for swiped transactions, and $35 million for keyed-in transactions. Because of the additional 15-cent fee per transaction, let’s add another $15 million (which might be generous, but would break down to 100 million transactions at $10 apiece).

In all, the company’s annual revenue would then be close to $122 million.

Most, but not all of that revenue, is then handed over to the credit card companies for processing fees.

To be sure, the company has grown quickly since its inception, and has its eyes set on the very large point-of-sales market. This year, Square said it had plans to expand internationally, and has just hired a new executive from PayPal to take the lead on the effort. In the future it could also generate revenue from advertising or other loyalty programs, although it does not today.

But, by at least one historical measure, the valuation is rich beyond belief.

PayPal, which was also looking to disrupt the banking industry by enabling peer-to-peer payments online, was sold for $1.5 billion to eBay in 2002, just months after going public at a valuation of nearly $800 million.

At the time it went public, the company was roughly doubling year over year and had generated $103.7 million in 2001, its first full year of operations — or slightly less than Square’s estimated revenues.

Much like PayPal back then, Square faces intense competition, making alliances with much larger companies or raising big war chests critically important.

Square faces stiff competition and pricing pressure from Intuit, eBay’s PayPal, Google and other upstarts, like Pay Anywhere.

Still, it has made a splash that is seeing major reverberations around the sector, which a big valuation will make larger still.

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I think the NSA has a job to do and we need the NSA. But as (physicist) Robert Oppenheimer said, “When you see something that is technically sweet, you go ahead and do it and argue about what to do about it only after you’ve had your technical success. That is the way it was with the atomic bomb.”

— Phil Zimmerman, PGP inventor and Silent Circle co-founder, in an interview with Om Malik