Square: The Mega-Disrupter Everyone Wants to Be In, Even the Investors Who Keep Passing

By Sarah Lacy , written on July 9, 2012

From The News Desk

Fortune has a long story about Square with the bold, never-mind-if-it's-quite-true, pick-me-up-off-the-newsstand-anyway headline "The Death of Cash."

If only pulling that headline off were so easy.

Companies have proclaimed the death of cash for decades and decades. Checks didn't do it. Travelers checks didn't do it. Credit cards didn't do it. Debit cards didn't do it. PayPal didn't do it.

Cash, in all its dirty, inefficient, multi-currency forms, is the financial cockroach of the world. Everyone wants it dead, but no matter what technology-based, nuclear blast hits it, it just doesn't die.

Will mobile phones finish a job that's barely even been started? You can easily come up with a bullish case. There are more mobile phones on the planet than toilets. It's the first time a presumed "cash killer" has come close to global ubiquity -- stretching into the farthest reaches of the globe, the tiniest villages, the poorest slums. Like water through rocks, mobile phones have worked their way into places that computers, banks, and even electricity has not.

And Square -- unquestionably the leader of the mobile payment pack in terms of innovation, vision, cash, team, and buzz -- wisely has created something that isn't just iPhone dependent. It fits into a headphone jack, something every phone has, even though it only works on Apple and Android devices right now. This is one thing that sets Jack Dorsey apart from so many mobile entrepreneurs. As he talked about at AllThingsD last year, he wanted Square to (ultimately) be usable anywhere, the same way he wanted people to be able to Tweet from anywhere and any device too. He gets that just people with iPhones don't pull off a revolution. (I mean that literally in the case of Twitter and the Arab Spring, and figuratively with the war on cash.)

As the world becomes more of a tightly wound global village, the original PayPal vision Max Levchin and Peter Thiel had of a universal, borderless currency seems less crazy than it did in the 1990s. Almost futuristic examples like the near-ubiquitous M-Pesa in Kenya point to a cash-less, pay-for-cabs-by-text-message world that we've never come close to before.

It's an enticing enough vision with the potential impact so great and the spoils so gargantuan that Square's valuation has been bid into the billions of dollars, despite massive execution challenges still to come. The company reportedly closed on its most recent round weeks ago, although nothing has been announced yet. Reports have pegged the valuation as high as $4 billion (although other sources have told us it's not quite that high).

But there's something lodged in the scars of our collective institutional memory when it comes to this decades-long death of cash promise that won't let some VCs pull the trigger-- no matter how promising Square might seem. Ask both Benchmark Capital and Andreessen Horowitz what company of the past few years they most regret not investing in. Both say Square, without missing a beat.

But here's the thing: Square has continued to raise money even after each firm has expressed these regrets, and each firm remains on the sidelines, still saying they regret it but still not muscling their way into the deal. Many other firms don't talk as openly about it, but have the same mixed emotions.

Every time I have this conversation I think of the Nordstrom Rack in San Francisco. The line always snakes around the front row of clothing racks. There is one rack that is the point of no return before a sales associate waves a little flag at you to come check out. It's where you stash the dress you thought you wanted, but ultimately can't justify at the last minute.

I've been going to this Nordstrom Rack for nearly ten years, and it's always the same rack. There's something psychologically hard-coded into the design of the store. The line is just long enough that you have time to rethink each of your accumulated items of Nordstrom off-priced bounty.

Do I really need this purse I picked up when I came in, now that I'm getting these boots?

Sure it's 50 percent, but do I really need this leopard print nightgown? 

Wait a minute -- I have $50 of makeup here. How'd that happen? 

You hem and haw, and then you hit that rack. You are next in line and make the judgement call. Whatever you decide you don't need gets awkwardly thrown amid whatever the store owners have put there.

That rack is one of my go-to spots. It's continually heaped up with shoes, makeup, purses, dresses, towels -- anything that looked good but was ultimately deemed too much of an extravagance. It's like the curation that everyone else has done for you of the best things in the store that they want, but for whatever naggling reason can't pull the trigger on.

Square is the ultimate rack-of-regret startup. Every investor -- save firms like Khosla Ventures, Kleiner Perkins, and Sequoia Capital who are all in the company -- wants it, and regrets not buying it even as they are passing it up again.

And surprisingly with each round, there has been a different reason for the buyers' remorse. Those reasons have ranged from concerns about Square co-founder Jim McKelvey's management chops to Jack Dorsey's ability to run Square and handle product at Twitter. There have also been concerns over the ambition of Square's mission, the challenges of hardware companies in general, and of course the ever-escalating price. Word has it the bulk of this recent round went to large institutional investors, not traditional VCs.

The tension within Benchmark over this one was palpable at a recent dinner several of the partners had with a few members of the press. Peter Fenton was locking his head between his forearms like he was in an earthquake safety video, bemoaning the firm's inability to pull the trigger, while Bill Gurley sat at the other end of the table, articulating the bear case in his Elvis-like Texas drawl. That bear case includes the challenges of pulling off such a large vision, with the added risk many VCs associate with being a hardware company. One of other big reasons they said no? The concern that Dorsey was spreading himself too thin between Twitter and Square -- nevermind that Fenton, as a board member of Twitter, was the one who roped Dorsey back into a day-to-day role with his first company.

We talked to Ben Horowitz about this at last month's PandoMonthly too -- as Andreessen Horowitz has been calling Square the one that got away for many months. "We passed on Square in the first round, which was a $40 million round, which seems at least in retrospect a bit of a mistake," he said. "The big mistake we made on that was we went for lack-of-weakness over strength." As Horowitz explained earlier that evening, most insanely great entrepreneurs have a big weakness, and the firm prides itself on investing in the strength, not saying no to the weakness. But Square was an exception to their rule-- one both Marc Andreessen and Horowitz say they regret, but haven't rectified with an investment as the price has continually gone up.

Horowitz explains more fully in this mini-clip below:

For firms that stick to early stage investing, the window to get a piece of Square is long past. But many stage-agnostic firms continue to agonize over whether or not to pick Square off of "the rack of regret." So far, Square has had little trouble finding people to pull the trigger -- as evidenced by the money raised at valuations that give even bullish wanna-be Square shareholders pause.

But one thing is clear: Square will need more money. The vision is just too big and very capital intensive. Even consumer Internet companies like Twitter, Zynga, Groupon, and Facebook took gobs of cash to get big, and rewiring the global laws of commerce is almost a Tesla/SpaceX level of ambition.

From here on out, two things could happen. The valuation could keep going up the way Facebook did. Or Square could hit a snag, the global economy could put a chill on its money-raising ability, forcing the company to do a down round. That could give firms lusting over the company the chance to snap up shares at a bargain. But down rounds come with their own demons. Employees' ownership can get squashed, causing discontent, an exodus of talent, and a general sense that maybe this grand vision can't be pulled off after all. That could provide the latest excuse for some not to invest.

It's hard to remember a single company that has caused so much consternation on the part of top investors in the Valley in a long time. The price of the early Google rounds were scoffed at by several investors (including Benchmark again and many others), and David Sze of Greylock was considered mentally ill for investing in Facebook at a $500 million valuation. But there's a reason there are only two examples this extreme and this universally felt in recent memory.

If the agonizing and second guessing is already this acute, imagine how bad it'll get if Dorsey & Co. continue to execute. Even if they don't kill cash (still unlikely), there's a huge company that can be built here. This much is certain: Someone will be bragging in ten years' time.

Will it be the ones who passed or the ones who got in for the price of a "mere" $1 billion-$4 billion? The odds are in favor of the former -- given the laws of the Valley and cash's history of winning. But like most people who love digital disruption, I'm rooting for the latter.

[Illustration by Hallie Bateman]