Why Axis

Breaking down Lightspeed as it prepares to IPO

Dax Dasilva, CEO of Lightspeed, is seen in the company's Montreal office on Tuesday, September 15, 2015 in Montreal
Dax Dasilva, CEO of Lightspeed, is seen in the company's Montreal office on Tuesday, September 15, 2015 in Montreal. Paul Chiasson/Canadian Press
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Lightspeed filed its highly anticipated initial public offering (IPO) earlier this month. The Montreal-based point-of-sale (POS) software company started in founder Dax Dasilva’s Montreal apartment in 2005; it now has 700 employees in seven countries. When it lists its shares on the Toronto Stock Exchange (TSX) under the ticker LSPD, it will join the slim ranks of Canadian publicly-traded SaaS technology companies like Kinaxis, Shopify, and Enghouse.

The Bank of Montreal, National Bank Financial and JPMorgan Chase & Co. are underwriting the share sale, which is expected to raise about $200 million, according to reports.

The Logic analyzed Lightspeed’s 211-page prospectus and spoke to several stock analysts, venture capitalists and industry experts to assess some of the lesser-known details of the tech IPO.

Our analysis shows that despite its fast-growing operation and ambitious expansion plans, a number of factors could hurt the firm’s prospects on the public markets, including a limited patent portfolio, a pending lawsuit, a sole-sourced key feature and a share structure that institutional investors typically oppose.

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Talking Point

Lightspeed has solid revenue and growth numbers along with the well-respected Caisse de dépôt et placement du Québec on its side. But an analysis by The Logic shows that the company also faces a number of risks as it prepares to go public.

The brokers

Wall Street giant J.P. Morgan Securities is one of Lightspeed’s three underwriters for its public offering, along with BMO Nesbitt Burns and National Financial. These firms will sell shares to investors on behalf of the company.

The presence of a U.S. broker should allow Lightspeed to tap investors in that market, said Nick Agostino, managing director at Laurentian Bank Securities. Lightspeed is going public only on the TSX, which limits its exposure to U.S. institutional investors; Shopify and Ceridian—the latter of which went public in April 2018—both listed on the New York Stock Exchange, as well.

Lightspeed may benefit from good timing. On February 11, Morgan Stanley announced it was acquiring TSX-listed Solium Capital—a Calgary-based maker of stock plan-administration software—for $1.1 billion. “Those funds need to find a new home,” said Agostino.

The share structure

Lightspeed is setting up a dual-class structure, under which some of Dasilva’s shares will carry four votes to a normal shareholder’s one. The setup means that Lightspeed’s founder can control the company even if his financial stake drops below the halfway mark.

Dasilva—who, through a spokesperson, declined to be interviewed for this story—bootstrapped the company for seven years before raising US$30 million in its first round of funding in 2012, led by Accel. He managed to attract the Palo Alto, Calif.-based venture capital firm at a time when its investment strategy saw Apple transforming the retail industry. Dasilva, a former Apple developer, used what he learned at the company to launch Lightspeed.

Since then, he’s been outspoken about encouraging founders to retain control of their companies and resist getting acquired too early. In October 2017, the Caisse de dépôt et placement du Québec bought out former investor Accel’s stake in Lightspeed in an effort to avoid acquisition.

“We want to build a tech anchor in Montreal. There can’t be only one Shopify and all the other [Canadian] tech companies are bought by foreign buyers,” Dasilva told The Globe and Mail about the decision to rebuff acquisition offers.

Lightspeed’s growth has required “a reinvention, every year, of what my job is,” Dasilva said at SaaS North in Ottawa in November 2018, adding that he’s had to let other people take ownership of projects, which has helped build trust.

“Very easily a company can reflect a founder’s strengths and weaknesses,” he said, suggesting that leaders hire executives who are “not clones of yourself.”

Dual-class structures are popular in the tech sector. According to PwC, 48 per cent of technology, media and telecom IPOs in the U.S. between January 2015 and July 2018 used the system; 21 per cent of all IPOs used it within the same timeframe. Facebook and Google both have them, as does Shopify.

Some large institutional investors like the Ontario Teachers’ Pension Plan, the Canada Pension Plan Investment Board (CPPIB) and the Ontario Municipal Employees Retirement System oppose dual-class structures on principle because they allow a company’s management to resist other shareholders’ demands for change.

But the Caisse is an exception. It’s “important for an entrepreneur-founder to have a significant interest in the company,” according to the fund, and it considers a multi-voting share ratio of up to six to one to be acceptable.

Major Canadian institutional investors do own stocks in tech companies with dual-class structures. CPPIB held $76 million in Shopify stock, $1.15 billion worth of Facebook and $2.37 billion of Google parent company Alphabet as of March 31, 2018, according to the organization’s filings. But it and other pension funds buy many public equities through programs that mimic top stock indices.

The boardroom

The Caisse will be the only shareholder other than Dasilva with more than 10 per cent of Lightspeed’s voting rights once the IPO is complete. The Caisse has the right to nominate one of Lightspeed’s directors as long as it controls shares representing more than 20 per cent of voting rights, according to the filing.

The provincial pension fund invested US$136 million in Lightspeed’s US$166-million Series D round in October 2017, and also co-led its US$61-million Series C raise in 2016. While its exact stake is redacted, a source with knowledge of the company said the Caisse will have the same number of shares before and after the offering. That suggests the fund is not selling any of its stake.

Investors are not all that familiar with Lightspeed’s management, but they know the Caisse, said Agostino. The fund has a good track record in tech as one of the biggest shareholders of CGI—one of the country’s largest publicly-traded firms in the sector—and has invested in promising Quebec-based startups like travel software firms Hopper and Plusgrade. The Caisse’s current holdings in Lightspeed are through its private-equity arm, which operates separately from its public-markets division. But the latter could step in when Lightspeed goes public, given the fund’s knowledge of the company, according to Agostino.

“Certainly having that meaningful, sizeable and credible lead order could help … in terms of the traction of the IPO,” he said.

The market

Lightspeed has grand ambitions. Its prospectus lists a “global opportunity of US$113 billion per year,” based on the number of small- and medium-sized businesses on the planet. It’s a segment of the market that Dasilva has long seen as neglected by traditional rivals.

The company’s platform is designed for independent retailers and restaurants and is used at 47,000 locations in 100 countries, according to its prospectus. For comparison, Toronto-based TouchBistro, which focuses on the food-service space, has 15,000 customers. Auckland-headquartered Vend, which primarily caters to boutiques and small stores, has 25,000.

The POS market was worth US$56.7 billion in 2016, according to Transparency Market Research (TMR). Legacy hardware makers like NCR—originally Nation Cash Register—Samsung, Toshiba and Panasonic remain prominent, but the space is “fairly fragmented,” according to TMR.

The financials

Lightspeed had full-year revenues of US$71.9 million in 2018. Its revenue for the fiscal year ended in March 2018 was US$57.1 million, and its fiscal year ended in March 2017 was US$42.6 million.

The company is looking to raise US$151 million in its offering, according to The Globe and Mail.

Lightspeed’s prospectus shows a compound annual growth rate of 36 per cent, and 89 per cent of its revenue comes from recurring software subscriptions and payment fees.

Thirty-five percent of Lightspeed’s revenue comes from outside North America. International expansion is a core focus of its growth strategy, although the company doesn’t specify which markets it’s targeting.

Lightspeed’s revenues are significantly lower, and its target higher, than other Canadian SaaS firms that have recently gone public.

Real Matters, a real-estate software platform, had a projected US$276 million in revenue in 2016 according to its prospectus; it raised US$114 million on the TSX in a May 2017 offering. Shopify made US$105 million in 2014, before raising US$131 million in a May 2015 offering.

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The transactions

Lightspeed’s gross transaction volume (GTV)—the sales its users made through its platform—was US$13.6 billion in 2018 and US$10.6 billion for its most recent fiscal year ended on March 31, 2018. Both those figures are lower than the US$15 billion annually that the company quoted on its website in 2017.

A source with knowledge of Lightspeed’s operations said the 2018 numbers were lower because they excluded Lightspeed’s legacy system, which could only be used on Apple products. Lightspeed’s main product is now a cloud POS, launched in 2013 following the acquisition of MerchantOS.

The patents

Lightspeed’s prospectus says intellectual-property (IP) rights are important to its business, warning that there are “a large number of patents” in the tech industry, and “frequent claims and related litigation” over IP. But the company has filed only a single patent application under the name “Technologies for Point of Sale Transactions” in the United States, Canada, Europe, Australia and Mexico.

Square, which also started as a point-of-sale company, has filed for 508 patents in the U.S., according to the World Intellectual Property Organization (WIPO)’s database. But “they have a hardware piece to what they’re doing,” said Brent Holliday, CEO of Garibaldi Capital Advisors. He said this is why patents are necessary; they’re less important for software companies like Lightspeed. Square’s first big product was a card reader that plugged into a smartphone’s headphone jack, while Lightspeed’s POS hardware kit comes from third-party manufacturers.

The WIPO database shows TouchBistro has also filed a single patent application. Vend has none.

The lawsuit

Lightspeed is currently being sued in Quebec’s Superior Court by two numbered companies. They allege that its retail POS solution Onsite—which integrates the management of physical and e-commerce operations—infringes on their copyrighted IRON software. The two companies are seeking “an ongoing royalty,” as well as $27 million in allegedly misbegotten profits and $3 million in damages. The prospectus does not state the specifics of the alleged infringement.

The Canadian Intellectual Property Office lists 99257 Canada Ltd. as the owner of IRON, though Dasilva is named as one of its co-authors. The patent was registered in May 2016. The numbered company was incorporated in 1980 and is registered to Hyman Bloom of Ace Mortgage in Montreal, a real-estate lending company. Bloom appears to have been involved in at least five earlier court cases—mostly involving real-estate disputes—and none appear related to patents.

Bloom confirmed to The Logic that he is involved in a lawsuit against Lightspeed, but declined to share specific details. Lightspeed’s prospectus notes that it has not yet filed a defence, but says the claim is “without merit.”

The partners

In January, the company launched Lightspeed Payments, an integrated payment-processing solution, to U.S. customers. Its prospectus says expanding the service is “a significant growth opportunity.”

Lightspeed’s customers perform billions in transactions every year; taking a larger cut of that via payment-processing fees could quickly add up. Shopify launched a similar service in 2013, and it’s now its fastest-growing business line.

But while it carries the Lightspeed name, the actual processing for its payments service is done by Cincinnati, Ohio-based Worldpay, according to the prospectus. Lightspeed and Worldpay have a three-year agreement, and the former “could incur substantial delays and expenses in finding and integrating an alternative payment service provider” if the deal is terminated, it says.

The debt

Lightspeed has a US$15-million line-of-credit with Silicon Valley Bank (SVB), the collateral for which is “substantially all” of its assets, including cash and inventory.

Debt holders typically take priority over equity holders if a company defaults, said Boris Wertz, CEO of Version One Ventures. But the agreement with SVB won’t affect investors unless the company starts performing poorly. “In this IPO, they could use some of that [cash raised] to pay back the loan,” he said.

The company’s balance sheet shows no long-term debt, suggesting it hasn’t used the loan.

The returns

Lightspeed doesn’t anticipate paying dividends, so purchasers in the offering “may never receive a return on their investment,” according to the prospectus. But, of course, investors can still see a return if Lightspeed shares increase in value over time.

Dividends are generally paid once a company moves past being able to use its capital to make internal investments, but a fast-paced tech company like Lightspeed would continue re-investing in the growth of the business to increase the price of shares.

Shopify similarly does not pay dividends, nor does it plan to. “It’s not the same business as Shopify or a perfect analogy, but in the world of tech growth, I think of Lightspeed in that light,” said Brice Scheschuk, chief financial officer at Globalive Capital. “They’re not paying a dividend because they need the capital they’re raising to deploy into spectacular return-generating growth opportunities, and that’s great for shareholders.”

Only six of the 15 firms on the S&P/TSX Capped Information Technology Index issued a dividend between 2014 and 2018, according to data from Morningstar, an investment research company.