Toast looks toward $18B valuation in upcoming IPO

Cheers, Boston

As if the Boston startup market needed additional momentum, it appears restaurant software startup Toast will dramatically bolster its valuation in its upcoming IPO.

For a city perhaps best known internationally for its hard tech and biotech efforts, to see Toast not only rebound from its early-pandemic layoffs to a public debut, but to target a valuation closer to $20 billion than $10 billion, is a coup.

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In a new S-1/A filing this morning, Toast indicated an early IPO range of between $30 and $33 per share, leading to a maximum fundraise of $825 million in its IPO. The company was last valued at $4.9 billion in early 2020, when Toast raised $400 million. The company is set to dramatically supersede that valuation mark thanks to expanding revenues and an especially strong second quarter.

Let’s dig into the company’s new IPO price range, calculate simple and fully diluted results, and see what we can learn from where Toast may price. Recall that the company has a mix of recurring software (SaaS) incomes as well as fintech revenue (payments, mostly). Its revenue mix is interesting, and how Toast prices could help us better understand how to value vertical SaaS startups that are pursuing a payments-and-SaaS business approach.

Into the filing!

Toast’s IPO valuation

Toast is selling 21,739,131 Class A shares in its IPO. They get one vote. Class B shares get 10. If you were considering buying into Toast’s IPO in hopes of having a say in its future, don’t. You won’t. The company’s IPO is really a method by which public-market investors can endorse the company’s current management group — or decline to buy any ownership at all.

Regardless of how we feel about corporate governance structures designed to eliminate the influence of common shareholders, Toast will have 499,332,681 shares outstanding after its IPO, or 502,593,550 if its underwriters choose to purchase their allotted greenshoe option.

At the company’s expected IPO price range of $30 to $33 per share, Toast is worth $14.98 billion at the low end, and $16.48 billion at the top. Inclusive of shares from its underwriters’ option, Toast’s simple IPO valuation range expands from $15.08 billion at the bottom to $16.59 billion at the top.

Those numbers don’t take into account certain shares, like fully vested stock options that can be exercised. Inclusive of those shares, we can calculate a fully diluted valuation of $17.9 billion, per Renaissance Capital. That’s darn close to $18 billion.

Regardless of which number you prefer, each is a multiple of Toast’s final private valuation, which means that a company that laid off staff in 2020 is set to have a rollicking IPO. Such are the vicissitudes of business.

Is that expensive?

Whenever we see a valuation upgrade of this sort, it’s our job to ask if investors are paying up more for prior results or for future growth. In the case of Toast, the answer may be both.

That’s because the company posted a solid recovery from its Q2 2020 pandemic declines, meaning that investors are paying for its rebound. And investors may pay a premium for Toast’s shares thanks to its very solid Q2 2021 results.

To put that into perspective, Toast grew from $198.6 million in Q1 2020 revenue to $279.0 million in Q1 2021, or just over 40%. From Q2 2020 to Q2 2021, it grew 192.5%.

Yes, but aren’t we comparing a 2021 figure to the lowest ebb of Toast’s 2020 results? Yes, but that’s just part of the story. Sure, Q2 2021 is super impressive at Toast compared to its year-ago result. But more importantly, Toast grew just over 52% from Q1 2021 to Q2 2021 alone. So, investors are buying the company’s recovery and recent revenue growth acceleration in its public offering.

Now, to some valuation math magic. Taking Toast’s revenues as a whole, at the top end of its valuation range — $17.9 billion, fully diluted — the company is worth 10.5x its Q2 2021 run rate (calculated by taking the quarter’s aggregate revenue results and annualizing them).

Cheaper than you expected, given where software stocks are trading at the moment? I understand if so. But keep in mind that in the second quarter of 2021, just 8.9% of Toast’s revenues came from software. The vast majority came from its lower-margin payments business. And a bit came from its breakeven-or-worse efforts in hardware and services. (The latter two categories are effectively loss leaders for the company’s more lucrative business lines, which we view as pretty smart, so don’t take the margin note before as a diss).

Given that Toast has a revenue mix favored toward payments, its implied IPO revenue multiple may in fact be somewhat toothsome for its investors. For context, in the second quarter of 2021, Toast generated $37.6 million in software revenues, and $353.6 million in finance incomes, the latter category including “transaction-based payment processing services for restaurants,” Toast reports.

In its most recent quarter, Toast’s software revenues had gross margins of around 66%, while its finance incomes generated gross margin of just 20.7% of the revenue line item.

Toast is a majority payments business, with a modest-in-comparison — if lucrative — software business. Getting a double-digit revenue multiple off of majority 20% gross margin revenue is brilliant, frankly. We’re not endorsing the valuation, mind, just noting that, based on what the company presents in its most recent report, it feels pretty far from parsimonious.

Taking this to our startup roots, it’s a good data point for software-and-payments companies hoping to raise new capital at strong valuations. If Toast’s IPO does well, it could set a solid watermark for companies pursuing its business model. Just don’t expect to get the same sort of multiple at your startup unless your revenue growth is accelerating.

More simply, startups that offer software and payments tech, but derive the majority of their top line from the latter category over the former, should anticipate a run-rate multiple of less than 10x at IPO. So, run your numbers accordingly.