When ServiceTitan filed its IPO documents last week, the tech world wondered if the stuck IPO market was finally unlocking. However, experts believe that ServiceTitan's IPO might not be a sign of a thawing market, but rather a harbinger of late-stage companies being forced to go public with unfavorable terms.

The concern stems from a "compounding IPO ratchet structure" disclosed in ServiceTitan's S-1 documents. This structure means that if the company goes public at a stock price lower than what the venture investors paid, ServiceTitan will have to grant those investors more shares to cover the loss. The twist is that the company agreed to a compounding annual rate of 11% quarterly, starting from May 22, 2024, for every quarter it delays its IPO.

According to Meritech Capital's analysis, ServiceTitan would need to debut at above $90 per share to negate paying its Series H investors more stock. However, Meritech calculates that the company's financials currently justify a stock price closer to $72 per share, given its revenue and growth rate. This means that any delay in the IPO would require ServiceTitan to price even higher to avoid the unfavorable terms, further diluting the holdings of other major investors.

Venture capitalist Bill Gurley commented on the situation, warning founders to steer clear of investors asking for compounding ratchets. However, Alex Clayton, general partner at Meritech Capital, believes that the term is not necessarily "dirty" and that ServiceTitan's lawyers and executives likely understood and agreed to the risk to get a higher valuation and avoid a down round.

Down rounds can be damaging to employee morale, future investing rounds, and media headlines. However, founders often agree to such terms to protect investors from overpaying. Clayton notes that this is a kick-the-can-down-the-road tactic, and Gurley advises founders to take a down round if that's what the company is really worth, rather than playing valuation term-sheet games.

The implications of ServiceTitan's IPO filing are far-reaching. Clayton believes that we'll likely see more such unfavorable terms buried in S-1 disclosures, given the struggles of founders to maintain high valuations in 2022. This could mean that the IPO window isn't necessarily opening, and that companies are being forced to go public due to unfavorable terms rather than a genuinely open market.

However, if retail investors respond positively to ServiceTitan's IPO, it could potentially open the IPO window. As Miles Dieffenbach, Managing Director of Investments for Carnegie Mellon's endowment, noted, ServiceTitan's IPO is likely driven by the compounding ratchet structure rather than a genuinely open market.

ServiceTitan did not respond to a request for comment. As the tech world watches ServiceTitan's IPO unfold, it remains to be seen whether this will be a one-off or a sign of things to come for late-stage companies.