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Square Inc.: Valuation and Intellectual Property Issues for Acquisition

Square Inc., owner of the credit card payment system adapted to use on smart phone devices, is being rumored for acquisition by a number of large tech suitors such as Google, Apple, and eBay’s PayPal according to a recent Wall Street Journal article. The company has grown rapidly since its inception in 2009 with card processing rates of $20 billion in 2013 and 2014 projections growing to $30 billion. Valuation of the company is estimated at $5.2 billion based on insiders sold shares earlier this year.

Additional financial information found a $100 million loss in 2013 and over half of the $340 million in raised capital from equity financing in 2009 depleted. Square offers its customers a 2.75% fee for use of the credit card payment system. After paying processor fees and other associate costs Square saw a 27% gross margin in 2012 fall to 21% in 2013. A larger acquiring tech company, with an established infrastructure in place, would be able to reverse the gross margin trend and better utilize the remainder capital. This should quickly result in getting the company profitable and grow the profitability moving forward.

For a company looking to acquire Square, a potential affect on the offer price is a pending patent infringement suit. The suit brought early this year by REM Holdings 3, LLC has a strong case of infringement based on its 2010 patent titled “Card Reader Device for a Cell Phone and Method of Use." The inventor, Robert E. Morley Jr. a Washington University professor, claims infringement and is seeking damages past and future.

In early 2009 Square Inc. founding member James McKelvey Jr. came to Mr. Morley to discuss a method to utilize smart phone technology. A patent (U.S. patent no. 7,810,729) was later submitted and issued naming Mr. Morley as the sole inventor. Mr. McKelvey disputed this and filed a suit in 2010 to be added as an inventor on the patent, which is still pending. In January 2014, Mr. Morley filed a patent infringement against Square based that the company is using his patented technology for their business.

As with many technology companies the valuation is strongly influenced by its Intangible Assets and, in particularly, Intellectual Properties. An exclusive right of a patent in the marketplace places along with growing revenue allows a company such as Square to carry a valuation into the $5 billion range. At best for Square, Mr. McKelvey’s name gets added to the patent giving him a level of rights to the patent. Mr. Morley would still have a stake in the patented invention and can sue/negotiate for a licensing fee or settlement. On the other hand, if Mr. McKelvey is not awarded inventor status Mr. Morley’s current patent infringement claim will carry prominent merit and can be worth a substantial value of the company.

What does the current financial, potential growth rate and pending patent issue do to the acquisition prospects of Square? A prospective acquiring company conducting its due diligence would need to take into account not only growth prospects but the possible effect of the pending suits have in discounting the $5 billion valuation. Decisions would need to be made concerning Mr. Morley as to the purchase, licensure or litigation of the patent, a very valuable asset to Square.

Business Intangibles, LLC assists businesses and holding companies with their Intangible Asset and Intellectual Property concerns, creating financial value and building equity. Services include assessments, value creation, valuation, and strategic planning of going concerns and new ventures.

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