Vlad Tenev, Robinhood
Robinhood’s ability to add hundreds of thousands of new customers during a week of chaos, along with its IPO prospects, convinced Silicon Valley backers that a multi-billion-dollar cash infusion was worth it.
CNBC spoke to three of Robinhood’s investors, who agreed to speak about the emergency funding without being named, because the conversations were private. All of them said there was “strong demand” for investors to get a piece of Robinhood, even as the company stared down a public relations and regulatory crisis.
The trouble started last week, as Robinhood restricted trading for a list of stocks including GameStop. Amateur investors had bid up those names on social media, causing massive losses for hedge funds that shorted them.
Robinhood was not the only brokerage firm to do this. Still, its decision was met with a big backlash from traders and even celebrities on Twitter and Reddit. Some accused the company of colluding with hedge funds to shut down the buy-side of the trade. Lawmakers from both major parties also lobbed accusations of market manipulation at Robinhood. (Robinhood CEO’s Vlad Tenev said it did not make the move because of any outside pressure.)
But the biggest near-term crisis, was having enough capital to meet regulatory requirements.
Brokerage firms like Robinhood need to send cash every day to the Depository Trust Company to make sure there’s enough collateral backing up customer trades in the two days it takes them to settle. That formula is based on volatility among other factors, which picked up last week as stocks like GameStop shot up 400%, and rookie traders were deploying leverage.
The amount Robinhood was expected to post for names like GameStop and AMC increased tenfold, the company said in a blogpost. Robinhood’s operations team woke up to a request at 3:30 a.m. PT on Thursday from the National Securities Clearing Corp, the third party where it reports the collateral, CEO Tenev told Elon Musk in a conversation on the audio chat app, Clubhouse. The total amount Robinhood needed to post came in at $3 billion, according to Tenev.
At the time, Robinhood did not have the capital.
The first step was to call up venture capital investors. They were able to round up $1 billion in convertible debt, sources said. That debt will convert to equity when Robinhood goes public, and those investors will get a 30% discount to the market price.
“In spite of the trouble last week, the metrics suggest retail trading is exploding and Robinhood is still the only game in town,” one investor told CNBC. “This is going to be a big company and if you believe they’re going to IPO, you can get in right now at a discount.”
That first tranche was oversubscribed on Thursday, and investors said that Robinhood turned investors away — at first.
They decided to open up a second round with the same debt structure that amounted to $2.4 billion. In total, Robinhood brought in $3.4 billion over a few days in capital to meet its regulatory requirements. Because it was debt, not equity, Robinhood’s $11.7 billion valuation on paper did not change. The start-up also tapped a $600 million line of credit from JP Morgan and Goldman Sachs.
Investors said that should be “more than enough,” for now. Robinhood is also profitable on a GAAP basis, one investor said. The cushion should be big enough that Robinhood’s balance sheet can handle the shock of similar capital issues cropping up again, the investors said.
As of Wednesday midday however, Robinhood was still limiting some trading in GameStop and AMC.
A flood of cash would also put Robinhood in a stronger position ahead of an IPO, which investors expect to happen within the next year but would not give specifics. A direct listing and special purpose acquisition company, or SPAC, are still on the table, but the company “hasn’t decided yet,” one investor told CNBC.
Robinhood declined to comment on the deal structure and IPO plans.
Robinhood saw fierce criticism from investors like Chamath Palihapitiya — who is taking another investing platform, Sofi, public through a SPAC — and rapper Ja Rule, tweeting #deleteRobinhood. Hundreds of users on social media threatened to leave Robinhood for other brokerage firms, and the company is facing multiple class action lawsuits from angry users.
One venture capital investor who saw the internal growth metrics last week said the flood of new investors “far outweighed” any attrition. Robinhood was the top app in the iOS app store for multiple days. It also led the industry in app downloads by a wide margin with 600,000 people downloading the free-trading app, according to JMP Securities analysis.
That metric was the silver lining investors focused on when weighing whether to throw billions of dollars at the company.
“It’s the fastest growing consumer app, and has better engagement than social media,” one investor said. “The majority of those new traders won’t be trading GameStop.”
Growing too fast has also been a criticism of Robinhood. Palihapitiya and others have suggested that Robinhood stop bringing in new investors until the start-up can shore up last week’s issues. Despite those warnings, Robinhood is spending on marketing for brand awareness. The start-up announced its largest brand campaign ever on Wednesday, with a commercial airing during the Super Bowl.
Despite the tumultuous week, at least three investors were aligned on wanting Tenev to continue leading the start-up through its public debut.
“Vlad as a leader is fantastic— this week has been tough on the whole team,” one investor told CNBC.
Robinhood’s chief financial officer, Jason Warnick, said there was also support for the CEO internally. He told CNBC that Tenev “mobilized” the team in an “incredibly effective way” through recent weeks and there was “absolutely no one else I would want to be with.”
Still, they said the start-up made mistakes. Among those were the messaging from Robinhood in the hours after shutting down customer trades. One said he wished Robinhood could have a “mulligan” and said they should have clearly explained the liquidity issue, while tackling the hedge fund theories out of the gate.
On Thursday, Robinhood’s CEO told CNBC that “there was no liquidity problem, and to be clear this was done preemptively so we did this proactively and thousands of other securities remain tradeable on the platform.”
Tenev, who co-founded Robinhood, is facing immense pressure on Capitol Hill. Senator Elizabeth Warren sent the start-up a letter asking for an explanation of why Robinhood shut down trades. He is expected to testify at a House Financial Services Committee hearing later in February. On Wednesday, one of Robinhood’s regulators, FINRA, issued a report saying that it’s increasing oversight of “game-like” trading apps. Regulation is a risk but it’s “impossible to price in,” one investor said.
Robinhood, and the rest of the online brokerage industry, rely on what’s known as payment for order flow as their profit engine in lieu of commissions. Market makers pay e-brokers like Robinhood for the right to execute customer trades. The broker is then paid a small fee for the shares that are routed, which can add up to millions when customers trade as actively as they have this year. That practice may come under fire after the events of last week.
“Robinhood’s value is not the revenue model, it’s the user engagement,” one investor said.