Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section presents management’s perspective on our financial condition and results of operations, including performance metrics that management uses to assess company performance. The following discussion and analysis is intended to highlight and supplement data and information presented elsewhere in this Annual Report, and should be read in conjunction with our consolidated financial statements and notes elsewhere in this Annual Report. It is also intended to provide you with information that will assist you in understanding our consolidated financial statements, the changes in key items in those consolidated financial statements from year to year, and the primary factors that accounted for those changes. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which might not be indicative of our future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections titled “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors.”
We refer to our “users” and our “customers” interchangeably throughout this Annual Report to refer to individuals who hold accounts on our platform. The FINRA definition of “customer” under Exchange Act Rule 15c3-3 means any person from whom or on whose behalf a broker or dealer has received or acquired or holds funds or securities for the account of that person. However, because we do not earn consideration from users (other than Robinhood Gold Subscribers and debit card users), users are not “customers” as defined in ASC 606, Revenue from Contracts with Customers. Accordingly, our users do not meet the definition of “customer” for purposes of the accounting rules. See Note 1 to our consolidated financial statements in this Annual Report.
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Overview
With respect to the year ended December 31, 2021, as compared to the year ended December 31, 2020:
• we generated total net revenues of $1.82 billion compared to $959 million, for year-over-year growth of 89%;
• we incurred a net loss of $3.69 billion, which included aggregate costs of $3.62 billion associated with share-based compensation and the change in fair value of our convertible notes and warrants, compared to net income of $7 million;
◦ Share-based compensation expense totaled $1.57 billion compared to $24 million. For the year ended December 31, 2020, share-based compensation expense all related to stock options (no expense relating to restricted stock units was recognized because a vesting condition had not been met as our IPO had not yet occurred).
◦ The net loss for the year ended December 31, 2021 also included total expense of $2.05 billion associated with the change in fair value of convertible notes and warrant liability issued in February 2021.
• our Adjusted EBITDA (non-GAAP) was $34 million compared to $155 million;
• we had Net Cumulative Funded Accounts of 22.7 million compared to 12.5 million, for year-over-year growth of 81% ;
• we had Monthly Active Users (MAU) of 17.3 million in December 2021 compared to 11.7 million in December 2020, for year-over-year growth of 48%;
• we had Assets Under Custody (AUC) of $98 billion compared to $63 billion , for year-over-year growth of 56%; and
• we had Average Revenues Per User (ARPU) of $103 compared to $109 , for a year-over-year decrease of 5%.
For definitions of “Net Cumulative Funded Accounts”, “MAU”, “AUC” and “ARPU” please see “—Key Performance Metrics.” Adjusted EBITDA is a non-GAAP financial measure. For more information about Adjusted EBITDA, including the definition and limitations of such measure, and a reconciliation of net income (loss) to Adjusted EBITDA, please see “—Non-GAAP Financial Measures.”
COVID-19 Update
In March 2020, the World Health Organization declared the outbreak of the novel coronavirus referred to as “COVID-19” to be a global pandemic. In response to the pandemic, we enabled nearly all of our employees, to work remotely and restricted business travel. In the fourth quarter of 2021, we elected to become a “Remote First” company, allowing a large segment of our employees to have no assigned location or regular in-office requirement. When this program is fully implemented, following the cession of COVID-19 exemptions, some teams will need to live within a commutable distance to an office location for regulatory and business reasons, and a small segment of our workforce will still need to come into the office. All employees will have access to our offices throughout the country and, as vaccination rates among the population have increased, we have started to allow some employees to voluntarily return to work in our corporate offices. The timing of any full return for those employees who will eventually be
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required to come into the office has not been determined and will be impacted by developments related to the pandemic, such as the severity and transmission rate of the virus and its variants.
At the onset of the COVID-19 pandemic, we saw substantial growth in our user base, retention, engagement, and trading activity metrics, and over the course of the pandemic we saw periodic all-time highs achieved by the equity markets generally. During this period, market volatility, stay-at-home orders, and increased interest in investing and personal finance, coupled with low interest rates and a positive market environment, especially in the U.S. equity and cryptocurrency markets, helped foster an environment that encouraged an unprecedented number of first-time retail investors to become our users and begin trading on our platform. However, we have seen the growth of our user base in recent periods slow compared to the accelerated growth we experienced in 2020 and the first half of 2021. For example, the pace of growth in new funded accounts slowed considerably in the second half of 2021 compared to the first half of 2021. Additionally, to the extent that government stimulus measures enacted in response to the pandemic contributed to an increase in customer engagement, that benefit may not have continued as those stimulus measures have expired. For example, we saw Monthly Active Users decline from 21.3 million in June 2021 to 17.3 million in December 2021.
The COVID-19 pandemic also resulted, in part, in inefficiencies or delays in our business, operational challenges, additional costs related to business continuity initiatives as our workforce had to transition suddenly to working remotely, and increased vulnerability to cybersecurity attacks or other privacy or data security incidents. The extent of the continuing impact of COVID-19 on our business, financial condition, and results of operations will depend largely on future developments, including the duration of the pandemic, actions taken to contain COVID-19 or address its impact, our ability to adapt to the long-term distributed “Remote First” workforce model we have adopted, the impact on capital and financial markets, and the related impact on the financial circumstances of our customers, all of which are highly uncertain and difficult to predict.
Key Performance Metrics
In addition to the measures presented in our consolidated financial statements, we use the following key performance metrics to help us evaluate our business, identify trends affecting our business, formulate business plans, and make strategic decisions:
Year ended December 31,
(in millions except ARPU) 2019 2020 2021
Net Cumulative Funded Accounts (1)
5.1 12.5 22.7
Monthly Active Users (MAU) (2)
4.3 11.7 17.3
Assets Under Custody (AUC) (3)
$ 14,135.6 $ 62,978.5 $ 98,006.9
Average Revenues Per User (ARPU) (4)
$ 65.7 $ 108.9 $ 103.3
________________
(1) A Robinhood account is designed to provide a user with access to any and all of the products offered on our platform. We define “Net Cumulative Funded Accounts” as New Funded Accounts less Churned Accounts plus Resurrected Accounts (each as defined below). A “New Funded Account” is a Robinhood account into which the account user makes an initial deposit or money or asset transfer, of any amount, during the relevant period. An account is considered “Churned” if it was ever a New Funded Account and its balance (measured as the fair value of assets in the account less any amount due from the user and excluding certain Company-initiated credits) drops to or below zero for at least 45 consecutive calendar days. Negative balances typically result from Fraudulent Deposit Transactions (as defined below) and, less often, from margin loans. An account is considered “Resurrected” in a stated period if it was a Churned Account as of the end of the immediately preceding period and its balance (excluding certain Company-initiated credits) rises above zero. Examples of credits excluded for purposes of identifying Churned Accounts and Resurrected Accounts are price correction credits, related interest adjustments, and fee adjustments.
“Fraudulent Deposit Transactions” occur when users initiate deposits into their accounts, make trades on our platform using a short-term extension of credit from us, and then repatriate or reverse the deposits, resulting in a loss to us of the credited amount. For more information about Fraudulent Deposit Transactions, see “—Key Components of our Results of Operations—Operating Expenses—Operations” below.
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The following table describes the annual changes within Net Cumulative Funded Accounts:
Year ended December 31,
(in millions) 2019 2020 2021
Beginning Net Cumulative Funded Accounts 3.3 5.1 12.5
New funded accounts 2.3 8.0 12.2
Resurrected accounts 0.2 0.3 0.5
Churned accounts (0.7) (0.9) (2.5)
Ending Net Cumulative Funded Accounts 5.1 12.5 22.7
(2) We define MAU as the number of Monthly Active Users during a specified calendar month. A “Monthly Active User” is a unique user who makes a debit card transaction, or who transitions between two different screens on a mobile device or loads a page in a web browser while logged into their account, at any point during the relevant month. A user need not satisfy these conditions on a recurring monthly basis or have a Funded Account to be included in MAU. Figures in the table reflect MAU for the last month of each period presented. We utilize MAU to measure how many customers interact with our products and services during a given month. MAU does not measure the frequency or duration of the interaction, but we consider it a useful indicator for engagement. Additionally, MAUs are positively correlated with, but are not indicative of, the performance of revenue and other key performance indicators.
(3) We define AUC as the sum of the fair value of all equities, options, cryptocurrency and cash held by users in their accounts, net of receivables from users, as of a stated date or period end on a trade date basis. The following table sets out the components of AUC by type of asset:
Year ended December 31,
(in millions) 2019 2020 2021
Equities $ 11,721.8 $ 52,983.1 $ 72,113.3
Cryptocurrencies 414.7 3,527.0 22,135.8
Options 244.6 2,117.0 1,530.8
Cash held by users 2,413.8 7,947.3 8,760.2
Receivables from users (659.3) (3,595.9) (6,533.2)
Assets Under Custody $ 14,135.6 $ 62,978.5 $ 98,006.9
Net Deposits and net market gains drive the change in AUC in any given period. We define “Net Deposits” as all cash deposits and asset transfers received from customers net of reversals, customer cash withdrawals, and other equity and cash amounts transferred out of our platform (including in connection with debit card transactions and account transfers in or out of our platform through the ACATS system) for a stated period. The following table describes the annual changes within Assets Under Custody:
Year ended December 31,
(in millions) 2019 2020 2021
Beginning AUC $ 8,359.5 $ 14,135.6 $ 62,978.5
Net Deposits 4,295.7 31,034.4 27,405.9
Net market gains (losses) 1,480.3 17,808.5 7,622.5
Ending AUC $ 14,135.6 $ 62,978.5 $ 98,006.9
(4) We define ARPU as total revenue for a given period divided by the average of Net Cumulative Funded Accounts on the last day of that period and the last day of the immediately preceding period.
Non-GAAP Financial Measures
Adjusted EBITDA
We collect and analyze operating and financial data to evaluate the health of our business, allocate our resources and assess our performance. In addition to total net revenues, net income (loss), and other results under GAAP, we utilize non-GAAP calculations of adjusted earnings before interest, taxes, depreciation, and amortization (“Adjusted EBITDA”). Adjusted EBITDA is defined as net income (loss), excluding (i) interest expenses related to credit facilities, (ii) provision for (benefit from) income taxes, (iii) depreciation and amortization, (iv) share-based compensation, (v) change in fair value of convertible
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notes and warrant liability, (vi) significant legal and tax settlements and reserves, and (vii) other significant gains, losses, and expenses (such as impairments, restructuring charges, and business acquisition- or disposition-related expenses) that we believe are not indicative of our ongoing results. This non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for or superior to financial information presented in accordance with GAAP, and may be different from similarly titled non-GAAP measures used by other companies.
The above items are excluded from our Adjusted EBITDA measure because these items are non-cash in nature, or because the amount and timing of these items are unpredictable, are not driven by core results of operations, and render comparisons with prior periods and competitors less meaningful. We believe Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our results of operations, as well as providing a useful measure for period-to-period comparisons of our business performance. Moreover, Adjusted EBITDA is a key measurement used by our management internally to make operating decisions, including those related to operating expenses, evaluate performance, and perform strategic planning and annual budgeting. The following table presents a reconciliation of net income (loss), which is the most directly comparable GAAP measure, to Adjusted EBITDA:
Year ended December 31,
(in thousands) 2019 2020 2021
Net income (loss) $ (106,569) $ 7,449 $ (3,686,432)
Add:
Interest expenses related to credit facilities 991 4,882 20,218
Provision for (benefit from) income taxes (1,018) 6,381 2,000
Depreciation and amortization 5,444 9,938 25,495
EBITDA (non-GAAP) (101,152) 28,650 (3,638,719)
Share-based compensation 26,667 24,330 1,572,253
Change in fair value of convertible notes and warrant liability — — 2,045,657
Significant legal and tax settlements and reserves
— 101,600 54,910
Adjusted EBITDA (non-GAAP) $ (74,485) $ 154,580 $ 34,101
Key Factors Driving Our Performance
Growing Our Customer Base
Sustaining our growth requires continued adoption of our platform by new customers. We will continue to introduce products and features to attract new customers and we will seek to increase brand awareness and customer adoption of our platform through broad-scale brand marketing and the Robinhood Referral Program (defined below).
Expanding Our Relationship with Existing Customers
Our revenue has generally increased over time as we have introduced new products and features to our customers and as our customers have increased their usage of our platform. We aim to grow with our customers over time as they build and manage their wealth. Our ability to expand our relationship with our customers will be an important contributor to our long-term growth. Additionally, we strive to strengthen our relationships with our customers by responding to customer feedback not only through the introduction of new products, but also through improvements to our existing products and services.
Investing in Our Platform
We intend to continue to invest in our platform capabilities and regulatory and compliance functions to support new and existing customers and products that we believe will drive our growth. As our customer
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base and platform functionalities expand, areas of investment priority will likely include product innovation, educational content, and technology and infrastructure improvements. We believe these investments will contribute to our long-term growth.
We expect to continue increasing headcount throughout 2022, though at a lesser rate than in 2021. These additional employees will be staffed on projects to enhance platform capabilities, drive product innovation, and further augment regulatory and compliance functions.
Customer Interest in Investing and Saving
Our results of operations are impacted by the overall health of the economy and retail investing and saving behaviors, which include the following key drivers:
• Seasonality . Our business can be subject to seasonal fluctuations due to such factors as retail interest in investing, overall number of market participants and trading volumes, varying numbers of trading days from quarter-to-quarter, and declines in trading activity around holidays. Seasonal trends may be superseded by market or macroeconomic events, which can have a significant impact on equity and cryptocurrency valuations and trading activity.
• Consumer Behavior . Consumer behavior varies over time and is affected by numerous conditions. For example, behavior might be impacted by social or economic factors such as changes in disposable income levels, general interest in investing, and volatility in the stock and cryptocurrency markets. There might also be high profile initial public offerings, or idiosyncratic events impacting single companies, that impact consumer behavior.
• Market Trends . As financial markets grow and contract, our customers’ investing, saving, and spending behaviors are affected. Our operating history has coincided with a period of general macroeconomic growth in the United States, particularly in the U.S. equity and cryptocurrency markets, which has previously stimulated growth in overall investment activity on our platform; we could also be impacted by any slowdowns in growth or downturns in the U.S. equity and cryptocurrency markets.
• Macroeconomic Events . Customer behavior is impacted by the overall macroeconomic environment, which is influenced by elements beyond our control, including economic and political conditions, inflation, tax rates, the ongoing COVID-19 pandemic, unemployment rates, and natural disasters.
For more information about how market trends and macroeconomic events can adversely impact our results of operations, see “Risk Factors—Risks Related to Our Business.”
Key Components of Our Results of Operations
Revenues
Transaction-Based Revenues
Transaction-based revenues consist of amounts earned from routing customer orders for options, cryptocurrencies, and equities to market makers. When customers place orders for options, cryptocurrencies, or equities on our platform, we route these orders to market makers and we receive consideration from those market makers. With respect to equities and options trading, such fees are known as payment for order flow (“PFOF”). With respect to cryptocurrency trading, we receive “Transaction Rebates.” In the case of equities, the fees we receive are typically based on the size of the publicly quoted bid-ask spread for the security being traded; that is, we receive a fixed percentage of the difference between the publicly quoted bid and ask at the time the trade is executed. For options, our fee is on a per contract basis based on the underlying security. In the case of cryptocurrencies, our rebate is
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a fixed percentage of the notional order value. Within each asset class, whether equities, options or cryptocurrencies, the transaction-based revenue we earn is calculated in an identical manner among all participating market makers. We route equity and option orders in priority to participating market makers that we believe are most likely to give our customers the best execution, based on historical performance (according to order price, trading symbol, availability of the market maker and, if statistically significant, order size), and, in the case of options, the likelihood of the order being filled is a factor as well. For cryptocurrency orders, we route to market makers based on price and availability of the cryptocurrency from the market maker.
Net Interest Revenues
Net interest revenues consist of interest revenues less interest expenses. We earn and incur interest revenues and expenses on securities lending transactions by lending shares that we hold as collateral for margin loans extended to our users. We also earn interest revenues on margin loans to users, as well as on our segregated cash, cash and cash equivalents, and deposits with clearing organizations. We incur interest expenses in connection with our revolving credit facilities.
Other Revenues
Other revenues primarily consist of Robinhood Gold subscription fees, proxy rebate revenues, and ACATS fees for facilitating the transfer of part or all of their accounts to another broker-dealer.
Operating Expenses
Commencing with the filing of this Annual Report, we have revised sub-categories within our operating expenses to better reflect the business as considered by management. Prior period amounts have been reclassified to conform to the current presentation.
Brokerage and Transaction
Brokerage and transaction costs primarily consist of broker-dealer transaction expenses (such as fees paid to centralized clearinghouses and regulatory fees), market data expenses, cash and share-based compensation and benefits as well as allocated overhead for employees engaged in clearing and brokerage functions, and cash management transactions expenses (such as network fees and card processing fees). A large portion of our brokerage and transaction costs are variable and tied to trading and transaction volumes on our platform.
Technology and Development
Technology and development costs primarily consist of cash and share-based compensation and benefits as well as allocated overhead for engineering, data science, and design personnel who support and improve our platform and develop new products, costs for cloud infrastructure services, and costs associated with computer hardware and software, including amortization of internally developed software.
Operations
Operations costs consist of customer service related expenses, including cash and share-based compensation and benefits as well as allocated overhead for employees engaged in customer support, and costs incurred to support and improve customer experience (such as third-party customer service vendors).
Operations costs also include our provision for credit losses and fraud in connection with unrecoverable receivables due to Fraudulent Deposit Transactions and chargebacks for unauthorized debit card use. The provision for credit loss is equal to the unsecured receivable balance owed by users, i.e., the difference between the amount due from users and the fair value of the assets in the users’ accounts. We seek to reduce Fraudulent Deposit Transactions and unauthorized debit card usage by
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deploying and iterating on machine learning models that identify high risk users and transactions on our platform. In addition, upon identifying high risk users and transactions, we seek to prevent further losses by introducing friction into the user experience (for example, by not offering the identified customer access to instant funds) or implementing restrictions to mitigate the risk of these transactions (such as temporarily restricting withdrawals). Due to the fraudulent nature of these transactions, recourse and collection of the funds is limited. The provision for credit losses also includes losses related to our margin lending and proxy rebate activities.
Marketing
Marketing costs primarily consist of marketing incentive expenses associated with the Robinhood Referral Program, as well as digital marketing, brand marketing, and creative services costs for creation, production, and placement of advertisements and marketing content. Other marketing costs include cash credits we offer to customers, which primarily relate to remediation for losses experienced by our customers due to service interruptions on our platform and reimbursement of direct losses incurred by our customers from allegedly unauthorized account activity. Marketing costs also include cash and share-based compensation and benefits as well as allocated overhead for employees engaged in the marketing function.
Under the Robinhood Referral Program we credit referring and referred customers with a stock reward, with the potential value of each share ranging from $3 to $225. Each stock reward is selected randomly from our previously purchased inventory of settled shares held exclusively for this program. This inventory is comprised of shares of stock of issuers that are widely held among our customers’ accounts (i.e., held by at least 5,000 customers). Referring customers can earn more than one reward through the Robinhood Referral Program by making multiple referrals, subject to a maximum of $500 in total rewards earned annually per customer. From time to time, we offer multiple stock rewards per referral. Stock rewards are also available to customers who sign up through paid marketing channels. In order for rewards to be earned by the referring and referred customer, the referred customer must fulfill certain conditions stated in their promotion, such as linking his or her bank account to our platform. After the referred Robinhood account is approved, each customer must claim his or her stock reward in the Robinhood app within 60 days of notification thereof, at which point the stock is deposited to such customer’s Robinhood account. Customers do not provide any cash consideration for the stock reward.
General and Administrative
General and administrative costs primarily consist of cash and share-based compensation and benefits as well as allocated overhead for certain executives and employees engaged in legal, finance, human resources, risk, and compliance. General and administrative costs also include legal expenses, settlements and penalties, business insurance, and other professional fees.
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Results of Operations
The following table summarizes our consolidated statements of operations data:
(in thousands) Year ended December 31,
2019 2020 2021
Revenues:
Transaction-based revenues $ 170,831 $ 720,133 $ 1,402,350
Net interest revenues 70,639 177,437 256,962
Other revenues 36,063 61,263 155,831
Total net revenues 277,533 958,833 1,815,143
Operating expenses: (1)
Brokerage and transaction 45,459 111,083 152,343
Technology and development 94,932 215,630 1,232,787
Operations 33,869 137,905 373,129
Marketing 124,699 185,741 327,369
General and administrative 85,504 294,694 1,370,520
Total operating expenses 384,463 945,053 3,456,148
Change in fair value of convertible notes and warrant liability — — 2,045,657
Other expense (income), net 657 (50) (2,230)
Income (loss) before income tax (107,587) 13,830 (3,684,432)
Provision for (benefit from) income taxes (1,018) 6,381 2,000
Net income (loss) $ (106,569) $ 7,449 $ (3,686,432)
_______________
(1) Includes share-based compensation expense as follows:
Year ended December 31,
(in thousands) 2019 2020 2021
Brokerage and transaction $ 427 $ 227 $ 7,527
Technology and development 9,499 18,024 609,307
Operations 139 61 20,261
Marketing 85 613 49,731
General and administrative 16,517 5,405 885,427
Total share-based compensation expense $ 26,667 $ 24,330 $ 1,572,253
The 2019 and 2020 amounts exclude the effect of share-based compensation for awards with performance-based conditions because the qualifying event, our IPO, had not occurred and, therefore, could not be considered probable. Upon our IPO in 2021, we recognized $1.01 billion of share-based compensation. For more information, see “Share-based compensation” in Note 1 to our consolidated financial statements in this Annual Report.
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Comparison of the Years Ended December 31, 2021 and 2020
A discussion of our results for fiscal year 2020 compared to fiscal year 2019 can be found in our IPO prospectus, filed with the SEC on July 30, 2021, under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations — Comparison of the Years Ended December 31, 2019 and 2020." We do not believe the reclassification of the sub-categories within operating expenses has materially affected the continuing relevance of any of this discussion and any changes that would be necessary to reflect the revised subcategories are not material to an understanding of our business.
Revenues
Transaction-Based Revenues
Year ended December 31,
(in thousands, except for percentages) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Transaction-based revenues
Options $ 110,656 $ 440,070 $ 688,899 298 % 57 %
Cryptocurrencies 9,487 26,708 419,382 182 % 1,470 %
Equities 50,688 251,200 287,734 396 % 15 %
Other — 2,155 6,335 NM 194 %
Total transaction-based revenues $ 170,831 $ 720,133 $ 1,402,350 322 % 95 %
Percentage of total net revenues:
Options 40% 46% 38%
Cryptocurrencies 4% 3% 23%
Equities 18% 26% 16%
Other —% —% —%
Total transaction-based revenues 62 % 75% 77%
Comparison of Years Ended December 31, 2021 and 2020
Transaction-based revenues increased by $682.2 million primarily driven by a 81% increase in Net Cumulative Funded Accounts which resulted in higher daily average revenue trades in cryptocurrencies, options, and equities.
We define “daily average revenue trades” as the total number of revenue generating trades executed during a given period divided by the number of trading days in that period. Our daily average revenue trades for cryptocurrencies increased significantly from 0.1 million to 1.2 million. The number of users placing cryptocurrency trades increased 455% while the average notional volume traded per trader was up 83%. In late December 2021, for the first time during the periods presented, we updated our pricing agreements with crypto market makers. Our rebate, which is subject to change from time to time, slightly more than doubled with these changes. We also added another venue to increase capacity and further improve competition for customer orders.
Our daily average revenue trades for options increased by 34% from 0.6 million to 0.8 million. The number of users placing option trades increased 43% while the number of options contracts traded per trader was up 1%.
Our daily average revenue trades for equities increased by 38% from 2.2 million to 3.1 million. The number of users placing equity trades increased 75% while the average notional volume traded per trader was down 30%.
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Net Interest Revenues
Year ended December 31,
(in thousands, except for percentages) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Net interest revenues:
Securities lending $ 6,380 $ 98,165 $ 137,153 NM 40 %
Margin interest 19,104 66,781 131,823 250 % 97 %
Interest on segregated cash and securities 36,281 13,401 4,023 (63) % (70) %
Other interest revenue 9,865 3,972 4,181 (60) % 5 %
Interest expenses related to credit facilities (991) (4,882) (20,218) 393 % 314 %
Total net interest revenues $ 70,639 $ 177,437 $ 256,962 151 % 45 %
Percentage of total net revenues:
Securities lending 2% 10% 8%
Margin interest 7% 7% 7%
Interest on segregated cash and securities 13% 2% —%
Other interest revenue 4% 1% —%
Interest expenses related to credit facilities (1)% (1)% (1)%
Total net interest revenues 25% 19% 14%
Comparison of Years Ended December 31, 2021 and 2020
Net interest revenues increased by $79.5 million primarily due to higher interest revenues earned on margin loans to users and through securities lending activities, partially offset by increased interest expense related to our revolving credit facilities and lower interest revenue earned on segregated cash and securities.
Interest revenue earned on margin borrowings increased by $65.0 million due to an increase in both the number of margin borrowers and the average per-user margin balance. Average margin receivables outstanding increased from $1.99 billion due from 125 thousand average users to $4.91 billion due from 218 thousand average users. Robinhood users must be Robinhood Gold subscribers in order to enable margin borrowing in their accounts. The first $1,000 in margin borrowed by each user is not charged interest. Additional margin borrowed was charged at a 5% annual rate until December 2020 when we lowered this rate to 2.5%, where it will remain until March 2022, at which point it will be increased to 3%. Net interest revenues earned from securities lending transactions increased $39.0 million as we grew our securities lending program, which benefited from growth in margin borrowings. These increases were partially offset by an increase of $15.3 million in interest expenses, which includes commitment and unused fees related to credit facilities in connection with the April 2021 Credit Facility (see Note 11 to our consolidated financial statements in this Annual Report for further information) and a decrease of $9.4 million in interest revenue earned on segregated cash and securities balances due to the decrease in the Federal Reserve's benchmark target rate to near zero.
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Other Revenues
Year ended December 31,
(in thousands, except for percentages) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Other revenues $ 36,063 $ 61,263 $ 155,831 70 % 154 %
Percentage of total net revenues 13% 6% 9%
Comparison of Years Ended December 31, 2021 and 2020
Other revenues increased by $94.6 million primarily due to an increase in subscription revenue of $43.9 million driven by an increase in paid subscribers to Robinhood Gold from 0.9 million to 1.3 million. Additionally, ACATS fees charged to users for facilitating the transfer of their account to another broker-dealer increased by $25.8 million and proxy rebate revenue increased by $22.9 million as a result of the growth in our user base.
Operating Expenses
Year ended December 31,
(in thousands, except for percentages) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Operating expenses:
Brokerage and transaction $ 45,459 $ 111,083 $ 152,343 144 % 37 %
Technology and development 94,932 215,630 1,232,787 127 % 472 %
Operations 33,869 137,905 373,129 307 % 171 %
Marketing 124,699 185,741 327,369 49 % 76 %
General and administrative 85,504 294,694 1,370,520 245 % 365 %
Total operating expenses $ 384,463 $ 945,053 $ 3,456,148
Percent of total net revenues:
Brokerage and transaction 16 % 12 % 8 %
Technology and development 34 % 22 % 68 %
Operations 12 % 14 % 21 %
Marketing 45 % 19 % 18 %
General and administrative 31 % 31 % 76 %
Total operating expenses 138 % 98 % 191 %
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Brokerage and Transaction
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Broker-dealer transaction expenses $ 17,082 $ 54,505 $ 48,185 219% (12) %
Market data expenses 11,697 21,327 32,962 82% 55 %
Employee compensation, benefits, and overhead, excluding share-based compensation 4,879 6,993 14,309 43% 105 %
Cash management transaction expenses 815 3,942 11,574 384% 194 %
Share-based compensation 426 226 7,527 (47)% NM
Other 10,560 24,090 37,786 128% 57 %
Total $ 45,459 $ 111,083 $ 152,343 144% 37 %
Comparison of Years Ended December 31, 2021 and 2020
Brokerage and transaction costs increased by $41.3 million primarily due to an increase in market data expenses of $11.6 million and an increase in cash management transaction expenses of $7.6 million, which were in line with the growth in our user base. Share-based compensation expense increased $7.3 million as vesting conditions were met upon our IPO and other employee compensation, benefits, and overhead increased $7.3 million as we continued to grow our brokerage teams to support the growth of our user base and platform. Other brokerage and transaction costs also increased due to higher bank charges of $5.3 million and regulatory fees of $4.5 million. These increases were partially offset by decreases in broker-dealer transaction expenses, primarily due to a $15.7 million decrease in clearing fees as a result of a reduction of certain of these fees effective in June 2021 offset by a $8.5 million increase in losses attributable to the market price fluctuations that impacted fractional shares transactions.
Technology and Development
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Share-based compensation $ 9,499 $ 18,025 $ 609,306 90% NM
Employee compensation, benefits, and overhead, excluding share-based compensation 51,625 103,998 282,915 101% 172 %
Cloud infrastructure services 23,574 67,372 266,834 186% 296 %
Software and tools 8,800 22,201 62,144 152% 180 %
Other 1,434 4,034 11,588 181% 187 %
Total $ 94,932 $ 215,630 $ 1,232,787 127% 472 %
Comparison of Years Ended December 31, 2021 and 2020
Technology and development costs increased by $1.02 billion primarily due to an increase in share-based compensation expense of $591.3 million as vesting conditions were met upon our IPO and an increase in o ther employee compensation, benefits, and overhead of $178.9 million as we also continued to grow our engineering, data science, and design teams to support the growth of our user base and develop new products. Additionally, we experienced increases in costs for cloud infrastructure service of $199.5 million due to infrastructure expansion necessary to meet increased capacity requirements for our platform, and costs for software and tools of $39.9 million to support the growth of our headcount.
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Operations
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Employee compensation, benefits, and overhead, excluding share-based compensation $ 11,461 $ 35,379 $ 126,017 209% 256 %
Provision for credit losses and fraud 11,108 61,313 107,054 452% 75 %
Customer experience 8,164 28,300 97,121 247% 243 %
Share-based compensation 138 61 20,261 (56)% NM
Other 2,998 12,852 22,676 329% 76 %
Total $ 33,869 $ 137,905 $ 373,129 307% 171 %
Comparison of Years Ended December 31, 2021 and 2020
Operations costs increased by $235.2 million primarily due to an increase in employee compensation, benefits, and overhead of $90.6 million as we increased the number of our dedicated customer support professionals. Costs related to third-party customer support vendors for customer experience increased $68.8 million as we continued to make investments to support our growing user base. Provision f or credit losses and fraud increased $45.7 million mainly driven by increased unauthorized debit card usage and an increase in loss incurred per account related to Fraudulent Deposit Transactions. Additionally, we recognized an increase in share-based compensation expense of $20.2 million as vesting conditions were met upon our IPO.
Marketing
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Marketing incentives $ 29,187 $ 80,826 $ 120,706 177% 49 %
Digital marketing 55,744 35,398 50,576 (36)% 43 %
Share-based compensation 86 614 49,731 614% NM
Employee compensation, benefits, and overhead, excluding share-based compensation 2,659 8,356 37,848 214% 353 %
Brand marketing 20,717 28,992 24,224 40% (16) %
Creative services 13,603 12,075 22,416 (11)% 86 %
Other marketing 2,703 19,480 21,868 621% 12 %
Total $ 124,699 $ 185,741 $ 327,369 49% 76 %
Included in marketing incentives are costs associated with the Robinhood Referral Program, which are comprised of the fair value of awards earned in the current period, changes in estimate of unclaimed awards earned in the current and prior periods, fair value adjustments of shares held to support the program, and reversals related to awards that expire unclaimed. The fa ir value adjustments of shares held to support the program were immaterial for the periods presented. The following table summarizes the Robinhood Referral Program liability activity for the periods indicated:
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Years ended December 31,
(in thousands) 2019 2020 2021
Beginning balance, January 1 $ 978 $ 303 $ 695
Fair value of current period awards 37,893 85,849 126,513
Changes in estimate of unclaimed awards for current and prior periods (1,886) 927 333
Reversals related to unclaimed, expired awards (7,256) (7,715) (9,816)
Claimed awards (29,426) (78,669) (117,628)
Ending balance, December 31 $ 303 $ 695 $ 97
Comparison of Years Ended December 31, 2021 and 2020
Marketing costs increased by $141.6 million partially due to an increase in share-based compensation expense of $49.1 million as vesting conditions were met upon our IPO. Marketing incentives increased $39.9 million and substantially all of which was due to higher costs associated with the Robinhood Referral Program . Other employee compensation, benefits, and overhead increased $29.5 million as w e continued to increase our marketing personnel headcount to support the growth of our business. In addition, there were increases in digital marketing expenses of $15.2 million and creative services costs of $10.3 million primarily related to advertising spend leading up to our IPO.
General and Administrative
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Share-based compensation $ 16,518 $ 5,405 $ 885,427 (67)% NM
Employee compensation, benefits, and overhead, excluding share-based compensation 34,049 79,206 196,086 133% 148 %
Legal expenses 10,800 56,175 101,307 420% 80 %
Settlements and penalties 1,409 105,506 70,349 NM (33) %
Other professional fees 10,006 29,561 53,812 195% 82 %
Business insurance 1,982 4,340 24,970 119% 475 %
Other 10,740 14,501 38,569 35% 166 %
Total $ 85,504 $ 294,694 $ 1,370,520 245% 365 %
Comparison of Years Ended December 31, 2021 and 2020
General and administrative costs increased by $1.08 billion primarily due to an increase in share-based compensation as vesting conditions were met upon our IPO including $501.2 million related to executive compensation arrangements (see Note 12 to our consolidated financial statements in this Annual Report for further information). Other employee compensation, benefits, and overhead increased by $116.9 million as w e continued to increase our general and administrative personnel to support the growth of our business. L egal expenses increased $45.1 million primarily related to certain legal matters, partially offset by a reduction in settlements and penalties of $35.2 million. See Note 16 to our consolidated financial statements in this Annual Report for further information.
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Change in Fair Value of Convertible Notes and Warrant Liability
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Change in fair value of convertible notes and warrant liability — — $ 2,045,657 NM NM
Comparison of Years Ended December 31, 2021 and 2020
Change in fair value of convertible notes and warrant liability was due to the mark-to-market adjustment of the convertible notes and warrants we issued in February 2021. Upon completion of our IPO, the aggregate outstanding principal and accrued interest of the convertible notes converted into 137.3 million shares of Class A common stock and the warrants became equity-classified, which resulted in the warrant liability being reclassified to additional paid-in capital . There will be no additional mark-to-market adjustments related to the convertible notes or warrant liability. See Note 7 to our consolidated financial statements in this Annual Report for further information.
Provision for (Benefit from) Income Taxes
Year ended December 31,
(in thousands) 2019 2020 2021 2019 to 2020
% Change 2020 to 2021
% Change
Provision for (benefit from) income taxes $ (1,018) $ 6,381 2,000 (727)% (69)%
Comparison of Years Ended December 31, 2021 and 2020
Provision for income taxes decreased by $4.4 million primarily due to the income tax benefit recognized from the partial release of our valuation allowance resulting from the recognition of net deferred tax liabilities in connection with the Say Technologies acquisition, and offset by the change in valuation allowance on our remaining U.S. federal and state deferred tax assets and by our current federal and state taxes payable.
Liquidity and Capital Resources
Source and Uses of Funds
We expect to use our available cash, cash equivalents, and investments, including potential future borrowings under our revolving lines of credit and potential issuance of new debt or equity, to support and invest in our core business, including investing in new ways to serve our customers, potentially seeking strategic acquisitions to leverage existing capabilities and further build our business, and for general capital needs (including capital requirements imposed by regulators and SROs and cash deposit and collateral requirements under the rules of the DTC, NSCC, and OCC). Based on our current level of operations, we believe our available cash, available lines of credit, and cash provided by operations will be adequate to meet our current liquidity needs for the next 12 months.
Cash, Cash Equivalents, and Investments
Our cash, cash equivalents, and investments were $6.28 billion and $1.40 billion as of December 31, 2021 and 2020. Our investment portfolio comprises highly liquid available-for-sale securities, including asset-backed securities, commercial paper, corporate bonds, and government bonds.
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Convertible Debt and IPO
In January and February 2021, we received gross proceeds of $3.55 billion from the issuance of two tranches of convertible notes and related warrants. The convertible notes were converted into Class A common stock upon the completion of our IPO.
On August 2, 2021, we closed our IPO of our Class A common stock and on August 31, 2021, we sold additional shares of Class A common stock pursuant to the option granted to the underwriters. The total net proceeds received were approximately $2.05 billion after deducting underwriting discounts, commissions, and offering expenses payable by us. We used a portion of the net proceeds we received in the IPO to repay borrowings made under our revolving lines of credit (which borrowings were utilized to fund tax withholdings due prior to the IPO closing as a result of RSU settlements in connection with the pricing of our IPO).
Revolving Lines of Credit
As of December 31, 2021, we had a total of $2.81 billion in committed revolving lines of credit. See Note 11 to our consolidated financial statements in this Annual Report for further information.
The following table summarizes our short- and long-term material cash requirements as of December 31, 2021:
Payments Due by Period
(in thousands) Total 2022 2023-2024 2025-2026 Thereafter
Operating lease commitments $ 258,982 $ 32,646 $ 68,176 $ 56,160 $ 102,000
Non-cancelable purchase commitments (1)
1,162,370 279,068 479,670 403,566 66
Total $ 1,421,352 $ 311,714 $ 547,846 $ 459,726 $ 102,066
(1) Non-cancelable purchase commitments are determined based on the non-cancelable quantities or termination amounts to which we are contractually obligated. They primarily relate to commitments for cloud infrastructure service and business insurance.
In addition to lease and purchase commitments, we have a committed financing agreement with a contractual term of 30 days and a daily minimum commitment of $25 million.
Regulatory Capital Requirements
Our broker-dealer subsidiaries (RHF and RHS) are subject to the SEC Uniform Net Capital Rule, administered by the SEC and FINRA, which requires the maintenance of minimum net capital, as defined. Net capital and the related net capital requirements may fluctuate on a daily basis. RHS and RHF compute net capital under the alternative method as permitted by the SEC Uniform Net Capital Rule.
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The tables below summarize the net capital, capital requirements and excess net capital of RHS and RHF as of periods presented:
December 31, 2021
(in thousands) Net Capital Required Net Capital Net Capital in Excess of Required Net Capital
RHS $ 2,841,411 $ 134,568 $ 2,706,843
RHF 153,408 250 153,158
In January and February 2021, we received gross proceeds of $3.55 billion from the issuance of two tranches of convertible notes and related warrants, of which an aggregate of $2.0 billion was contributed to RHS in February 2021. Pursuant to the SEC Uniform Net Capital Rule , capital contributed to RHS is included in its net capital calculation and may not be withdrawn for one year from the time of contribution. This restriction lapsed in February 2022, however, no capital has been returned to the parent company as of the date of filing of this Annual Report.
Cash Flows
The following table summarizes our cash flow activities:
Year ended December 31,
(in thousands) 2019 2020 2021
Cash provided by (used in):
Operating activities $ 1,260,085 $ 1,876,254 $ (884,773)
Investing activities (12,312) (32,330) (237,880)
Financing activities 375,350 1,275,883 5,203,421
Cash provided by and used in operating activities consisted of net income (loss) adjusted for certain non-cash items including change in fair value of convertible notes and warrant liability, share-based compensation expense, provision for credit losses, depreciation and amortization, and the effect of changes in operating assets and liabilities. Net operating assets and liabilities at any specific point in time are subject to many variables, including variability in user activity, the timing of cash receipts and payments, and vendor payment terms.
For the year ended December 31, 2021, cash flows used in operating activities was $884.8 million, primarily due to a net loss of $3,686.4 million, adjusted for the add back of non-cash expenses of $3,719.8 million, consisting primarily of change in fair value of convertible notes and warrant liability of $2,045.7 million, share-based compensation expense of $1,570.4 million, provision for credit losses of $78.3 million, and depreciation and amortization of $25.5 million. Additionally, there was a cash outflow due to changes in operating assets and liabilities of $918.1 million, primarily due to an increase in receivables from users, net, of $3,361.9 million, driven by an increase in margin receivables due to growth in our user base offset by an increase in collateral received for securities loaned of $1,729.9 million and an increase in payables to users of $578.5 million driven by an increase in customer cash held in line with the growth in our user base.
For the year ended December 31, 2020, cash provided by operating activities was $1,876.3 million partially due to a net income of $7.4 million, adjusted for the add back of non-cash expenses of $95.5 million, consisting primarily of provision for credit losses of $59.1 million, share-based compensation expense of $24.3 million, and depreciation and amortization of $9.9 million. Additionally, the cash generated from operating activities increased due to a net inflow from changes in operating
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assets and liabilities of $1,773.3 million, primarily due to increases in payables to users of $3,532.1 million and securities loaned of $1,247.1 million, partially offset by an increase in receivables from users, net of $2,772.0 million, driven by increases in customer cash held, securities loaned, and margin receivables in line with the growth in our user base.
For the year ended December 31, 2019, cash provided by operating activities was $1,260.1 million, primarily due to net loss of $106.6 million, adjusted for the add back of non-cash expenses of $43.4 million consisting primarily of share-based compensation expense of $26.7 million, provision for credit losses of $11.1 million and depreciation and amortization of $5.4 million. Additionally, the cash generated from operating activities increased due to a net inflow from changes in operating assets and liabilities of $1,323.3 million, primarily due to increases in payables to users of $802.8 million and securities loaned of $674.0 million, driven by increases in customer cash held and securities loaned in line with the growth in our user base.
For the year ended December 31, 2021, cash flows used in investing activities were $237.9 million, which primarily consisted of $125.4 million used for business acquisitions, net of cash acquired. Additionally, cash flows used in investing activities included $63.2 million in purchases of property, software, and equipment, $27.2 million for the purchase of investments, and $20.5 million in capitalization of internally developed software. For the years ended December 31, 2020 and 2019, cash flows used in investing activities were $32.3 million and $12.3 million, which primarily consisted of $24.4 million and $7.3 million in purchases of property, software, and equipment and $7.9 million and $5.2 million in capitalization of internally developed software.
For the year ended December 31, 2021, cash flows provided by financing activities were $5,203.4 million, which primarily consisted of proceeds from the issuance of convertible notes and warrants of $3,552.0 million and proceeds of $2,052.4 million from issuance of common stock in connection with our IPO, net of offering costs, partially offset by taxes paid related to net share settlement of equity awards of $422.1 million. We also drew and repaid $1,968.3 million on our credit facilities. For the years ended December 31, 2020 and 2019, cash flows provided by financing activities were $1,275.9 million and $375.4 million, which primarily consisted of $1,267.3 million and $372.7 million in proceeds from issuance of redeemable convertible preferred stock, net of issuance costs. We also drew and repaid $937.7 million and $137.0 million on our credit facilities.
Critical Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting estimates addressed below. We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results. For additional information, see Note 1 to our consolidated financial statements in this Annual Report. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results might differ significantly from these estimates under different assumptions, judgments, or conditions.
Business Combinations
We allocate the fair value of purchase price to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase
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price over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customer contracts, acquired technology, and trade names, based on expected future growth rates and margins, attrition rates, future changes in technology and royalty for similar brand licenses, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results might differ from estimates.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination and is allocated to reporting units expected to benefit from the business combination. We operate and report financial information in one operating segment. We test goodwill for impairment at least annually, in the fourth quarter, or whenever events or changes in circumstances indicate that goodwill might be impaired. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach. In testing for goodwill impairment, we first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if we conclude otherwise, we proceed to a quantitative assessment.
The quantitative assessment compares the estimated fair value of a reporting unit to its book value, including goodwill. If the fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary. However, if the book value of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
Income Tax
We make significant judgments and estimates to determine any valuation allowance recorded against deferred tax assets. Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe that they will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets including, but not limited to, historical cumulative loss experience and expectations of future earnings, tax planning strategies, and the carry-forward periods available for tax reporting purposes. Our judgment regarding future profitability may change due to many factors, including future market conditions and the ability to successfully execute business plans and/or tax planning strategies. Should there be a change in the ability to recover deferred tax assets, our tax provision would increase or decrease in the period in which the assessment is changed.
We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized. We account for uncertain tax positions, including net interest and penalties, as a component of income tax expense or benefit. We make adjustments to these uncertain tax positions in accordance with applicable income tax guidance and based on changes in facts and circumstances. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact to our consolidated financial statements and operating results.
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Share-based Compensation
Time-Based RSUs
We have granted RSUs that vest upon the satisfaction of a time-based service condition (“Time-Based RSUs”). Prior to our IPO, our Time-Based RSUs vested based upon the satisfaction of both a time-based service condition and a performance-based condition, namely the occurrence of a liquidity event such as the IPO. The fair value of our RSUs is estimated based on the fair value of our common stock on the date of grant. The time-based service condition for our awards is generally satisfied over four years. We record share-based compensation expense for Time-Based RSUs on an accelerated attribution method over the requisite service period. The performance-based condition for our pre-IPO grants was satisfied upon the occurrence of the IPO in 2021, at which point we recorded a cumulative one-time share-based compensation expense determined using the awards’ grant-date fair value. Share-based compensation related to the remaining time-based service after the IPO is recorded over the remaining requisite service period. No performance-based conditions exist for our post-IPO grants.
Market-Based RSUs
We have granted RSUs that vest upon the satisfaction of all the following conditions: time-based service conditions, performance-based conditions, and market-based conditions. The time-based service condition for these awards generally is satisfied over six years. The performance-based conditions are satisfied upon the occurrence of a qualifying event, as described above. The market-based conditions are satisfied upon our achievement of specified share prices.
For market-based awards, we determine the grant-date fair value utilizing a Monte Carlo valuation model, which incorporates various assumptions including expected stock price volatility, expected term, risk-free interest rates, expected date of a qualifying event, and expected capital raise percentage. We estimate the expected term based on various exercise scenarios, as these awards are not considered “plain vanilla.” We estimate the expected date of a qualifying event based on our expectation at the time of measurement of the award’s value.
We record share-based compensation expense for market-based equity awards on an accelerated attribution method over the requisite service period, and only if performance-based conditions are considered probable to be satisfied. We determine the requisite service period by comparing the derived service period to achieve the market-based condition and the explicit time-based service period, using the longer of the two service periods as the requisite service period. Upon the occurrence of our IPO in 2021, we recorded a cumulative one-time share-based compensation expense determined using the grant-date fair values. Share-based compensation related to remaining time-based service and market-based conditions to be met will be recorded over the remaining derived requisite service period.
Common Stock Valuations
Prior to our IPO, given the absence of a public trading market for our common stock and in accordance with the American Institute of Certified Public Accountants Accounting and Valuation Guide, Valuation of Privately-Held Company Equity Securities Issued as Compensation, our board of directors exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of fair value of our common stock.
These factors included:
• independent third-party valuations of our common stock;
• the prices paid for common or convertible preferred stock sold to third-party investors by us and prices paid in secondary transactions, including any tender offers;
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• the rights, preferences and privileges of our redeemable convertible preferred stock relative to those of our common stock;
• our financial condition, results of operations, and capital resources;
• the industry outlook;
• the valuation of comparable companies;
• the lack of marketability of our common stock;
• the likelihood of achieving a liquidity event, such as an IPO or a sale of our company, given prevailing market conditions;
• the history and nature of our business, industry trends, and competitive environment; and
• general economic outlook including economic growth, inflation, unemployment, interest rate environment, and global economic trends.
Our board of directors determined the fair value of our common stock by first determining the enterprise value of our business, and then allocating the value among the various classes of our equity securities to derive a per share value of our common stock. The enterprise value of our business was primarily estimated by reference to the closest round of equity financing or tender transaction preceding the date of the valuation. In a few cases, we also utilized the income or market approaches.
The income approach estimates enterprise value based on the estimated present value of future cash flows the business is expected to generate over its remaining life. The estimated present value is calculated using a discount rate reflective of the risks associated with an investment in a similar company in a similar industry or having a similar history of revenue growth. The market approach estimates value based on a comparison of the subject company to comparable public companies. From the comparable companies, a representative market value multiple is determined and then applied to the subject company’s financial forecasts to estimate the value of the subject company.
In allocating the enterprise value of our business among the various classes of stock prior, we primarily used the option pricing method (“OPM”), which models each class of stock as a call option with a unique claim on our assets. After the allocation to the various classes of stock, a discount for lack of marketability (“DLOM”), is applied to arrive at a fair value of the common stock. A DLOM is meant to account for the lack of marketability of a stock that is not traded on public exchanges.
In addition, we also considered any secondary transactions involving our capital stock. In our evaluation of those transactions, we considered the facts and circumstances of each transaction to determine the extent to which they represented a fair value exchange and assigned the transactions an appropriate weighting in the valuation of our common stock. Factors considered include the number of different buyers and sellers, transaction volume, timing relative to the valuation date, whether the transactions occurred between willing and unrelated parties, and whether the transactions involved investors with access to our financial information.
Application of these approaches involves the use of estimates, judgments, and assumptions that are highly complex and subjective, such as those regarding our expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies, and the probability of possible future events. Changes in any or all of these estimates and assumptions or the relationships between those assumptions impact our valuations as of each valuation date and may have a material impact on the valuation of our common stock.
Following the completion of our IPO, there is an active market for our Class A common stock, so we no longer apply these valuation approaches.
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Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements in this Annual Report.