The S-1 Club | Is Lemonade more than another SoftBank growth-machine?

Welcome to new subscribers. For those just joining, The S-1 Club is a community for those that want to be in the know before the opening bell. Once a month, we break down a business prepping for its public bow, sharing our analysis and thoughts from the community. Then we follow up, to unpack what happened after the fact. As always, nothing in this message should be construed as investment advice — this is a place for collaboration, not instruction. Thanks for joining us.


Contributors

Dave Ambrose

Byrne Hobart

Jon Hale

Tina He

Tanay Jaipuria

Mengxi Lu

Mario Gabriele

Brief

  1. Why Buffett loves insurance

  2. How companies use reinsurance to throttle losses

  3. Lemonade's differentiation in behavioral economics

  4. The big bet on capturing users as they "graduate"

  5. Growing premiums (and marketing spend)

  6. SoftBank's long shadow

  7. Suiting up against the Fortune 100

  8. A positive Covid story

  9. A tease, or the real deal?

TL;DR

Digital insurance company Lemonade is expected to list on July 1st. The company will price shares between $23 - $26 under the ticker LMND. That values the business at $1.30B - $1.47B, less than $2B figure in Lemonade's last private round. Backed by SoftBank, Lemonade has leveraged paid marketing to grow gross written premiums, a proxy for revenue, by a 450% CAGR since 2017. Losses have mounted, too, with the company still unprofitable. While the markets have been kind to emerging growth companies with a tech story to tell, Lemonade's long-term success may depend on their ability to more effectively capture customers as they graduate from renting to owning property. That, plus expanding the core product line, could yield a more appetizing LTV: CAC ratio.

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An introduction to insurance

As the joke goes, the CEO of an insurance company asks one of his employees to write the policy for a new product.

The employee spends all day researching and calculating, trying to find the clearest way to communicate the details of the policy in question. At the end of the day, they bring a copy to their CEO.

The CEO looks it over for a minute. “This is clear, concise, and well-written,” he says, his voice rising. “Do it again!”

Despite employing 2.69MM Americans, and flooding our TV screens with affable geckos and Oscar-winner actors, insurance remains an industry associated with opacity. Sure, your daydreams might be haunted by the Liberty Mutual jingle, but do most of us really grasp how the industry works? Before we turn to Lemonade, and the decisions they’ve made to disrupt the status quo, it’s worth giving a brief rundown of the sleepiest of industries.

How does insurance work?

At its core, insurance is about risk. Or more accurately, how to manage it. Insurance companies do this by selling customers contracts that can be redeemed in the case of a possible future event. Health insurance can be redeemed when a medical procedure is needed (in theory...). Home insurance can be redeemed when property damage occurs. Life insurance contracts can be redeemed when...well, you know.

Insurance companies are able to offer these contracts by assessing the risk associated with the uncertain event in question. How risky is it to offer insurance on a condo in a hurricane zone? What about one next to a sinkhole? The process of underwriting involves reviewing the information associated with a particular asset, whether that's a house or a human body. In turn, that determines the premium customers pay, usually on a monthly basis. As you’d expect of for-profit companies, these premiums are priced to leave plenty of margin.

Beyond making money from premiums, insurers also profit from their positive cash flow cycle. Because insurers bring in money before they pay it out (if they ever do), they’re able to put money to work. By investing cash on hand, insurers make money off “the float,” knowing that customers are unlikely to need it back in the short-to-medium term.

These industry characteristics are part of the reason why a 20-year-old Warren Buffet put half of his net worth into GEICO stock. It later became a subsidiary of Berkshire Hathaway.

Insurance is a great business, but it does have an Achilles heel: susceptibility to steep losses. A single catastrophic event can precipitate a flood of payouts. One landslide and years of premiums could be wiped out. To mitigate the risk of a single event upending balance sheets and causing default, insurers often take out “reinsurance” policies.

That sounds confusing, but it's actually pretty straightforward: insurance companies insure themselves against losses they might incur, just like us. While this caps upside (insurance companies give part of customer premiums to the reinsurance company), it protects downside. In the event of a catastrophe, the reinsurance company will typically cover losses above a certain threshold.

Give me an example

We're with you. Here's a high-level scenario to explain the flow of cash.

  • Your house is in a high-water zone. You take out flood insurance which costs $10/month with Aqua Alta Insurance. Good decision!

  • Your premiums with Aqua Alta cover $1K worth of damage. Not a ton, but better than nothing.

  • Your 99 neighbors take out the same policy because you live in a neighborhood of simultaneously savvy and risk-loving homeowners. With 100 identical policies, Aqua Alta is on the hook for $100K in the case of a flood.

  • To minimize exposure, Aqua Alta buys a reinsurance policy from Redux Reinsurers. Acqua Alta gives $3 of your monthly premium to Redux, in the knowledge Redux will cover losses over $20K.

  • A storm hits. Your basement, filled with vintage Pokemon cards, Little League trophies, and report cards noting your intelligence but temperamental attitude, are ruined. You're not alone: all 99 other houses in your neighborhood are flooded. Claims for $100K are made to Aqua Alta.

  • The beancounters at Acqua Alta have a brief meltdown in their reasonably-priced sedans before remembering their reinsurance policy. Acqua pays only $20K worth of claims themselves, before tapping Redux to cover the remaining $80K. Hooray!

There’s plenty of complexity in the real-world structure of these arrangements. But this gives a window into the mechanics at work.

Why does this matter?

As they’re at pains to show in their S-1, Lemonade does things differently. Not only do they strip back industry argot and bring transparency to the space, they operate with a fundamentally different model, and use reinsurance more radically.

We’ll dig into these distinctions over the course of the briefing, along with plenty more. We bring them up now, though, because they inform the critical questions an analyst should ask about Lemonade:

  • Is Lemonade an insurance or tech company? How should it be valued?

  • What has driven Lemonade's extensive use of reinsurance? What is its effect on the business?

  • In 2019, Lemonade raised $300MM from SoftBank. To what extent does it follow the hypergrowth-heinous-loss model of other SoftBank venture investments?

  • How can Lemonade grow their LTV given their start with renters' insurance? Will they be able to effectively capture customers as they "graduate" to homeownership?

  • How big is the renters' insurance opportunity? For Lemonade to even approach the market caps of companies like Progressive ($47B) or Allstate ($34B), what do you need to believe in terms of product expansion?

  • Does Lemonade really want to be a public company? Or is this an attempt to flush out a buyer?

Jargon

Company history

Do you remember the world before the virus? Back in that halcyon era, some of us used to visit coffee shops, even going as far as to sit in them for more than a few minutes at a time.

If you ever braved a New York City Starbucks, you may have happened across a rather strange little device, the size of a coaster. These plastic disks, sitting on idly on table-tops, are made by Powermat, an Israeli provider of wireless charging technology. Though we're yet to see one in use, in theory, they allow you to enjoy your latte while juicing your phone, sans plug.

Why do we dwell on this vestige of another era?

Because before he started Lemonade, Daniel Schreiber was President of Powermat. He served for four years, winding down his time in 2015. Ever since his stint running Alchemedia, a software security firm he founded in 1997 as a recent college graduate, Schrieber had the entrepreneurial itch to create something big of his own. He'd sidelined that yearning while at Powermat, but by April of 2015, he'd set out to build something of his own, once more.

Reportedly, Schrieber knew he wanted to tackle a big market that had yet to be disrupted. Insurance, with its gargantuan size and permanent slumber, fit the bill. Not long after he'd chosen his target, Schrieber added firepower: Shai Wininger, the former founder of Fiverr, hopped aboard.

Five years later, we can see what Schrieber and Wininger have achieved. Not only have they built a full-stack digital insurer, they've managed to make insurance seem almost cool. To date, the company has primarily focused on renters' insurance, with a smaller line of business in the homeowner's market. They've succeeded in building a tech-savvy product that creates a meaningfully different experience for customers. Speed is part of that. In one well-publicized example, the company broke a "world-record," granting a payout for a stolen Canada Goose jacket in three seconds. (Our hunch? The coat flew south for the winter). Beyond speed, a sense of mission has proven pivotal. Lemonade's “Giveback” program donates excess profits to charity. This encourages good behavior (more below), in addition to earning genuine affection: Lemonade’s Net Promoter Score (NPS) is 70, while the industry average is 17.

Along the way, they’ve brought color to an otherwise drab industry. Literally. Lemonade’s signature magenta color scheme got them into trouble last year when Deutsche Telekom, the company behind T-Mobile, sent a letter ordering the insurer to discontinue the hue. For the time being, the color remains.

This success has not come without a cost. Like so many growth stories of the last decade, Lemonade's rise has been fueled by heaving sacks of venture money. Lemonade has raised a total of $480MM since inception, with the largest tranche coming from mega-fund, SoftBank. It’s perhaps surprising then that the company is considering listing so soon: that $300MM Series D was announced little over a year ago. That’s caused some to wonder whether Lemonade even wants to go public, or is more interested in dangling their fast growth and digital chops in front of the starched shirts at ING, AXA, Allianz, or AIG.

Assuming Lemonade is genuine in its ambition, its $253MM - $286MM raise at a $1.4B valuation, will represent another significant chapter in Schreiber and Co’s story.

Market

Insurance is one of the largest markets in the world. Global premiums from property, casualty, and life insurance amount to $5T, while 11% of the US GDP comes from these policies. Twelve of the Fortune 100 are insurance companies, with an average age of 125 years old. (In case you're curious, the notable events of 1895 include the patenting of the diesel engine, Oscar Wilde's arrest, and the creation of the Nobel prize). Despite their size, with leading insurers bringing in $100B a year in revenue, none hold more than 0.4% of the market. Though dominated by incumbents, there is considerable fragmentation.

It’s also a services-intensive and analog business, particularly in property insurance. Agents sell 93% of homeowners' insurance, indicating how little is handled online. That appears to be changing. Online insurance now represents a $31B domestic market and is growing at a good clip. The compound annual growth rate (CAGR) was 9% from 2015 to 2020.

As more transactions move online, Lemonade should be well-positioned to capitalize. As of 2019, the company held just 0.1% of the homeowner and renters' insurance market. Established brands like State Farm and Allstate hold 19% and 10%, respectively.

In the medium-term, the company will hope to win over more of the 43.3MM US renter households, which host as many as 83.2MM people. As we alluded to, much of Lemonade’s success may be in capturing the "graduation" of this cohort from relatively low-value renters' insurance to higher value homeowners' insurance. Renters' insurance costs an average of $15/month, while homeowners insurance runs at $100/month. It’s estimated that 5.52MM homes are bought each year, though not all are migrating from rentals, of course.

It’s worth pointing out that the figures above apply to the US market. Lemonade has global ambitions and already operates in Europe. The EU is a more complicated market, with steep variations in homeownership. Whereas 96.4% of Romanians own their homes, only 51.5% of Germans do. That gives some indication of why Lemonade began its assault on Europe in Germany and the Netherlands (69%).

Product

Lemonade is the new shop on an over 300-year old block. At its core, it is a full-stack insurance carrier offering renters and homeowners insurance in both the United States and Europe. Lemonade is licensed in 40 states and currently operates in 28, home to approximately 75% of the US population. Lemonade's business is highly concentrated in California, New York, and Texas, which account for approximately 61% of gross written premiums (GWP). Lemonade also holds a pan-European license, which allows them to sell in 31 countries across the continent.

The products Lemonade offers, which cover stolen or damaged property, and personal liability, is similar to that sold by other insurers. Where the differentiation occurs is in the company's technology, UX, and model. Specifically, the company uses AI, a data-driven backend, and behavioral economics to distinguish itself.

Chatbots and AI

Lemonade claims it can provide a binding quote in under two minutes through its onboarding bot, "AI Maya." To process claims, the company relies on "AI Jim," who was responsible for that three-second payout we mentioned above. Across the board, Lemonade believes that a "delightful experience" (a phrase mentioned 12 times in the S-1 filling) is the foundation for improving underwriting and claims processing, and ultimately reducing the loss rate. Beyond these chatbots, Lemonade touts the importance of AI in its operations, with an increasing percentage of customer support tickets handled by AI. Current figures are at roughly 30%.

Data-driven backend

On the backend, Lemonade has been developing a data-driven technology platform that drives every part of its business, including growth, marketing, underwriting, claims processing, and so on. The "closed-loop" system reportedly generates "copious amount of data" to "delight customers and extend [Lemonade's] competitive advantage." Lemonade reports they've collected 2B data "entries," with a typical sign-up producing ~1.7K data points. Though a little light on detail, there certainly appears to be a deep commitment to capitalizing on the information generated throughout the customer lifecycle.

Behavioral economics

As you'd expect, fraud is a big concern for insurance companies. Faceless monoliths renowned for their love of loopholes and fine print do not engender much sympathy from the public, fraudsters included. To try and moderate the incentives to file false claims, Lemonade employs a little behavioral economics. First, the company commits to taking a flat fee of roughly 25%, making it clear that they have no incentive to profit beyond that point. Then, they give customers the chance to pick a charity of their choice, through the "Giveback" initiative. Non-profits include charity: water, American Red Cross, the ACLU, and others. The customer is then placed into a "cohort" with other users that chose the same charity. At the end of an insurance period (a year, for example), any money left over from that cohort, after paying claims, goes to the charity in question. This is a nifty use of incentives: rather than bilking a ruthless insurance company, users are depriving a charity of their choice. Lemonade is betting that users are less likely to bend the truth when that's the case, ultimately reducing fraud and increasing trust. Through the Giveback initiative, Lemonade donated $600,000 to charity in 2019. Not a bad marketing strategy, either.

Future products

Right now, Lemonade's slate is fairly bare, especially considering the bundling behavior so common in insurance. If a renters' insurance customer wants to cover their car, they'd have to go elsewhere. That's not a problem consumers face when buying from some of the industry's old reliables. There has been some movement on that front: Lemonade announced plans to offer pet insurance in both the US and EU, later this year. In the long-run, the company plans to ladder up tackling travel, car, life, and other forms of insurance.

Model

The core of Lemonade's business model (as Lemonade would describe it) is a digital, direct, technology-enabled customer-centric offering. What does that mean? They sell insurance over your phone. But you knew that already.

To put a finer point on it, there are critical competencies Lemonade needs as a digital insurer company: acquiring customers efficiently, pricing risk appropriately, collecting premiums, processing claims, and minimizing administrative costs.

Technology is part of the equation, helping Lemonade execute these competencies. Specifically, Lemonade uses AI and other tech for front-office processes (customer onboarding and claims experience), and back-office tasks (internal processes and fraud detection). The company also leverages data and automation in its marketing efforts. That shows. Marketing efficiency has doubled over the last 12 months, a rapid improvement. Lemonade now generates $2 of in-force premium for every $1 of marketing spend. (What does "in-force" mean? Just that a customer has paid their premium, and they are actively covered.)

Aside from these core elements, there are some interesting kinks to Lemonade's model. Namely, reinsurance.

In our Acqua Alta example above, we talked about the vulnerability insurance companies have to exceptional events, like a hurricane, flood, or some other act of god. Because of that, insurers are mandated to keep significant amounts of capital in reserve. In some instances, companies are required to keep $1 on hand for every $2 of premiums received, making these capital-intensive businesses. As we discussed, insurance companies look to smooth out bottom-line volatility by employing reinsurance, but it also helps reduce this cash requirement.

Lemonade takes this to the next level. The company leverages a combination of "proportional" and "nonproportional" reinsurance. In the "proportional" reinsurance case, Lemonade hands off 75% of its premiums, in return for a 25% "ceding commission," and doesn’t have to worry about any of the claims associated with these 75% of premiums. This shifts capital requirements and risk onto the reinsurer, lowering the surplus capital that Lemonade needs to have on hand from 2:1 (50 cents per dollar of premium) to 7:1.

Hypothetically, if Lemonade used reinsurance for 100% of their claims, then their loss ratio would be irrelevant. They'd also cease to be a full-stack insurer, serving as lead-gen for other insurers. To further improve loss ratios but minimize the risk on the remaining 25% of claims, Lemonade uses a combination of additional reinsurance structures to ensure the maximum payout they would ever need to make is $125K.

This approach to reinsurance ends up having a meaningful impact on the company's gross margin. Based on Lemonade's risk modeling, gross margins should only vary by +/- 3% in 95 out of 100 years, which is remarkably stable.

Net/net: by using reinsurance, Lemonade eliminates risk on 75% of their claims, and caps their maximum payout at $125K. Though that limits their upside, it means they have much lower capital requirements and lower gross margin volatility. It's a pretty savvy way to grow quickly, without needing to accumulate dead capital, while engineering a steady margin structure. Investors in both private and public markets tend to look favorably on these kinds of characteristics.

Unit economics

Let's take a look at Lemonade’s unit economics.

Lemonade’s renters' insurance plans start at $5/mo and their homeowners' insurance plans start at $25/mo. Typical prices are a bit higher though — the average renter pays Lemonade $150/year and the average homeowner pays them $900/year.

If we do a back-of-the-envelope CAC estimate based on Sales and Marketing spend and change in customers for the year ending March 31st, 2020, the CAC for a new customer was ~$130. That gives us one estimate, though it doesn't entirely jibe with the company's claims that they bring in $2 in premiums per $1 spent on marketing. Using that framework, we'd expect CAC to be ~$75 for a customer paying $150/year in premiums. Part of this discrepancy can be explained by Lemonade's claim that their marketing efficiency is increasing, doubling over the last year.

Now, Lemonade’s gross margin on these customers is ~18%, implying that they make ~$27/year ($150 * 18%) in gross profit per customer per year. That results in a payback period of 2.8 years.

Lemonade also discloses some information about retention rates, which gives us a sense of how long customers keep their policies. They disclose one-year and two-year retention rates of 75% and 76%, though these numbers exclude company-initiated cancellations, which decrease these figures by 13% and 5%, respectively. All told, Lemonade loses roughly ~40% of customers between Year 1 and Year 2, and ~30% of remaining customers between Year 2 and Year 3. That's a pretty leaky bucket.

If we use these numbers to estimate a Lifetime Value (LTV), we get an average customer lifetime of approximately 3.5 years. This allows us to calculate the LTV of a renter: $150 / year in premiums * 18% margins * 3.5 years = $94.50. This gives us a LTV / CAC ratio of 1.26 ($94.5 / $75).

What does this all mean? Well, while Lemonade can cover its CAC, it doesn't have much wiggle room. These figures are far from impressive and bring to mind one of the key questions we pointed out at the start: how can Lemonade expand their LTV?

Lemonade mentions its desire to capture customers as they "graduate" from a renters' policy to a homeowners' policy. The ability to pull this off is arguably Lemonade's biggest bet: homeowners' insurance is more lucrative but also much more competitive. It's also a market that tends to incentivize bundling, which may limit Lemonade's ability to make inroads. As we mentioned, the company has a pretty limited product set at the time of filing.

Management team

One of the most important foundations of a business is its management team. Great executives are rigorous in capital and resource allocation while influencing strategy across the organization. Lemonade’s management is fairly representative of the business itself: operators heavily influenced by the power of direct marketing (as covered in the "Model" section), a highly converting product organization, and an organization that operates at a fraction of the size of other insurance players. In other words, this looks like a very nimble, fast-moving group.

One of Lemonade’s secrets is that management has been successful at building two publicly-traded consumer businesses that rely heavily on paid marketing. We’ll first focus on a co-founder who isn’t as visible as CEO Schrieber, CTO Shai Wininger. One of Wininger’s strengths is his DNA as a co-founder of Fiverr (FVRR), the business that allows anyone to request digital gig work in an instant. The same playbook that allowed FVRR to scale consumer bookings rapidly (via rabid TV, social, and PPC marketing) appears to have permeated Lemonade, too.

Interestingly, Wininger’s title is not CMO. It’s difficult to see how and where the marketing cost centers report to, in fact. According to the S-1, Wininger actually holds six (!) different titles inclusive of the CTO: Co-Founder, President, Secretary, Treasurer, Chief Operating Officer, Chief Technology Officer. He's got his hands full.

Something that’s buried in the S-1 is that both Schrieber and Wininger completed a secondary transaction in October 2019. Across two transactions, $10MM worth of equity was sold to “two venture funds.” It’s become quite common for founders to “take money off the table” but it always raises concerns when thinking about the incentives — and the timing — that induces managers to sell. Case in point: by the time Schrieber and Wininger sold their shares, SoftBank already had contributed nearly 89% of all capital to the business. Studying other Vision Fund businesses, we’ve witnessed bad outcomes before when odd secondary situations occurred...does the name Adam Neumann ring a bell?

A management team also represents what the business is today and wants to become, so it’s worthwhile to think about Schrieber's key leaders. One of these lieutenants is Tim Bixby, Lemonade’s CFO (and the highest-paid executive disclosed in the filing) as well as John Peters, the company’s Chief Insurance Officer. These two executives help guide the inner-workings of what is a complex business — one part technology company and another part insurance provider. (If you're looking for a hint of which part is bigger, check the headcount. According to LinkedIn data, over 80% of employees are involved in finance, operations, administration, legal and support. That doesn't necessarily mean tech is a secondary priority, but it is indicative of where the operational intensity of the business lies.)

Prior to Lemonade, Bixby served as the CFO of Shutterstock (SSTK). While he helped take the company public, it was a bumpy ride during his 2012 - 2015 tenure. That said, he should be well-suited to Lemonade’s consumer-centric product, given those bonafides. As Chief Insurance Officer, Peters oversees the foundation of the company and his background is equally solid: as a former executive at Liberty Mutual and McKinsey, he actually discussed the power of technology to improve underwriting operations. Lemonade fittingly recruited him in the fall of 2016 following a 15-year trajectory in risk management and insurance product strategy.

For an insurance business, we’re wondering why there’s an executive title called “Chief Business Development Officer,” but such a role exists at Lemonade. Jorge Espinel holds the position, having been on the executive team for just 1.5 years. His prior stints at Spotify (as Head of Global Business Development), 21st Century Fox, and AOL (all in business or corporate development) point to a strategic rationale to grow the business outside of paid marketing. We think Espinel will be an important executive to watch in the quarters to come.

Finally, as CEO, Daniel Schreiber commands one of the most impressive Glassdoor ratings we’ve seen: 97% of employees “approve” of his ability to guide and set direction for Lemonade.

As we discussed earlier, Schrieber's background is vast and diverse as a serial entrepreneur (starting as a corporate attorney, to a marketer, to starting his first startup in the security space and evolving into executive positions at Powermat). What makes Schreiber an exceptionally compelling leader for Lemonade is his ability to communicate. He has a rare talent for simplifying complex topics (understanding how insurance “works” is certainly one of them). It's clear how central this is to the company's vision and marketing. Looking at Schreiber's LinkedIn shows that from Lemonade's earliest days, the company was writing about these topics, keen to educate and illuminate consumers.

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Investors

Lemonade’s funding history is a case study in pivoting from software to full-stack. They raised their first round in late 2015, with $13MM from Sequoia Israel and Aleph, an Israeli venture capital fund. Later rounds included a strategic investment from XL Innovate, the venture arm of XL Insurance (now AxaXL), and from General Catalyst. These first few rounds were modest — a total of $60MM through the Series B in late 2016.

Then SoftBank arrived. SoftBank has led two rounds, one for $120MM (at a $570MM valuation) in late 2017, and then $300MM (at $2.1B) in April 2019.

It’s notable that Lemonade’s valuation radically increased once SoftBank got involved. Ninety percent of the company’s post-money valuation dates post-Masa. That’s not just because SoftBank was blindly buying the hype: this was also when Lemonade’s unit economics started to look reasonable. In 2017, Lemonade wrote $9MM of premiums, losing $3.12 for every $1 of premiums written. But in 2018, gross written premiums rose to $47MM with losses per dollar dropping to $1.13. That still wasn't sustainable, of course, but every variable was moving in the right direction: they were scaling the business and improving margins.

The usual SoftBank thesis is that once a company’s core model is established, the only acceptable goal is to scale it to dominant market share as quickly as possible. After all, if Lemonade can create a scalable system for attracting customers, underwriting risk, and quickly paying claims, then someone else can do it, too. Since most Lemonade customers are new to renters' insurance, Lemonade has found a new market segment to tap, and their funding let them capture it before competition caught up.

Another aspect to Lemonade’s huge later funding is signaling: if a growth company raises a slightly larger round than their last round, it validates the market; if they raise a gobsmacking amount of money, it makes the market uninvestable because every other company is competing against someone with infinite resources and the need to spend them. A large round with a liquidity preference basically forces a company to spend money (the liquidity preference is equivalent to selling the investor a put option, which means the more Lemonade grows the more out-of-money the option is, i.e. as long as their model eventually works, the faster they grow, the cheaper their funding turned out to be).

The risk to the tidal-wave-of-money approach to funding startups is that it may not be enough, and the company may have to come back for yet another round. For most venture funds, risking $120MM but potentially needing to invest more to recoup their original funds would be a dangerous move. But in SoftBank’s case, their total investment of $420MM is less than 0.5% of their available capital. When SoftBank was still aggressively investing Vision Fund I and raising Vision Fund II, maneuvers like the late-stage Lemonade rounds weren’t just practical: they were obligatory.

Financial highlights

We could slice, dice, and squeeze Lemonade's financials till kingdom come. But at the end of the day, there are three key questions we think get to the heart of the matter.

Is growth sustainable?

Though the data is limited, we're confident there's plenty more juice left in this lemon. Even with a tough Covid-19 theoretically dampening March, Lemonade grew 1Q20 top-line revenue +138% year over year (YoY) on the back of strong premium growth.

In fact, since 2017, Lemonade has been growing premiums (a close proxy for revenue) at a CAGR of 450%. That. Is. Crazy. Especially for an insurance company.

You might expect this strong growth to come at the cost of increased risk, or more aggressive underwriting (handing out insurance policies to absolutely anyone). Not the case. In that same 2017 - 2020 period, Gross loss ratio has decreased by 296 percentage points. Lemonade is growing rapidly while reigning in risk and decreasing exposure to claims loss.

This is impressive stuff, and atypical for the industry. Traditional incumbents generally expand market share by relaxing standards, underwriting aggressive policies, and absorbing the resulting claims losses that come their way. They do so to under-price competition and acquire new customers. When an incumbent makes this kind of a play, they're creating a "soft market," essentially conditions in which there's an excess supply of insurance relative to demand. That results in a race to the bottom and a crushing price war.

Lemonade's navigated the high-wire act: growth looks healthy and sustainable, risk is being adequately controlled, and underlying loss metrics have improved.

Is there a path to profitability?

Yes, Lemonade is enjoying strong top-line growth. But, like most early-stage companies, this growth has come at the expense of profitability. Net loss in the most recent 1Q20 quarter alone was $15MM. Why so unprofitable?

First, we should mention that Lemonade does not benefit from the same capital efficiency as a true software company. While SaaS companies command gross margins in the 80 - 90% realm, Lemonade has yet to hit an adjusted gross margin of 20%. This is a by-product of the insurance business, even with Lemonade's engineering: loss from claims is considered a variable cost of sale, which eats into gross profit.

That's okay. As we've discussed, Lemonade's model isn't to swing for the fences and take on too much risk. Instead, the company's designed to reduce gross margin variability. To continue the baseball analogy, management is more interested in bunting to get on base than crushing a home run once in a blue moon. As noted in the "Model" section, Lemonade predicts gross margin should stay within a +/- 3% band per reporting period. So far, gross margin is coming in stable and as desired (17% in 2018 and 2019, and 18% in 1Q20). This stability helps management more accurately plan for the future and control cash flow.

However, while gross margin is in the black, profit is still very much in the red. What's causing this and will it reverse? From a glance at the statements, there are three key fixed expenses: claims loss, sales and marketing, and general and administrative.

We've mentioned claims loss in discussing top-line growth. This loss is business as usual for an insurance company, and we believe Lemonade is managing this risk well. So that's not the problem.

Sales and marketing? It's definitely high, coming in at 134% of 2019 revenue. However, S&M is a base ingredient to create high growth. Without it, the company likely wouldn't have been able to power its startingly rise. Over time, we'd look for this to decrease as a percent of revenue, as Premium Per Customer (PPC) improves, brand value grows, and viral adoption takes hold. For now, S&M spend looks acceptable. We've said before that $1 in S&M converts into $2 of premiums written. We can live with that.

Moving on to general and admin expenses. At first glance, this makes for rough reading. As of 1Q20, G&A increased 550% YoY, rising from $2.8MM to $18.2MM. That’s somewhat astonishing, given revenue only jumped 134%. What's going on?

Before you start your short-orders, a little detail: of the $15.4MM increase, $12.2MM is a non-cash stock contribution to the Lemonade Foundation. This is non-recurring. An additional $1.1MM of the increase comes from non-recurring legal fees associated with the upcoming public offering. If we adjust and normalize for these one-off events, total 1Q20 G&A expenses comes in at $4.9MM. Though still a 175% increase YoY, again, it's more palatable. Lemonade is a growing company, and given the fixed nature of G&A expense, growing pains can be lead to a bumpy ride.

In summary, we believe expenses are adequately managed. Once Lemonade scales customers beyond a critical mass and overcomes high fixed costs within the business (S&M and G&A), the business should turn a profit.

Is the underlying business model working?

There's one metric we want to focus on here: Premium Per Customer (PPC). Essentially, how much a customer pays for their policy. It's a useful metric to look at over time because it gives an indication of how Lemonade is growing with its customer base. If this figure improves, customers are increasing their reliance on Lemonade, purchasing more policies, and trusting the platform to cover more valuable assets.

The Lemonade team has done a solid job here. The above chart shows consistent linear growth in PPC month over month. On average, customers are growing their platform spend at a 16% CAGR. Customers who bought Lemonade renters' insurance three years ago spend 56% more on their renters' insurance now than when they first joined. Clearly, customers value the Lemonade offering and are engaging positively. Moreover, from a financial perspective, this growing PPC might improve LTV down the line, hopefully helping the 1.26 LTV: CAC ratio we griped about earlier.

One final, closely-related metric: the conversion ratio. To improve LTV: CAC, Lemonade needs to attract more valuable customers, and capture existing users as they "graduate" from renting to owning. As we said earlier, this may be a key determinant in Lemonade's future prospects. How does Lemonade stack up?

If the above chart has you confused, you're not alone. Of "active condo policies" (homeowners insurance policies), only 9.8% of the 12,445 total previously bought renters' insurance. That's not particularly encouraging news, indicating that either (i) Lemonade's customer base is slow to "graduate" to homeownership or (ii) the company is inefficient at capturing them. If the former is true, it suggests Lemonade's millennial market is lower-value, while if the latter is true, it indicates the company has yet to crack a core part of the business. A more accurate reflection of the company's success with capturing "graduates" might look something like this:

While Lemonade would argue that a lower percentage of "graduates" indicates success in marketing to brand new buyers, we're not so sure. Ultimately, we think this metric is something to keep an eye on over the coming quarters. If Lemonade is going to get the most out of their marketing spend, they'll need to better monetize their current base.

Our takes on valuation, and the specter of SoftBank

In discussing this company, we kept coming back to one point, again and again: SoftBank. For better or worse, much of the last few years have been defined by the venture fund. In Lemonade's growth, profitability, and strategy, we see plenty of Masayoshi's fingerprints.

A few of us decided to give our 2c on the fund's role, with particular reference to valuation.

Lemonade is a good case study of a good insurance offering that got valued as a software subscription business, and in many parts, a model that venture capital pushed to the limits. In Lemonade’s fundraising history, one can’t help but focus on SoftBank’s involvement. As we discussed earlier, 89% of the company’s paid-in capital came from this one investor, and as Chamath Palihapitiya would highlight, SoftBank has shown to “weaponize” and in effect, “torpedo” a company with capital that isn’t required to sustain a durable operation. — Dave

Of all the companies subjected to SoftBank’s "investment by gavage," Lemonade appears to be one of the healthiest. Though relatively immature and valued as a software company with SaaS margins, they have nevertheless succeeded in shaking up a dusty industry. That, combined with the oddly welcoming public markets, put the company in a position to surge in the short-term, making up some of the difference from the last round. The hard work of winning customers beyond renters' insurance, comes after. — Mario

The Lemonade funding model — establish the possibility of decent unit economics, then provide an overwhelming amount of cash to acquire more customers — is high-risk at the level of any one investment. But it’s a high-probability way to find at least a few big winners and to lower the probability that competitors destroy them. As long as the fixed costs of Lemonade’s model are high, and the market they’re targeting is fairly untapped, the best funding strategy is to raise as much as humanly possible to scare off competition, grab all the available users, and keep improving the core economics. This won’t work every time, but at SoftBank’s scale it’s acceptable to think about probabilities; the law of large numbers actually applies when the pool of investable funds is $100B. — Byrne

Valuing Lemonade is tricky. Is Lemonade an insurance company? Perhaps superficially. However, if it is, it's not a particularly good one (at least currently). Looking at loss ratios, I would argue Lemonade is a sub-average to middling underwriter at best. But this is missing the point. Using reinsurance, Lemonade passes most of its insurance risk to 3rd parties. At most, underwriting improvements/deterioration will nudge gross margins by max +/- 3%. Given that the bulk of the material risk is in failing to acquire new customers and hold on to them as they mature, I think of Lemonade as more akin to a software platform. It offers customers simple onboarding, automated claims processing, and an engaging ecosystem. The insurance wrapping delivers this experience to a market ripe for disruption. While just my humble opinion, I see the logic in valuing Lemonade more like SaaS. — Jon

A week ago, Lemonade included an expected price range of $23 - $26 per share in the latest updated S-1. The mid-point of the range, $24.50, implies an equity value of $1.4B, just over 14x their 2020 GWP run-rate revenue. That is an attractive multiple for a high growth SaaS company. But Lemonade is not yet a SaaS company — it’s more like a marketing machine. The broad range of valuation outcomes will ultimately depend on the company’s 2020 growth rate and the peer-set public investors decide to benchmark Lemonade against. Lemonade’s perceived value as a digital-first insurance provider and its brand awareness among millennials might warrant a premium, while its margins and small scale may warrant a discount. At the end of the day, each of these contributes to Lemonade’s ability to generate future free cash flow, which will ultimately determine its value. — Tina

Competition

Incumbents

As Lemonade expands offerings to homeowners and higher-value customers, it will encroach on the old guard of traditional insurers. Though less tech-savvy, these slow-moving giants still present stiff competition. They offer bundled insurance policies, control deep financial resources to weather soft markets and have built strong household brands. As Lemonade operates in the Property & Casualty insurance market, we have provided a breakdown of the ten largest US competitors by market share. You are likely familiar with most, if not all of these players.

As we touched upon in the "Market" section, this is a fragmented space. While no insurer has more than 0.4% of the insurance market more broadly, the figures above refer specifically to Property & Casualty insurance. Though somewhat moderated, the same trends hold: the 10th largest US player only commands a 2.6% market share. We did a back-of-the-envelope Herfindahl-Hirschman Index (HHI) calculation, a metric that refers to market concentration.

While we did this mostly to make our old Econ professors proud, it's worth knowing that HHI measures market concentration from 0 (un-concentrated) to 1 (monopoly). A metric below 0.15 indicates an un-concentrated market. Using the figures above, and making the hyper-conservative assumption that the rest of the market is equally shared by 25 competitors (there are clearly far more), the HHI stands at 0.035.

Though there are plenty of giants, Lemonade can pick off smaller players before ever needing to enter their orbit. There are over 5,900 insurance companies in the US, with 2,500 focused on P&C. If the top 10 companies control 44% of the market, a significant chunk is saturated with run-of-the-mill, salt-of-the-earth insurers. The "gangster move" to paraphrase Scott Galloway is for Lemonade to use their technological advantage, and gobble up Main Street.

There are other plays to make, too. Indeed, if they wanted to, Lemonade could become a powerful ally of whales and minnows alike.

For incumbents, Lemonade could serve as a useful distribution channel, offering different products to their customer base. Given the company's limited offerings at the moment, that might allow Lemonade to grow LTV without cannibalizing existing policies, though it might provide an impediment for future innovation.

Another alternative would be to outsource their technology stack, allowing analog companies of all sizes to benefit from Lemonade's data, customer service, and interface. That doesn't seem to be in line with the company's strategy to date, but it might move them closer to true SaaS margins.

Ultimately, to quote the venerable Ron White, "When life gives you lemons, make lemonade...And find someone who's life has given them vodka and have a party." There's no reason Lemonade and the old guard shouldn't play nicely. There may even be a fortifying cocktail to be made.

Insurgents

Lemonade is far from the only startup tackling the insurance market. There's PeerCover, which offers crowd-funded insurance (pretty interesting), Jetty, which offers insurance as a broader financial product offering, Hippo, Kin, Clearcover, and many others. Insurtech is an established and growing segment in the venture ecosystem.

What sets Lemonade apart, is the reinsurance business model, focus on low-greed margin capture, and socially-minded charitable rebates. Lemonade is zeroing in on an "everyone wins" P&C insurance platform. That separates the company from glossy and technologically slick offerings that operate similarly to incumbents behind the scenes.

Could other insurgents replicate Lemonades' model? That looks tough in the short-term. The company has compiled significant amounts of underwriting and customer data, which enables automated onboarding and claims processing. While its right to be skeptical of businesses that profess to be "data-driven," the proof seems to be in the pudding: Lemonade's loss ratio continues to fall. Evidently, the AI-based underwriting formulas are improving.

Just as importantly, Lemonade has created a following and formidable brand built around social values. The company's NPS is an admirable 70. Current and future insurgents will be hard-pressed to provide renters and property owners with a comparably creative, "delightful" offering.

Why now?

Behind all of this information and analysis, a more foundational question still lingers: does Lemonade want to go public? Some commentators have suggested the company is going through the IPO rigamarole in an attempt to seduce would-be buyers.

Looking at the state of the business, there’s reason to think that might be the case. From a revenue perspective, the company is relatively immature and is yet to truly diversify its product set. Given the limitations of renters' insurance, you might expect Lemonade to have waited until they'd better penetrated the homeowners' market.

That said, we think this is going through. There are a lot of reasons to think it might go well for the company. The markets have treated the 2020 IPO class warmly with another emerging growth company, Vroom, rising 145.9% since its debut earlier last month. Others, like ZoomInfo, have also fared well.

Less buzzy entrants from Lemonade’s own industry have performed nicely, too. SelectQuote rose 28% since listing earlier this summer. Everquote, which listed in 2018, has grown more than 78% year-to-date. While both companies are quote-comparison tools rather than full-stack insurers, their strong showing is encouraging, all the same.

Covid-19

It’s become de rigueur for S-1s to mention how the company has been impacted by Covid-19. The two answers are: “It’s been bad (but it’s probably temporary)” or “It’s been good (but we don’t exactly want to brag).” Lemonade is in the latter camp: their S-1 has April numbers, with in-force premiums up 130% YoY (versus +133% for Q1), despite a lower marketing budget.

Covid might have a longer-tail impact, though, both on growth and costs.

On the growth side, Lemonade uses some outdoor marketing, which is not nearly as effective when most people stay locked up. That’s offset somewhat by their direct marketing efforts, which benefit from cheap ad inventory on social media — every major ad-driven internet company highlighted the massive outperformance of direct-response marketing due to the pandemic, and Lemonade is doubtless part of that trend.

On the cost side, Covid could be negative because more people are spending time at home, which means they have more opportunities to accidentally break their possessions. While the macroeconomy is in a weird state, with a severe recession offset by so many stimulus programs that the poverty rate has declined and growth stocks are at record highs, the amount of fundamental uncertainty is way up. This could lead to higher rates of fraud, or at least a higher percentage of customers making claims they’d otherwise not bother with.

Commentary

We've talked with some of the smartest folks we know, both in the S-1 Club and beyond. We've also gathered commentary from across the web.

I’d consider myself a careful bull. I believe the combo of market size ($5 trillion globally), opportunity for disruptors (antiquated tech + no company has more than 4% of the market), more robust data collection, and a more aligned business model with the consumer, positions Lemonade very well for the next several years. Two big IFs though: graduation & user acquisition. First, Lemonade needs to further prove that it can graduate a significant portion of its rental policyholders to homeowners & new products down the road. Second, it needs an older audience to start making money. Yes, it’s great that 90% of its customers are new to insurance, but these customers also have lower HHI & a 2-year payback period. They need to start acquiring the 40+ crowd soon. — Alex Lieberman, CEO of Morning Brew, S-1 Club Member

LMND is growing revenue but the IPO appears pricey and the company is burning through high amounts of operating cash, so I'll watch this IPO from the sidelines. — Donovan Jones, IPO Edge

The LMND IPO presents an opportunity to see if a disruptive player can remain independent. By opening the company up to public investment at a roughly $5B valuation (once the dust settles), it opens the door for a big (and stagnant) player to scoop them up and leverage their technology. If that happens, it will likely close the door on future players going public (and granting us the opportunity to be a part of it). I'm confident LMND has a strong product that can stand on its own and grow. The question is if the price the public pays at the outset is the price an acquirer will pay. — Brad Weaver, Founder of WhenWeWonder, S-1 Club Member

The pricing range that Lemonade is at least initially targeting is not terribly impressive. That said, it’s stronger than I anticipated. Instead of declaring that Lemonade’s currently proposed IPO pricing is a real disappointment in comparison to its final private valuation, I’d more herald it as a win in terms of what the company may be able to command as a public shop. By doing so, we do note that SoftBank probably overpaid for Lemonade equity in April 2019, however. — Alex Wilhelm, TechCrunch

They have over 700,000 customers...They've made huge inroads as a new company in the sector. I think [the market will] be very interested in Lemonade. — Kathy Smith, Renaissance Capital

Lemonade is a strong example of how technology and digital customer acquisition can lead to outsized growth within industries usually dominated by large, slow moving incumbents…[T]heir IPO is a nice win for the broader insuretech community. — Nima Wedlake, Thomvest Ventures

The bottom-line on Lemonade? It may happen fast or it may take a while, but tech will lead the market for the foreseeable future, and Lemonade has the right cocktail of frictionless experience, responsive customer service, high-scoring online customer reviews, and enough capital investment to outlast their detb and grab a decent piece of the $1.22T US market. — Nothing Something, S-1 Club Member

The companies that do get out [into the public markets] are the best-of-breed disruptors...the Lemonades of the world...What you’re going to see coming out of this recession is a lot of old industries weakened. The insurance industry is going to be weakened...and here comes this fist of stone called Lemonade. — Scott Galloway, Pivot


So, what do you think? Is Lemonade poised to continue 2020's IPO hot streak? Or is the juice not worth the squeeze?

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