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Groupon’s Bad Deal (newyorker.com)
69 points by mitmads 1241 days ago | hide | past | web | 53 comments | favorite



Google offered $6B to buy Groupon. Instead they took a private financing deal which allowed the founders and others to take some money off the table and go for an IPO.

The $6B from Google was real. The risk of proceeding was tempered by the private money. Nothing dishonest happened here. All that happened was a little overexuberance about the scalability of their business model.

While it's true that some people (including me) thought their model non-scalable back at the time, it's also true that a broken (analog) clock is right twice a day.

Everyone made their bets and they're all big boys and girls. That includes the public investors as well as the private ones.


Wasn't there some speculation at that time that Groupon may have shied away from the Google offer since they would have had to open up their books completely to an audit before the deal would have closed? (and they possibly didn't want to contend with the possibility of a botched Google deal)


What was the earn out? What was the due diligence before that was inked? I question that valuation whenever it comes up. Seems awful convenient to turn down $6B from the world's most analytical company, just before a public offering.


>> and they're all big boys and girls.

Thank you, not a phrase heard often enough I think.


The $6B from Google was real

Unless Google would have to agreed to a $6 Billion fee in the event of not being allowed to buy them, it wasn't, there was speculation that it may be blocked by the DOJ. Imagine being in limbo for 18 months or so when you need to grow. They took a chance and lost. Or some of them lost, execs did sell a bunch of stock


Deals that large usually come with a "breakup fee" on the order of hundreds of millions of dollars, precisely for this reason.


Yes, but the breakup fee for wasting 18-24 months at their stage might not have been enough.


I genuinely do not understand US securities law. One needs to be a "qualified" investor to invest in startups; these investors trade shares among themselves (no primary share issuance) at indefensible and unrealistic valuations, and they are later allowed to sell their shares (secondary issue) in the open market to "unqualified" investors.

Shouldn't the SEC and a bunch of attorneys be investigating this?

Congresses is having all kinds of hearings with banks for misselling mortgages and a dozen other shenanigans. Who is going to call on investors who (literary) pumped-and-dumped Groupon?

I still vividly remember watching Jeff Clavier defending the Groupon IPO valuation on TC TV (http://www.youtube.com/watch?v=MKrWtMmsl7I), and I couldn't feel more ashamed for all the unsubstantiated arguments he made back then. He wasn't the only one to do this.


The valuations for startups are generally pretty defensible. Any serious valuation number is based on somebody actually buying shares at that price, generally a professional investor with a lot of experience. The price of a thing is what the thing will bring.

Whether or not they're realistic is hard to say because they are bets on wildly unpredictable situations. Not long after Amazon IPOed, I considered shorting the stock because I thought it was wildly overvalued. Now it's worth circa 100x what it was worth then.

Qualified investors are just people with enough money that they are presumed to know what they're doing. The reason non-qualified investors generally can't buy in early is precisely because the SEC is protecting them from getting taken for a ride. The whole "going public" thing is mainly about disclosing enough that you're following the investor protection rules.

I agree that Groupon is a hot mess, but I don't expect that any rules were broken, and I don't know what new rule could have prevented it without doing more harm than good. Do you have something in mind?

My guess is that the people who bought Groupon stock made one of two classic mistakes. One is buying shares because they like the product. The other is buying because it's hot. I've seen professional investors make those mistakes too, and learn some valuable lessons thereby. It's sad that a lot of people had to learn those lessons with Groupon. But the SEC isn't there to protect people from ignorance or bad trading strategies. They're just there to stop fraud and cheating.


Just for disclosure, before doing the "startup thing", I worked for several years in the finance/investment/"vampire-squid" industry, so I've seen both side of the table (as a qualified investor). I've spent endless amounts of time in several non-tech IPOs, and public-to-private transactions. I can safely say that "I know how the investment industry works".

(i) price != value. For argument sake, lets say you go off to an pay $1 million for a 500 sqft in Portola. Is the price of the house $1 million, yes, you paid for it. Is it worth it, no. Investors are specialist at making both terms look the same.

(ii) Groupon is Groupon. Groupon is not Silicon Valley, Groupon is not Amazon, Groupon does not represent any other company/industry other than itself. Do not go the Amazon, Webvan, etc. route, because mixing stories does not make the story any more right. Groupon's fundamentals: revenue growth, customer-acquisition-cost, customer lifetime value, gross margins, working capital needs and cash flow generation were "not there". They never were. The IPO value could not be justified with even the most basic arithmetic. To justify the +$13bn valuation Groupon, well read this from 465 days ago (pre Groupon IPO comments) http://news.ycombinator.com/item?id=3270349

(iii) How could of this be prevented? The SEC could of asked (and should ask) 1,2,3,4,5, etc independent companies (be it McKinsey, an auditor such as KPMG or any corporate finance boutique) to provide a Fairness Opinion on the valuation (the right incentives should be put in place to avoid any conflict of interest in the future from potential revenues/business arising from the company one is analysing). If there is a large discrepancy between the Fairness Opinion and IPO price the IPO should be cancelled and any share trade should only be between qualified investors (but not in the stock exchange). If I were an investor, I would strongly vote against this... but now that I'm not, I can say this is an effective way of avoiding this pump and dump schemes.


As you know (having been in ibanking), the IPO sales process of shares goes something like this:

1. The company and ibanks determine the offer price and offer the shares to institutional investor customers (ranging from mutual funds, money managers to other banks).

2. The banks then turn around and sell these acquired shares as "IPO shares" at the offer price pre-market-open to their clients. Basically, "financial advisors" at places like BoA, ML, JPM, etc move these shares onto their retail customer base.

3. The next day, the market opens and the shares start trading in the open market. Any "mom and pop" investor can buy the shares on market.

Now, the institutional investors in (1) have done their homework and think it's worth buying the shares, whether they intend to keep the shares or push them onto someone else soon. So they don't need to be "protected" (as long as the S1 is accurate).

What about the people in (2)? Well, the sophistication of these retail investors ranges from sophisticated to clueless. Actually, there's really no material differnece between (2) and (3), other than (2) having a bit more money on average than their (3) counterpars.

But what can you really do when all the necessary financial information of a company is presented in the S1? Retail investors have developed this strange notion that investing in common stock is this "easy" way to make money, when in fact it has always been an area where "you better know wtf you're doing". Do you prevent "clueless" people from buying shares at all? Do you similarly prevent "clueless" billionaires from buying Picasso paintings?

I mean you'd think that if the IPO price is too high, then the investors simply wouldn't buy. After all, if we consumers think a product is too expensive (whether it be a house, a car, or a phone), we'll exercise discretion and shy away from the purchase. The underlying issue (provided that the S1 information is reasonable and accurate -- which is one valid concern you raise) I think is the ignorance and unfounded optimism of the average retail investor towards IPO shares. TBH I don't see how this "retail investors getting wronged" phenomenon gets rectified unless these investors themselves become educated about basic investment principles.


1) Yes, price does not necessarily mean value. But that is a really philosophical tangent (What is "value", bla bla bla etc.) that is pretty irrelevant. For all intents and purposes the two are interchangeable on the market. For all intents and purposes, the value of something economically is the highest price someone will pay for it.

2) >Groupon is Groupon. Groupon is not Silicon Valley, Groupon is not Amazon, Groupon does not represent any other company/industry other than itself. Do not go the Amazon, Webvan, etc. route, because mixing stories does not make the story any more right.

This argument is true in a tautological sense, but doesn't really provide a reason against comparing Groupon to other companies when valuing it. Yes, the fundamentals of Groupon matter, but growth in the abstract (not just YOY revenue growth) is difficult to evaluate. People will turn to other ways to evaluate companies, typically by comparing a company to other companies in the same sector. To give you an extreme example of this principle, VCs really don't care about an early startup's fundamentals. They'll look at the strength of the team and they'll evaluate (in a hand-wavy fashion, I acknowledge) the idea of the startup, and the reason they'll value, say, a YC startup with 3 co-founders at $6 million despite no revenue is because in their experience, they've seen companies with strong technical+operational teams return 100x. Yes, this example is not directly applicable to Groupon, since they did have revenue numbers to look at, but no doubt some people evaluated Groupon based on the idea of ecommerce growth.

I never thought Groupon was a good stock to buy. But I remember at the time that even though I saw that the fundamentals were weak, I personally could not be sure of myself because I saw my mother and many of her female friends (also mothers) buy tons and tons of Groupons. Hindsight is 20/20.

3) That is a terrible idea. How do you define "fairness?" Again, given that the inherent definition of "value" is essentially (in a market economy) the highest price someone is willing to pay, I don't see any situation in which a company's IPO would be canceled. In fact, this appears to be a de-facto price ceiling since you are essentially capping the valuation at whatever the SEC/auditor determines is the fair valuation, regardless of what people are willing to pay, something you will get virtually no economist to agree to. Last I heard, the SEC is not in the business of setting IPO prices (yes, you might argue that they're not technically setting the price, but the end result is that they are setting the price).


> the fundamentals of Groupon matter, but growth in the abstract (not just YOY revenue growth) is difficult to evaluate

Yes, forecasting growth is tough BUT if you have a price to start from, you can very easily back-solve the growth rate of a companies revenues, cash flow, etc. You don't have to be a genius to extrapolate that at a +$13bn equity valuation Groupon needed to achieve spectacular growth and cashflow generation over that next 5-7 years. Once you observe the implied growth rates, margins and cash-flow needed to be achieved one can genuinely analyse and criticise a valuation.

> That is a terrible idea. How do you define "fairness?" Again, given that the inherent definition of "value" is essentially (in a market economy)...

I don't think you understood my point. I'm not talking about something being fair (like you refer "fairness") or not, I'm talking about a Fairness Opinion or FO. An FO is an exercise that investment banks, auditors, consultants and other qualified parties, do on a daily basis. In the corporate world, specially with public companies, when a tender offer is received or presented an "independent" party provides a FO to inform investors and other stakeholders (primarily the board), that the offer is priced as expected or it is too high or too low. Issuing an FO is one of the most market friendly, pro free-market, instruments/exercises out there, instead of just dumping shares at a dubious valuation while deep-throating "unqualified" investors.

>But I remember at the time that even though I saw that the fundamentals were weak, I personally could not be sure of myself because I saw my mother and many of her female friends (also mothers) buy tons and tons of Groupons. Hindsight is 20/20.

I'm not saying that Groupon is not a viable business. I believe the contrary, I think there is a good business somewhere. But a good businesses can be under- and over-valued. The fact that people use Groupon doesn't make a ridiculous valuation justifiable.

> Again, given that the inherent definition of "value" is essentially (in a market economy) the highest price someone is willing to pay...

What you refer to here is the Price you are willing to pay; Value is a different thing. Any serious valuation exercise uses a discounted cash flow model driven by a solid operational model. Any other methodologies are simply hocus pocus. I suggest you read "The Intelligent Investor" by Benjamin Graham. It was published over 60 years ago, but it is as useful today as it was back then. This book distills value investing from speculation. Let me just finish by saying that the recent financial crisis, specially that of the US housing was due to the decoupling of prices and value; understanding both will be of value (no pun intended).


Thanks for the detailed reply.

Regarding 1, I know they're different. But value isn't knowable except in retrospect.

Regarding 2, my point with my Amazon story is that reasonable people can disagree about the value of something, and therefore be terribly wrong about price, and that it works both ways.

Regarding 3, it's interesting. I think your approach basically means that high-risk companies couldn't ever IPO, because there would be large legitimate differences in independent opinions. That seems like a high cost to pay. If I had my choice, we'd just outlaw sales and marketing. They'd put prospectuses up on web sites, announce the IPO date, and we'd see what happens. Equally unlikely that will ever happen, of course. Legislators and regulators don't work for the citizenry these days.

I think a market is essentially a giant learning machine. But because the knowledge is stored in humans, I think markets need to keep re-learning lessons. The dot-com bubble was a giant lesson in substance over dreams. More than a decade later, enough people had forgotten that they needed a lesson. Facebook and Groupon hopefully taught them that just because they think a product is swell and popular doesn't mean you should buy in at the IPO.


I don't think 3. Should be getting the ribbing it is as an idea. I think that SEC required "Amicus Briefs" would go a long way to tempering some irrational exuberance.

However the Prospectus document for the IPO at Groupon made sobering reading and covered pretty much all the points being raised here. Prospectuses are horrifying things to read carefully - everything that could go wrong is detailed.

So I would suggest turning 3. Into a requirement for a standard modelling simulation framework - which the SEC supports and mandates that the IPOing company provides whatever functions within that framework are representative of the various scenarios in the prospectus

Something similar is proposed for monitoring bank risk but I cannot remember the link - it's an SEC experiment from a few years back iirr.


I 100% agree that the Prospectus is "The Document" and that retail investors do not read it (and sadly may "professional" asset managers too).

Unfortunately the prospectus is a one-sided story, and it will never say if the valuation is stretched or not... even the price and issue number is inserted at the last minute! Yes, I know the company is book building, but if a company out there is going to go public, a public institution should be calling BS from a valuation stand point, and amend the "Risk Factors" of the company accordingly.

My point 3 was an in-extremis case. Nevertheless FO's are a very common and inexpensive instrument, and it is a shame that the public investor doesn't have access to this BS detector.


> I genuinely do not understand US securities law.

I just finished watching Econ 252 lectures from Open Yale, and the basic evolution of US securities law is explained pretty well. I highly recommend it. http://oyc.yale.edu/economics/econ-252-11

Generally speaking, regulation is a whack-a-mole game. In the 90s tech boom, companies typically went public as soon as possible to raise capital, and thus were subject to more scrutiny early on. Obviously that is not happening now. Perhaps the regulation needs to catch up with the current reality.


How about facebook? That was one of the most artful manipulations of the IPO system ever conceived. They didn't even make a majority of the company public, and yet managed to rake in a preposterous amount of money and cash out all of the early investors to an absolutely ridiculous degree. The stock is still down nearly 30% from the IPO level.


Facebook lost "only" a 27% of the initial price (maximal lost was 53%). Groupon lost 80% of the initial price (maximal lost was 90%)!


You are right, Groupon is not alone, FB and Zynga are the two other which come to mind in these recents times.


My understanding (which I heard from a pretty reliable source at the time) is that this deal was baked (both sides agreeing), but broke down because the Groupon board insisted on a guarantee from Google that it would close over anti-trust objections, and Google wouldn't give that term.

Background: in a typical acquisition, closing is subject to HSR anti-trust approval. If the government doesn't approve, then the deal breaks up. This means that the target company is taking a risk that after announcing the deal (and being paralyzed in a post-signing/pre-closing period that could last several months), the deal could be broken up and the target company could be left holding the bag and forced to get back on an independent path. Which is pretty rough.

In this case, Groupon wanted Google to go long the anti-trust risk -> in other words, Google would have to divest the asset if the government killed the deal.

I think (not sure) Google had given this term up on the AdMob deal, but believed that it couldn't do it again on the Groupon acquisition (which would have been the biggest deal Google had ever done), or it would have set a precedent that every other company would have insisted on going forward in M&A discussions.


FWIW, Andrew is one of the smartest founders I've met (and I've met a lot).


He does seem wicked smart. What would you gauge as his level of culpability in the questionable S1 filings prior to IPO? Was it something he overlooked, didn't understand, or the finance people doing their thing?


The honesty and empathy that he demonstrated in his memo to employees sure impressed me.


'Smartest' in what way? Is there a standout characteristic he has that other founders should emulate?


I didn't mean "smart" in a way different than it's ordinarily used.


Do appreciate the response and don't mean to press the issue, but guess I was just curious about what gave you that impression... particularly because, coming from you, it is an extremely high compliment that most on HN would be thrilled to hear.


smart

/smärt/

Adjective

Having or showing a quick-witted intelligence.

Verb

(of a wound or part of the body) Cause a sharp, stinging pain: "the wound was smarting".

Noun

Intelligence; acumen.


Why yes, we should all emulate the famous Groupon pump-and-dump. Sheesh.


Is Andrew one of the most determined?


Yes, I think so, though that is harder to judge from a conversation.


Imagine that billion divided up as $50,000 seed money to 20,000 new startups. Don't just plunk it down on them set up an automated system requiring justification for every expense. Then have a contest over the year where the earliest, best performers get to advance to another round of funding the next year.


I've suggested something like this before - I think it's brilliant (obviously) - although I truly would not bother with tracking the expenses (#) - at this level it's just noise.

I would suggest that this is the next evolutionary step for VCs - not managing 5m dollar investments but 100x as many 50k investments. But I doubt anyone in the VC industry wants to move from selling at Tiffany's to the KMart in Tucson, Arizona.

Luckily the VCs of Pune/Mumbai will have no such qualms. SV may find itself out-evolved quite quickly.

(#) well you may have to to avoid seed money for drug deals but you get my point


Isn't that what the banks and small business loans are for? VCs are a playing different game.


That's way too risky a game for banks. Banks want to put in $1 and be pretty much assured of getting $1.10 back next year.

If you go to a bank and ask for a business loan, they'll say, "Great! Let's see the last few years of your financial statements." If you say you don't have any because you haven't actually started your business yet, they will look at you funny and tell you to come back in a few years.

That's as it should be. We citizens guarantee that banks will always pay back depositor money. So they should only be allowed to make pretty safe loans.


"“I was fired today. If you’re wondering why… you haven’t been paying attention.”

Or maybe they were paying attention to the WRONG people.. such as.. oh say, HR and corporate spokespeople in Groupon who want you to believe Groupon is on the rise and will be a great company to work for!

Seriously, that statement is such an insult. Sounds like someone who can't admit he's wrong, by saying "Well duh! Didn't you knew this was gonna happen" to save face, rather than "Ok, I made a mistake by doing X, Y, Z"


How many people have been shouting about groupon being a BS company from day one? Sometimes I boggle at how dysfunctional this entire industry is.


It just paints a picture of Fox Moulder's "I Want To Believe" poster, but with a GroupOn logo instead of a UFO.

I was particularly surprised at how their 'aggressive accounting' didn't get them into hot water in the beginning.


I was one of those people - but to be fair, it's easy to dismiss a company, and given the failure rate of startups, you'd be right a lot more than you'd be wrong.

Being down about a startup is an easy game to play. Being optimistic - and being right - are much, much harder.


Title needs to be changed to reflect factual content of article: "executives ... and shareholders."


Done. Used the second half of that sentence to make it more appropriate.


Title changed again, far less informative - is this you or a mod?


No. The second mod is not mine.


Original HN title: "950 million of 1 billion of Groupon's funding wasn't used to fund the company"

This also stood out to me as an interesting claim from the article. Does anyone have a perspective on how that can happen without raising some sort of legal issue?


This was pretty well documented when it happened in 2011. You can do anything you want in a private company if the shareholders agree. In this case, Groupon's existing shareholders agreed to roll around in big piles of money so that new investors could get in at any price.


Came here to ask the same question as blahedo. Especially as the claim in made in the article, but not expanded. Are there any sources for or reports on this?


Google for "Groupon series D" or "Grouponzi".


That sounds like a win to me. How can anyone fault the founders for taking that deal?


Taking money off the table does tend to indicate a lack of confidence in the future of the company.


[deleted]


Groupon having a sound business model is completely debatable, though.

When your business model requires that your suppliers provide you with goods and services at a nearly ~75% off their typical retail value, so that you may sell it at ~50% of the typical retail value, and you must amass ~10,000 employees to perpetually hunt down supply inventory, the soundness and sustainability can be easily questioned.


Groupon was always a ponzi like scheme. Once they ran out of suckers (err businesses) their income dropped like a rock. Everyone I know uses Groupons but challenge them on actually visiting the Grouponee again and you hear crickets.


When people complain about how the $1 billion raised in 2011 just went to insiders - did the investors who contributed that $1 billion know where the money was going to go? If they knew, then it's all their fault.


They knew. And wrote the checks gladly.




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