Gloom Clouds Venture Capital Hopes for Groupon

October 22, 2011

It was supposed to be a golden year for struggling venture capitalists; a renaissance of sorts for the downtrodden IPO market; a star lineup of technology and social media hopefuls plumped up with record venture capital investments ready to make their highly anticipated debuts. Then it happened. The bottom fell out from the stock market as investors became spooked by fears of a double-dip recession and volatility replaced any sense of clear direction.  Dark clouds began to gather over the IPO market as valuations were hit by worsening business conditions and lower revenues for the fledgling superstars. IPOs were postponed, once, twice and indefinitely.  Gloom once again set in for venture capitalists who, just nine months earlier were as buoyant as fleas on a bubble. Oops, did we say bubble?



But not all was lost. One of the more highly anticipated IPOs of the year was going forward – damn the torpodeos! Full speed ahead!  Groupon, the recipient of a record $950 million of venture funds earlier in the year, filed for its IPO for the late fall. Investors and VCs were giddy once again.  The top investment bankers converged upon Groupon to make their pitch for underwriting bragging rights. Goldman Sachs, Morgan Stanley and Credit Suisse emerged victorious as lead underwriters and proclaimed the market valuation of Groupon to be in excess of $30 billion. It was to be a glorious pay day for everybody.  Then it happened.

After a nearly 100% increase in revenues during the first half of the year, it had skidded to a near halt during the summer increasing by only 13% in August indicating falling revenues at a time when the company had yet to generate a profit.  Cha-king.

Then it was discovered that, of the $950 million raised in January, $810 million was paid out to investors and employees with the company founders taking home over $300 million. Cha-king.

Then, after the SEC reviewed the filing, it was found that Groupon had applied some accounting maneuvers in order to boost its profit picture using a controversial method called Adjusted Consolidated Segment Operating Income (ACSOI). In essence, Groupon was trying to state profits without having to subtract marketing costs or stock-option payouts. Instead of $80 million in profits it tried to report, Groupon was forced to report more than $113 million in losses. Cha-king.

It was recently disclosed that, in order to finance its continuing operations, Groupon needs another quick infusion of $750 million which means the IPO can’t come soon enough.  But, that’s probably not what investors had in mind as they lined up to pump in $30 billion through the IPO. Well, they don’t have to worry, because it won’t cost them $30 billion; more like $10 billion, maybe less, which is the new guestimate on Groupon’s market valuation. But that’s OK because the investment bankers will still take home their hundreds of millions. Cha-king.

And now, with all of added scrutiny Groupon has invited as a result of its questionable finances, investors are now starting to question whether its business model is even sustainable. Increased competition in a maturing market amidst concerns over the likelihood that merchants will continue to market through loss-leading coupons, is instilling doubt over the prospects of sustained growth. Cha-king.

Even before its IPO, which, at this date, is still scheduled to proceed, the history of the Groupon experiment is being written and its failure is being analyzed. Beginning with over anxious venture capitalists trying to force growth where it won’t go, and overzealous investment bankers inflating valuations to spur investor enthusiasm, and ending with a company trying to appease its venture funders, investment bankers and the investing public by masking its dour profit outlook, there’s plenty of analysis to go around.  Had Groupon been allowed to grow organically, using incremental infusions of cash as opposed to nearly unmanageable lump-sums of capital, and given the time to prove the viability and profitability of its business model, might the story have turned out differently?  Of course, but then we wouldn’t have Groupon to kick around right now.



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