Groupon is the next Madoff, except big iBanks helped it rob investors

http://www.glgroup.com/News/Groupon-is-the-next-Madoff-except-big-iBanks-helped-it-rob-investors-54999.html

by chmike • 15 years ago

135 67 15 years ago

glgroup.com

ebaysucks3• 15 years ago

I really hope the Groupon IPO fails, because if it pops like the Linkedin one the bubble becomes undeniable IMO.

With all the free freshly printed money floating around on Wall Street, I am not holding my breath though.

Jarred• 15 years ago

I'm not educated well in economics, but I don't think there will be a bubble until massive amounts of people start investing in ideas for websites.

ebaysucks3• 15 years ago

The US bailouts were approximately $16K per capita, so whatever the banks receiving that money do with it replaces the massive amount of interest needed for a bubble.

WarDekar2• 15 years ago

What do you mean the LinkedIn IPO 'popped'- isn't LNKD currently around the same value as it was after the first day of trading? (90ish)

treelovinhippie• 15 years ago

The Groupon model IMHO is not sustainable unless they can generate repeat business. It's great a system for securing guaranteed customer numbers. But with such a huge discount to attract them, and with 50% of that going to Groupon coffers, I don't see the benefit to small-medium businesses. Larger businesses could write-off the deal and attempt to either increase brand awareness or upsell instore. But even then, they're risking enforcing a consumer mentality of only buying at the discounted rate.

mitultiwari2• 15 years ago

A few ways Groupon is helping local businesses:

1. Groupon is bringing offline local businesses online. The same way Google brought small advertisers/small businesses online.

2. Groupon could be a useful way for business to get some cash up front for future customers. That cash may help small businesses expand, instead of taking loans to expand.

3. Groupon cost of small businesses could be useful marketing cost since Groupon deal reaches out to many local customers.

Slightly old but interesting read on this: http://www.evanmiller.org/is-groupon-the-next-google.html

Further, this article itself mentions "Note massive competitors like Google, Facebook, Walmart, Opentable, etc. already doing their own versions of daily half-off deals". As people have said "imitation is the best form of flattery". So many Groupon clones show that there is a demand for such a service from both small businesses and consumer sides.

However, some of the accounting practices of Groupon and the way Groupon used recent investment money seems unusual and have raised a lot of eye-brows.

ookblah• 15 years ago

1. This is good, as long as these local business are being educated on the benefits/risks vs just being told it's good overall.

2. Groupon deals are used as a marketing tool to (hopefully) attract long-term customers/develop buzz. Merchants lose on every deal so I don't know what you mean by "cash up front".

3. Look at #2

Imitation may be the best form of flattery, but it may also just indicate that everyone is jumping into a hyped up market. Look at the aftermath of all the social networks. Except that Groupon doesn't benefit from user loyalty effects.

IMO, it's unsustainable growth in it's current form. I think they can develop a profitable business (as they did before), but sustaining that hyper growth curve....not so sure.

I don't understand what Groupon hoped to gain with it's "first-mover" advantage. Everyone I know (including me) who buys groupons does it just because they give the best deal for a specific business, not because I'm somehow loyal to Groupon. I will just as readily use Living Social or Buywithme or whatever other coupon site is out there. Until they fix this, the market will just be saturated with more and more players. Race to the bottom.

mitultiwari2• 15 years ago

When a deal appears for a business on Groupon, people buy those deals that day and visit that business later on. That's what I meant by "cash up front".

Yes, I agree with you that barrier to entry is very low. However, Groupon has so many businesses lined up (since they have maximum reach) that Groupon can choose the best deal to offer to customers. That's the advantage Groupon has compared to others.

cowboyhero• 15 years ago

Fair points, but:

1: This isn't exclusive to Groupon, and I'm not sure they're doing anything that CitySearch and AOL weren't doing in 1998.

2-3: Purely anecdotal but I've heard too many horror stories of small businesses being screwed by their groupon deals, essentially losing money on the discount and not attracting enough repeat business to justify the deal in the first place.

The problem with the model is that it attracts customers who are focused on price, not value. That's at odds with the proposition behind many specialty stores and boutiques (eg vinyl records, hair salons, upmarket clothing, etc).

Groupon as a standalone business just digitizes those local coupon books that used to come in the mail or be sold at bulk for ten bucks or whatever. That's a good web based business but not a great one.

cookiecaper• 15 years ago

I'm curious if Groupon has some minimum discount levels, because I frequently hear that people lost a lot of money on Groupon, and logically if you're going to lose a lot of money on a coupon you're offering, you won't offer it. Obviously some reduction in margin is necessary, but if it actually costs money to provide the service after the Groupon, that's a bit past the point of reasonability. The same rules that apply to traditional coupons should apply to Groupon because it's a similar target audience -- coupon clippers have never really been known to be "great customers".

Is there a reason so many businesses provide such deep discounts to Groupon? Are they just caught up in the hype, and Groupon can demand huge discounts because so many merchants want to use it?

tzs• 15 years ago

There are also many stories of businesses that did well. It probably depends on the kind of business, and exactly what the deal is. The local NPR station did a story on this a while back, and looked at a couple businesses and how it worked for them.

One that was a success was a small auto repair shop. They did a Groupon deal for $30 oil change for $10, so they were only getting $5 out of it which doesn't even cover the oil. They expected to get about 90 customers. They got 2277.

After three days of not sleeping and throwing up everything he ate, the owner snapped into action and bought a second car lift, added more staff, and scheduled appointments for all those people (which had people scheduled out for 8 months).

Overall, it worked out. The owner told the reporter that before this, he was driving a '93 Ford F150. Now he's got a Mercedes convertible and his wife has a BMW, both paid for. Sales are up $200k over the previous year, and half of the people from the deal have become repeat customers.

Compare this to the other business they looked at. This was a cafe that sold crepes and coffee. They were trying to get people to think of them also as a dinner place. They did a Living Social deal that for $40 let you come in six times (no more than once in a given month) for two entrees and a bottle of wine or a drink of your choice.

They got 1200 takers.

Like the auto repair deal, this one is a loser, depending on the customers buying other things to turn it around. Unfortunately for the cafe, the customers with the deal did not buy other things. They would not buy appetizers or desserts. They would just come in once a month for their six months, get their two entrees and a drink, and that's it. The owner says she lost $100k.

lucasjake• 15 years ago

I think ultimately what might happen here is that the government will regulate VC to make it difficult or illegal for fundraising rounds to be used primarily to pay off earlier investors. Saying it out loud like that made me realize how close to a ponzi scheme such a thing could easily become.

ebaysucks3• 15 years ago

So it's OK if you raise money in an IPO from a lot of small investors, but it becomes illegal if you raise money from a few experienced investors?

tomgallard• 15 years ago

Groupon can work excellently for small businesses. They just have to know what they're doing.

A friend runs a coasteering/outdoor activity business that has used them multiple times. As they have under utilized capacity , the marginal cost of extra customers is near zero (imagine they can take up to 12 people on an activity, but only have 3 booked in).

It doesn't matter if Groupon is taking 50% of this, they still see an increased profit.

The danger is, of course, cannibalizing their existing customer base, but, as a reasonably new company, its much more important to get money, and customers, coming through the door.

WarDekar2• 15 years ago

That's great if the businesses purchasing Groupons are aware of this and know how to use the deals to their advantage. The problem comes when Groupon doesn't care about the businesses they're selling to at all and push sales that actually hurt those businesses. It's great for Groupon's current revenue, but it's horrible for their long term prospects- there are only so many small businesses you can screw over before they all realize it isn't a good deal for them, and Groupon's business drops off a cliff.

And I'm not excusing the small businesses here- certainly they should do their own homework and determine whether doing a Groupon deal is a good business decision for them, but when Groupon sales people are pushing these things like crack and pressuring businesses into buying what is an obviously negative value deal, they (meaning Groupon) won't get good referrals in the business community, they won't get repeat customers, and they'll run out of 'users' to exploit.

From all accounts it seems sales reps at Groupon have no interest in helping their customers come up with deals that actually make sense and are only interested in volume because they get commission bonuses- this is not a long term business model.

craigmc2• 15 years ago

Groupon is presumably taking 50% of "50% of this"? And surely even for a service orientated business 25% is getting pretty close to the fixed cost base (fuel, insurance, kit, etc)?

puredemo• 15 years ago

So Google wanted to buy them for $6B because... why?

Just to jump into the action late and lose money?

luckyisgood• 15 years ago

Because Google wanted to buy time AND customers.

By buying Groupon, Google wouldn't have to spend their own developers' time to create what is now Google Offers. And time is expensive. Time spent on Google Offers was not time spent on, let's say, Google+.

Customers: E-mail addresses of 115M people have to be worth something. To Google, those addresses are probably worth more than something.

Also, Google has something Groupon does not: real cash in their pockets. Groupon must spend a lot of $$$ on avertising; to Google, marketing would be virtualy free.

What I'm saying is this: Groupon is running itself into bankruptcy; Google probably found a way to use their own resources to make Groupon wildly profitable.

patio11• 15 years ago

Groupon is a legitimate business, which sells a real product for real money, in a manner that attempts to generate value for customers in a two-sided marketplace. It is an exceptionally risky business, like every other startup that aspires to the trajectory of "Go from nowhere to selling a billion dollars of product in two years."

It is entirely possible investors will get burned in an extraordinary fashion on Groupon. It is also possible they will end up with money hats. Capitalism happens. If capitalism happening to you would negatively impact your ability to feed your family, do not buy stock in Groupon. (Do not buy any individual stocks, either.)

With regards to their accounting practices: I'm agnostic as to whether any particular treatment of another company's numbers is maximally reflective of the interests of third-parties wishing to invest in them. That said, have you noticed we are not exactly a paint-within-the-lines industry?

Heck, even answering very freaking simple questions with intent to be maximally honest while complying with all regulations gets very difficult. For example, when do you think you can recognize revenue for selling someone $10 for 1,000 gold coins if they then immediately spend 500 gold coins on a Sword of Dragonslaying? If you have not read about this specific case before, I guarantee your first three guesses are wrong. Or, to pick an example near and dear to my heart, what exactly is getting sold when you take $29.95 from a customer and mark their account as Registered? Is it real property? If so, where is that property sold? "The location that a customer takes delivery", swell: do they "take delivery" at my business or at my server or at their home address or at their place of work? Is it perhaps not a real property and instead royalties? Is it a fee for a service? Oh, that depends on whether customization and support is offered: how much support is support? Answering emails is support if I make changes to the product on the basis of them?

I have given tax offices on two continents head-explosions just with the accounting for BCC. This stuff is hard.

teej• 15 years ago

I think you've woefully misunderstood the issue at hand here.

No one is claiming that Groupon isn't a real business. They've made a household name and their reach is undeniable. Many of us have paid out of our pockets to buy from Groupon. I know I have.

No one is saying that investing isn't dangerous. The market has always worked this way and Groupon is no exception.

Recognizing & reporting revenue for software and virtual goods is a -solved problem-. Take a look at EA's earnings report or Zynga's IPO filing if you want to understand how the big boys do it. The accounting required is certainly tricky, but it's also widely accepted and tied to reality. While Zynga's profitabilty in the future is uncertain, their profitabilty right now is NOT.

====================

There are two core issues with the Groupon filing:

* Their use of ASCOI grossly misrepresented their profitability -right now-. They may have an innovative business, but the way they handle money isn't that different. Certainly not different enough for them to invent new ways to report earnings. Thankfully, the SEC agrees with me here and has asked Groupon to redo some of their funny math.

* Their last round of financing almost ENTIRELY went to cashing out previous investors. That has nothing to do with "taxes being hard". It has everything to do with sketchy business practices.

In conclusion - Groupon's filing isn't scary because IPO's are hard. Groupon's filing is scary because they were a little TOO creative with their math and they've done some undesirable things with their cash in the last 6 months.

timack• 15 years ago

"Their last round of financing almost ENTIRELY went to cashing out previous investors."

Sounds a bit like a Ponzi scheme.

notahacker• 15 years ago

To put it simply, Groupon provides a service which is essentially customer acquisition. In order to report a profit, they use unconventional methods of accounting that imply costs of their own customer acquisition are irrelevant to their profitability. It's not esoteric or one-off costs they're eliminating from their "profit" figure.

Given that Groupon have attracted attention more for their claims of profitability than any particular novelty or technical superiority it's more than a little concerning that using conventional accounting methods they're making a loss, and it's ongoing marketing expenses rather than one-off acquisitions and compensation schemes that are to blame.

powera• 15 years ago

Just saying "accounting is hard" doesn't mean anything about Groupon. Groupon's valuation is a bubble at best, and a scam at worst. Every accounting other than their own cherry-picked numbers supports this.

omarchowdhury• 15 years ago

"Note that original investors have cashed out more than $800 million, instead of using the money for operations."

michaelchisari• 15 years ago

Capitalism happens.

Except that the net economic effect of this kind of reckless activity and their subsequent collapse extends to people who have no idea what a Groupon is or does.

If it was a system that touched only those who actively engaged with Groupon, it would be a different story. But that's not how things work.

shareme2• 15 years ago

You miss-understand the issues involved:

1. Groupon management chose the high risk style of customer acquisition with high upfront marketing costs.

2. Groupon management chose to use funding rounds to cash first-inline investors and employees out due to choice in 1.

3. Groupon than chose to hide that high risk in A SEc filing.

I feel so strongly about the ethics here that I have refused to go to work fro any Lightbank Incubator start-up. Groupon ethically challenged operation. Similar to Enron, etc.

It is not if they will get burned its when

dedicated• 15 years ago

The local space is still to be figured out. The fact that Groupon can generate so much revenues, despite bleeding margins in its marketing expenditures, still makes it the leader in this disruptive field.

The bigger question is how and whether they will retain this lead, when local retailers and competitors get smarter about this space, and create better margins for themselves.

At the end of the day, the Wall Street traders will make the "proper" move and properly price it on its IPO day. How it will fare in the long run is still anybody's guess.

lsc• 15 years ago

Now, I'd certainly never put any of my dollars anywhere near a groupon IPO, but the article seems a little harsh.

"Recognizing phantom revenue (dollars that are supposed to flow to their clients) and not actual revenue (their cut)"

This seems fairly standard to me. I mean, when I sell co-lo, rather more than half what my customers pay me goes directly to pay /my/ provider, and yet my revenue is all of what my customer pays me, even though no matter how efficient my operation becomes, more than half of the money only sits in my account momentarily. This is my understanding of the commonly accepted distinction between revenue and profit.

I mean, clearly, groupon is a very high-risk "swing for the fences" kind of startup, and ACSOI does seem to be sketchy to the point of being deceptive, but revenue is revenue, and profit is profit. There's nothing wrong with reporting your actual revenue numbers before taking out your expenses; that's what revenue /is/

_delirium• 15 years ago

If you're passing through revenue, though, it's often not counted, though it seems to vary by industry and exactly how it's passed through. For example, Paypal's revenue is only its fees on transactions, not the entire volume of transactions that flow through Paypal: its role is a facilitator, and its revenue is what it gets paid for facilitation. The same is true of marketplaces, typically; eBay's revenue is its fees, not the entire volume of purchases that happens on eBay. Groupon arguably has a similar structure, in that they're a marketplace facilitating sales, in which case only their fees should be revenue, not the total volume of goods whose sales they facilitated. But it's arguable.

craigmc2• 15 years ago

Groupon's biggest issue as far as I can see is that the value of their cut of the deal will eventually be heck of a lot closer to $0 than it currently is.

They are exploiting a market inefficiency (the gap between small biz and their potential customers) and it one that is closing rapidly via a multitude of sources, and not just from competition within the daily deal sector.

And although this post title is clearly being deliberately provocative, one thing is true: there are going to be plenty of businesses and deals currently being lauded, which turn out to be total disasters (as there were in previous cycles - Enron, AOL Time Warner, Excite@Home, Webvan, et al). It is certainly not unthinkable that the Groupon IPO is going to be one of them...?

(the amount of money that has already been taken off the table must be a near-deafening warning bell)

ForrestN2• 15 years ago

The premise of this article, that Groupon is the next Madoff because it has already scammed many of its investors, is calling out some pretty powerful investors as idiots. This isn't saying just that participants in the IPO will be getting scammed, it's saying that the last rounds of private equity got scammed too.

I somehow doubt that this simplistic analysis trumps the thinking of major investors putting hundreds of millions into Groupon. Don't you think they were asking about customer acquisition? Don't you think they asked about why the initial investors were taking money off the table?

raganwald2• 15 years ago

Your argument is an Appeal to Authority. "Smart people invested, so it must be a good thing." Social proof is useful for making certain types of decisions, however discussions about posts on HN are not decision-making exercises, they are--ideally--analyses of the arguments advanced in the post itself.

If the analysis is wrong, we ought to be able to dispute it directly rather than assume that since all that big money is in the game, they must have analyzed these arguments and they must have disputed them.

ForrestN2• 15 years ago

Lots of other people are digging into the arguments themselves. But it's not just about the superior analysis of the investors, it's about their superior access to information. The idea that two simple, broadly available pieces of information (investors taking money out and completely transparent, though non-traditional accounting practices) are obviously disqualifying and yet people with strong track records are investing huge amounts of money makes me suspicious.

There are other signals of silliness here, most conspicuously the comparison to Madoff and Ponzi Schemes. It's link bait; even if Groupon is being manipulative with their accounting, they're still providing a real service to real people. They're providing value to businesses and customers. If their argument was about the sustainability of the model, or even just about the justification behind recent valuations, that would be something I'd be more interested in approaching in the way you describe.

I guess I wasn't aware that HN's limitations on ideal discourse are so severe. I figured there might be a way to add value by getting some perspective about the implications of this argument and their improbability.

tatsuke95• 15 years ago

"This isn't saying just that participants in the IPO will be getting scammed, it's saying that the last rounds of private equity got scammed too."

When Groupon IPOs, anyone with money already in stands to gain. The later into the pool you were, the less you stand to make, but I wouldn't go as far as calling the late equity "scammed".

Personally, I think the writing is on the wall for Groupon, and it's just a matter of time until implosion. However, that's not to say that many investors won't make a killing (some already have).

mattvanhorn• 15 years ago

Ironically, there were some pretty powerful investors scammed by Madoff as well. Herd mentality occurs everywhere.

nhangen4• 15 years ago

I'm not a fan of Groupon either, but damn, just because they are easy to poke at doesn't mean we should.

Investors are supposed to perform due diligence before investing in a company, and if they didn't, then they weren't scammed, they were stupid. Groupon's scheme is not that clever to the point where it can obfuscate the truth from an equally clever investor.

This is like blaming McDonald's for having hot coffee.

burgerbrain3• 15 years ago

If investors are allowed to talk about it, then why are not we? And are not many of us investors ourselves?

nhangen4• 15 years ago

Nothing wrong with talking about it, but reading the comments it seems like everyone is piling on.

I get it, people don't like Groupon, but some of this is less based in rationale than in emotion/personal disdain for the product.

nsimplex• 15 years ago

Is it the case the group buying model is inherently flawed as a business, or did Groupon screw it up just because they didn't execute properly and over-expanded? (assuming they did screw up, based on the recent reports analyzing their finances.)

In other words, what are the chances that other group buying sites will go downhill as will?

veyron• 15 years ago

Both are true.

Groupon picked the low hanging fruit already without consideration to their existing customers. I haven't heard a single compliment from my business-owning friends about working with groupon, and almost all of them now refuse to work with any daily deals site. So now they are pushing for other businesses which are much more expensive to find and woo.

The model itself is broken: the most successful places have no need to run a daily deal. The failing businesses have real incentive, but there's probably a good reason why they are failing in the first place (and some of my friends have noticed strange service irregularities -- recall the FTD issue earlier this year). Finally, New businesses are inadvertently hurting themselves. When you give out a free sample, people don't expect an item to be free. When you give a daily deal, everyone (not just the participants) mentally shift their price expectations, and it's hard to raise the price again without alienating both the daily deal followers and true customers.

What will win is a group buying program where people can come together and order a service (such as minibuses or family-style restaurants).

shareme2• 15 years ago

To give you an idea of ethically challenged Groupon is:

In the recent SEC statement mess Groupon attempted to pull a fast one by subtracting employee stock compensation. in the USA we have the accounting standards board which governs the accounting rules that accountants follow.

In fact you cannot get a state accountant license without committing to those rules and standards. Guess what one of those standards is never using a basis to subtract employee stock compensation from costs.

Which begs the question where did they get an accountant to sign off on that given that if it went through he or she would be subject to losing their state accountant license?

There is more here that we are not hearing..

I feel bad for Lightbank having such a bad shadow cast on their Startup incubator work by some of the founders.

awakeasleep• 15 years ago

Have you read about Lightbank's history? Groupon is one of the least shadowy things it has been involved with.

Also, if you think Eric and Brad aren't behind every single aspect of how Groupon is going public, you've got another thing coming.

Keep in mind, that Lightbank is not like ycombinator. It isn't settling for a few percent of the company.

byrneseyeview• 15 years ago

I tried to find where Groupon was "hiding $180 million of actual online marketing spend," but it was really tough. Unfortunately, Groupon's financial statements include that allegedly hidden number.

The author of this piece is not especially familiar with the daily deal market. OpenTable has consistently said that they don't want to be in the daily deal business, for example; they absolutely don't want to be a Groupon competitor. The author is also unfamiliar with developments in capital markets in the last ten years: it's gotten harder to IPO, but there's a lot more capital available for growth-stage companies. So it would be surprising and unprecedented if investor cash-outs didn't shift to the pre-IPO stage.

Finally, this is old news. This kind of article and analysis showed up when Groupon first filed their S-1 with GAAP financial statements (i.e. statements that would allow you to completely ignore CSOI). Calling it the next Madoff is a boring rhetorical trick. Groupon is not a great business, and I would rather be short than long at the projected IPO price. But it's also a real business that could be structured to earn a decent return for investors. Everyone can see that Groupon adds some value, and the real question for investors is whether they're right about the market size and the economics of the business.

Calling Groupon a ponzi scheme is amateurish.

Groupon is the next Madoff, except big iBanks helped it rob investors

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