PrivCo may be wrong, but LivingSocial's CEO is still sugarcoating this round
There is a world of people who have been poised, ready, and willing to dance on LivingSocial's grave.
The torches and pitchforks have come out in full force against daily deals as everyone who ever played a role in hyping Groupon tries to pretend they never did. As the distant number two to Groupon, that doesn't leave LivingSocial in a great position.
Beyond that, there are entrepreneurial purists who think LivingSocial shamelessly ripped off Groupon's business model, such as it was, and that this is all karma. Said our always acerbic Bryan Goldberg over Gchat this morning, "I don't wish ill on other founders or startups, but I do when they steal someone else's company so shamelessly."
So it's not a surprise when no sooner did LivingSocial raise $110 million, then a pack of vultures came out to rip the deal apart. PrivCo wrote a damning report that LivingSocial's CEO Tim O'Shaughnessy has directly refuted in a leaked internal memo.
Kudos to O'Shaughnessy for eviscerating what seems like at least a partially inaccurate report on a company that's an easy target right now. That said, let's be honest: LivingSocial is hardly out of the woods here.
There are a few parts of his memo that are pretty big "ifs" even for the most optimistic of entrepreneurs. He carefully phrases some things as rebuttals to PrivCo, that aren't really rebuttals to the overall concerns about LivingSocial's prospects.
Let's take a look at the wording:
- He characterizes that this wasn't an "emergency round" by saying they got their first term sheet two months ago and this has been an "organized, thought-out process." I don't doubt that. But that doesn't mean the company wasn't in an emergency cash situation. "Emergency" doesn't mean they were running around with their hair on fire screaming at people to give them cash. It means, simply, the company had to raise more money, or it would go bankrupt, maybe not within days but certainly months. As we detailed in an earlier post, LivingSocial was running out of cash and needed an infusion or a white knight to keep going, a fact that this fundraising and his memo essentially confirms. A single term sheet signed in December does not mean the deal was done or that fundraising was easy or that it was not an emergency situation. PrivCo's description may not be fair, and parts of it may be inaccurate, but O'Shaugnhessy's characterization isn't totally on the level either.
- Add to the "emergency" aspect that there are uniquenesses to the daily deals business. If merchants have no confidence that there's enough incoming money from new deals to pay them what they're owed, there can effectively be a run on the bank situation. That combined with dwindling cash is a hard position for anyone to be in when they are trying to fundraise -- I don't care how great your promise may be -- particularly when all of the existing investors are not reupping.
- He disputes the report of a four times liquidation preference, but he implicitly says that there is a multiple liquidation preference, which is an arduous term for any venture deal. It implies the negotiation was not easy, and LivingSocial was coming from a position of weakness. Period. Single liquidation preferences are the norm for a healthy company; multiple are not.
- His comments about valuation being a meaningless metric to consider are disingenuous. When you are on the way up, perhaps valuation is a faulty indicator, as I too have argued many times. But when you are doing a down round the valuation has real repercussions for your employees. Anyone who lived through the early 2000s gets that. In company after company, employees were left holding an empty bag. Sure, most VCs do carve outs of stock, because it doesn't help them to have a team with no incentive to get an exit. But that's usually limited to the management team unless it's a total recap. The rank and file employees suffer. Saying it's not an issue is about as disingenuous as people claiming Facebook's botched IPO didn't have cultural ramifications within the company.
- While he admits it was a down round, he down plays it by saying LivingSocial "only" needs to clear a $1 billion valuation to be okay. He points out that Groupon still has a $3.9 billion valuation. While true, Groupon is also then No. 1 player in the market, not a direct comp as O'Shaugnessy would have his employees believe. There is typically a far, far bigger delta between a number one and number two player in a market, so the comparison is misleading. And I'm not sure anyone is clear that Groupon's stock is done sinking.
- In the same graph, O'Shaugnhessy says that "in the event of an IPO, all preferred stock becomes common stock, and the preference stack goes away." I was stunned to read such a blithe assumption that an IPO is on the table for LivingSocial. Even the best fundamentals aside, we are in a different market reality than when Groupon went public. I don't get what banker they think wants to take the No. 2 daily deal site out when Groupon, Zynga, and even the far stronger Facebook have all struggled. Put another way, there is tremendous risk in this category that has not yet settled out. Institutional investors are not likely to bet on the number two player, when the number one player has plenty of shares available at a discount to its opening price. If you're a bull on daily deals, there's already a stock for you. The problem is there aren't many bulls. If I were O'Shaugnhessy I'd be concerned about leading employees on in thinking an IPO is still an option at this point.
- Perhaps the most worrying line, for me, was where he noted the company does half a billion in revenue. No doubt -- that is a lot of money. But the very knock on Groupon was that its revenue growth was unsustainable and hyper-inflated. The metric everyone wants to see with daily deals sites isn't big revenue in this climate. It's evidence that this model actually works and is sustainable. And LivingSocial is still not profitable despite more than $1 billion in private capital.
He was talking about the harrowing experience of running Opsware post-dot com bust and said, "I always thought it was my job to make everyone positive. [That] turned out to be really wrong -- like, dramatically wrong."
He went on to tell the story of a family friend who worked at AT&T. Horowitz also knew an executive at AT&T and asked if he ever came to see the rank and file staff. To which the family friend said, "He'll come around and talk to us every now and then...he'll come blow sunshine up my ass." Horowitz continues:
After that I really changed my style as a CEO, and I took the opportunity with every problem that we needed to fix to go in front of the company and say, 'Hey, here's what's wrong. Here's what we need to fix. If we can't beat these guys, they're going to kick our butts out the door.' That's the biggest lesson I learned around motivation in general. Every company has shit that's wrong with it.
[If you deny that] either you're stupid or you're lying. Well, I actually [knew what was wrong,] so [was] I lying? I thought I was just being positive.