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Groupon Belly Flops Into Michigan’s Social/Tech Start-Up Pool

by P.D. Lesko

Groupon was founded and is headed by graduates from the University of Michigan. In January 2012, former AnnArbor.con business reporter Nathan Bomey wrote a glowing piece about Groupon, its founders and their connection to the local “job innovator” scene. The Groupon “success story” should be seen as more of a cautionary tale about how “job creation” is not really about creating jobs, but rather creating wealth for “innovators.” The local “job creation” scene includes the University of Michigan which, Ward 2 Council candidate Sally Hart Petersen repeatedly told voters, “spins off a new company every few weeks.” As A2Politico revealed in February 2012, when President Obama’s $2.4 billion dollars in stimulus money landed in Wayne County, the bulk of the money went to the county’s k-12 school districts—Detroit Public Schools got over $200,000,000 dollars. In Washtenaw County, when the Obama administration’s $767,000,000 in stimulus funds hit, the University of Michigan, rather than local K-12 school districts took in stimulus funds hand over fist.

The University of Michigan has developed another clever way to tap into the state’s tax coffers: Ann Arbor SPARK. Steve Forrest, modestly referred to on SPARK’s website as simply being associated with the University of Michigan, headed SPARK’s Executive Committee in 2011. Forrest is the University of Michigan’s Vice President for Research. According to a press release sent out when Forrest was elected to head SPARK’s Executive Committee, “Forrest was appointed U-M?s vice president for research in September 2005 and is a professor in the departments of physics, electrical engineering, and computer science. He personally holds more than 185 patents and has co-founded several private companies. He has been a driving force behind the university’s recent efforts to strengthen ties with business and industry.”

Many of the spin-off companies from the University of Michigan referred to by Sally Hart Petersen, get taxpayer-financed help, office space, business plan evals and money from Ann Arbor SPARK. Not only is the University of Michigan hitting up taxpayers directly for billions of dollars to fund research and development in-house, once the companies created to develop and market the patented products are spun off, Michigan taxpayers continue to foot the bill—while the University of Michigan collects the patent revenues.

Patents are huge business in higher education. In 1980, the U.S. Congress passed the Bayh-Dole Act, allowing universities to cash in on research conducted by campus brainiacs. For the smartest of the bunch, those royalty streams mean big money. According to a 2008 piece about the top 15 universities that rake in patent revenues published in Forbes, “The big brains behind these discoveries typically bag one-third of the licensing revenues, which can range from .05% to 15% of the revenues that licensees generate from the patent. The royalty rate depends on the industry and how much additional research is needed to commercialize the product.” The universities, on the other hand, rake in the lion’s share. n 2008, NYU spent $210 million on research related expenditures and took in $157 million dollars in research-related income for an investment yield of 75 percent.

That same year, the University of Michigan spent $875,000,000 on research-related expenditures and took in $25,000,000 in research-related income, for a yield akin to panning for gold in Grayling. Michigan officials spent $35 dollars for every $1 dollar earned in research-related revenue, for a 2.8 percent return. Michigan taxpayers could have deposited the money in a certificate of deposit and earned 4 percent that year. However, research and patents have turned into a gambling addiction for many large public American universities. There’s always the next hand of poker that could be the Big Win. In 2008, Northwestern spent $824,000,000 million on research related expenditures and raked in a whopping $368,000,000 in research-related income.

Then there are the tech and social media companies that the University of Michigan wants to help get off the ground, such as Groupon. U of M has set up the $5.5 million dollar Wolverine Venture Fund, advised by (among others) Brad Keywell, a U of M grad and one of the original three founders of Groupon. The fund focuses specifically on social media start-ups. The Groupon “success story” AnnArbor.com writer Nathan Bomey wrote about in January 2012 should be seen as more of an economic cautionary tale. However, the media (certainly not local media) and investors just weren’t listening. In June 2011 a TechCrunch.com piece guest writer named Rakesh Agrawal penned a piece titled, “Why Groupon is Poised for Collapse.” In that piece Agrawal writes: “Groupon is not an Internet marketing business so much as it is the equivalent of a loan sharking business. The $21,000 that the business in this example gets for running a Groupon is essentially a very, very expensive loan.  They get the cash up front, but pay for it with deep discounts over time.  (This post applies to Groupon operations in the United States and Canada; it’s different in other parts of the world.) In many cases, running a Groupon can be a terrible financial decision for merchants. Groupon’s financials also raise questions about its ongoing viability. Buying Groupon stock could be as bad a deal for investors as running a Groupon offer is for merchants.”

Bomey skips mention of the June 2011 TechCrunch piece in his glam coverage of Groupon. However, the TechCrunch article was a damning bit of brilliant analysis that hit before Groupon’s November 2011 IPO. While the company raised close to $1 billion in cash 10 months prior to the IPO. By the end of March 2011, it had only $209 million in cash. What happened to all that money? The company’s IPO filing spills the beans: $810 million was paid out to CEO Andrew Mason and some of his backers, including Eric Lefkofsky, whom AnnArbor.com’s Nathan Bomey holds up a shining example of Ann Arbor grown business done right. Lefkofsky and his wife Elizabeth made off with over $310,000,000 from the money-losing company through various limited liability corporations they set up as early as 2007.

Groupon was dogged by controversy even as Nathan Bomey’s coverage gushed.

First, there was the class-action lawsuit that slammed the company for violating a variety of federal gift card regulations. Groupon settled. Then, Groupon got hit with an insider trading lawsuit by new shareholders who were, understandably, irate that the stock, that debuted at just under $30 per share, plummeted in value as insiders made off with sacks of cash. The value of Groupon has fallen 80 percent (to under $5 dollars per share) since the IPO, and the bad press is almost unrelenting. The Sunday August 19, 2012 edition of the Wall Street Journal detailed the pull-out of several of Groupon’s major pre-IPO investors who are, it appears, getting while the getting is good. On that news, the company’s stock dropped another 2 percent.

There have been repeated problems with Groupon’s accounting and the company was forced to revise its earnings statements—unusual for newly-minted public companies. This slip-up resulted in an April 2012 piece published in Forbes magazine titled: “Groupon: Where were the auditors?” It’s ironic (or perhaps prophetic) that a company nurtured by Ann Arbor SPARK should have auditing irregularities. In 2008, an audit of SPARK’s finances found “accounting problems that led to overbilling and underbilling due to geographic ineligibility. It also found conflicts of interest during its 2008 fiscal year,” reported the Ann Arbor News. SPARK officials now refuse to release financials to the public, including audits. In late 2011 and early 2012, A2Politico filed Freedom of Information Act requests with all local and county government entities that funnel public money to SPARK, and none of the city and county governments had copies of Ann Arbor SPARK’s recent audit statements, budgets or 990 tax return forms.

If only Groupon had that luxury.

In a piece posted on August 20, 2012 at InvestorPlace.com, writer Jeff Reeves has this to say about Groupon: “The company continues to see growth headwinds and suffer from messy accounting and the general impression of mismanagement.”

Groupon, located in Chicago, can’t even catch a break from the Chicago Tribune. The day after the Wall Street Journal’s August 19th published that investors were pulling out of Groupon, the Trib published: “Why Groupon is over and Facebook and Twitter should follow.” In that piece, writer Peter Cohan doesn’t mince words: “In June 2011, I wrote that the SEC should spare investors the agony of losing their money when Groupon sold its shares to the public. The SEC did not listen to me (no surprise there); Groupon went public in November 2011, and that day’s Groupon stock buyers are now 82% poorer….But Groupon’s biggest victims are the small businesses that get suckered in to accepting Groupons. Restaurants lose money on them because consumers flood the restaurants, order very low priced meals, strain waiters and cooks, get lousy service, and never return. Examples abound. As I wrote in June 2011, a restaurant in Portland, Ore. believes its decision to work with Groupon was its worst business decision ever – costing it $8,000. And according to the New York Times, Muddy’s Coffeehouse –it serves coffee and granola – had to take out a loan to cover its Groupon losses.”

Groupon’s biggest victims? That Bernie Madoff-sized vitriol.

In the January 2012 AnnArbor.com interview, Brad Keywell wouldn’t talk about Groupon’s “corporate strategies.” It’s possible, based on the reporting of business writers at publications with higher editorial standards than AnnArbor.com, Keywell had no idea what Groupon’s corporate strategies were. In AnnArbor.com’s groupy Groupon interview, Keywell coyly refuses to say whether his company might open an office in Ann Arbor. He does, however, say “ Michigan’s economy is ripe for an entrepreneurial turnaround. If Michigan gets it right, it can become a home to innovators and risk-takers and a home that embraces those that are out to change the world and tries to provide a super friendly home for their journey.”

Yeah. Right. Innovators and risk-takers? Biznobabble.

The Groupon Three have overseen a very public and embarrassing social media industry belly flop. The IPO lured rubes into investing in a company whose business model (as TechCrunch writer Rakesh Agrawal pointed out in June 2011) analysts have called “fatally flawed”—a model that is a “bad deal” for most merchants. Just as Governor Snyder did when he went on a trade mission to Europe and pitched investment in a failing Michigan tech company that had already lost $412.3 million dollars, Keywell pitches Groupon as a “fabulous business model” overseen by a “spectacular” CEO. Did the Groupon Three learn this scam in Ann Arbor at the knees of the master boondogglers running Ann Arbor SPARK (starting with Governor Rick Snyder, who headed SPARK until 2008)?

Slate.com writer Farhad Manjoo posted “The thrilling (and welcome) demise of Groupon.” It is a nail pounded firmly into an e-coffin. Manjoo writes:

Now, after a spectacular debut on the Nasdaq, Groupon is a public company. This week, it reported its second-quarter earnings results. The numbers were dismal. They paint an unmistakable picture of the future of Groupon and similar sites: The daily deals industry is drying up. Groupon reported that its customer growth slowed substantially over the second quarter, the amount of money that each customer spends on the site tanked, and the company’s “guidance” for the current quarter suggests that things are going to get a lot worse.

The spin from Groupon’s executives was not very encouraging. In a conference call with analysts, the CEO Andrew Mason kept talking up Groupon Goods, a service in which Groupon sells discounted merchandise to customers — in other words, something completely different from the coupons that earned the firm its IPO.

The fact that even Groupon is no longer banking on Groupons is fantastic news for everyone, especially all of us who are sick of morning email deal spam. But the biggest beneficiaries of Groupon’s problems are the world’s small-business owners, people who will no longer be taken in by its terrible deals. This week, Groupon’s stock was down nearly 30 percent. Its demise may not be imminent, but it seems assured. Let’s all rejoice.

Of course, in June 2011 Rakesh Agrawal suggested how small business “victims” could get back at the Big Bad Groupon:

Hacking Groupon

How would you exploit an overpriced loan? Don’t pay it back.

Assume that you’re a business that is unscrupulous and you’re looking to make a quick buck. You could create a wildly generous deal that would sell like crazy. In about 30 days, you’ll have 2/3 of your share of the deal. Then you shut down operations.

It also works for businesses that are just having a tough time. As critical as I am of Groupon, the slam dunk case is to sign up with Groupon if you’re going bankrupt. I strongly encourage every business that is about to go under to call Groupon. (Don’t tell them Rocky sent you.) It makes total financial sense—as a Hail Mary play. If you’re lucky, the upfront cash will be enough to help you stay afloat. If not, well, you were already going out of business. It may be your best option.

If hacking Groupon strikes you as sleazy, think of the Groupon Three, Keywell, Mason and Lefkofsky, making tracks with close to $500,000,000 of the almost $1 billion in capital raised prior to their company’s IPO. Don ‘t forget to add in a sprinkling of alleged insider trading, and a dollop of documented poor accounting practices. Ask yourself this: since when do the definitions of “entrepreneurialism” and “innovation” include taking advantage of small business owners and loan-sharking? Since forever, if we’re taking about organized crime. Who knows? Perhaps Keywell was suggesting Michigan is ready to be pillaged by entrepreneurs whose business models are based on time-honored methods employed by crime syndicates? I hope not. If Michigan’s economy is ripe for an “entrepreneurial turnaround,” as Keywell suggests in his AnnArbor.com interview, local business leaders and local venture capital firms (including the University of Michigan’s Wolverine Venture Fund) have to do a better job sniffing out the obviously flawed and even predatory (as The Chicago Tribune suggests about Groupon) social media and tech business models. The chances of that, alas, are slim to none. It would be better to simply strip all of these Michigan “job creation” hucksters of access to public money. Then, they can engage in all the risk-taking they want—with their own millions. Guys like Michael Finney, former Ann Arbor SPARK CEO and now head of the Michigan Economic Development, would be out of his $250,000 per year job.

If that happens, let’s all rejoice.

I’m hoping Groupon modifies its business model (a larger split with participating businesses and more restrictions on users come immediately to mind) and pulls through. After all, the company employs around 10,000 people. However, I’m cashing in my Groupon deals ASAP. Analysts predict that Groupon’s stock will fall to $3 a share before summer is over. From there, it could be all downhill. 

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