Friday, July 8, 2011

Groupon Commercial Finance

On a recent night out to dinner with friends, I had an argument with our companions, (pretty standard behavior on my part, actually,) that Groupon deals are a bad investment.  Today's WSJ story about copycat problems for Groupon makes me even more concerned.  Not surprisingly, huge numbers of competitors in the Boston area have sprung up. 

After purchasing my first Groupon deal, (to Fascino Restaurant in Montclair, NJ, which we enjoy several times a year,) it hit me that Groupon and it's race to the bottom competitors act as completely unregulated finance companies, issuing junk bonds and credit guarantees on those same junk bonds.  Groupon might be the worst financial guarantee insurer ever designed.

[DISCLAIMER: One reason I have not written much lately is that I am in the middle of setting up an insurance company over which I will exercise control.  This officially means I cannot risk advising anyone about anything insurance related until we have completed licensing.  Therefore, let me be very clear!  I am not providing anyone insurance advisory services, attempting to sell insurance or anything like that!]

How does Groupon Financial Guaranty (GFG) work? 

Imagine you own a restaurant. 

You are broke.  I know this because my wife's family business for god knows how long was restaurant and bar equipment and supplies.  Three generations of her family can confirm you are broke!

Virtually all restaurant owners are broke, even the really good ones with multi-million dollar revenues

You figure that GFG can help you raise some working capital and get great advertising at the same time.  How? Hundred dollar Groupon deals!  Sell $100 of food today for $50.  You receive $25 today (the underwriter and guarantor of the coupon keeps the other $25) with the obligation to pay off $100 at some time in the next year, when the coupons expire.

Maybe at Applebee's or McDonald's you don't lose money with a 75% discount on the food alone, but with your labor costs and higher cost food, you are definitely losing here.

You argue, however, that the coupon makes good sense.  It amounts to good advertising, getting your name in front of thousands of people who will become customers.  GFG clients who carefully track this information will tell you that you are wrong.  GFG raises capital from loan sharks (i.e. people willing to lend for an incredible deal and don't come back,) or your current customers who would have paid anyway.  (Sorry, Fascino!) 

Here's my scenario for what's really happening to you.  Your restaurant cannot make payroll, (that's why Town, above, went bankrupt!) No bank will lend you money.  So, you'll borrow from GFG to make payroll.  You'll rationalize. Late August is always slow--everyone leaves town!  Business will pick up in September.  

By September, business starts to pick up.  Coupons are rolling in!  Expenses rise dramatically as you're buying more food, and face more spoilage because you cannot predict customer flow as you had in the past.  Worse, your waitstaff is storming the Bastille because customers aren't tipping on the full price.  You know you're not making any money. 

By the second week of October, you're out of business because two waiters quit, but you couldn't make payroll anyway.  Only 250 of the 1000 you sold made it to the restaurant.

You may be out of business, but you're not a public company with shareholders.  GFG holds the risk on those coupons: They have to save their reputation.  GFG just lost $18,750.  (They need to refund $50 on 750 coupons, but on those coupons, they only made $25 each.)  

Sure, this won't happen every time, but it will.  Someone who understands accounting better than I do, please explain: Where on Groupon's balance sheet are the credit loss reserves?