Groupon caught in a firestorm

Worried investors are launching a string of lawsuits against the internet company just days after it was forced to restate its accounts

Well what did you expect, Groupon's chairman seemed to be saying: "It's like giving a seven-year-old a Ferrari. You're going to get a certain amount of chaos."

If Groupon's $13bn (£8bn) flotation last year was one of the most controversial in recent history, then that was as nothing to the firestorm engulfing the company now.

Just days after the internet sensation was forced to restate its first set of accounts as a public company, when its auditors warned its finance department suffered "material weaknesses", and as investors began lining up lawsuits, its chairman Eric Lefkofsky stepped on to a Chicago stage to address a chamber of commerce audience.

As well as likening the fast-growing company to a Ferrari – and perhaps his baby-faced chief executive, Andrew Mason, 31, to a seven-year-old – Mr Lefkofsky insisted the company was trying to learn from its mistakes.

"Our main focus is trying to figure out how this model evolves and not consistently falling on our face in public," he said. "I can only learn by doing something and failing. You can't tell me to avoid a pothole; I have to drive it."

Mr Lefkofsky is the serial entrepreneur and money man, while Mr Mason is the web designer who dropped out of college to build a company.

It isn't even four years since the pair turned their initial venture, an anti-corporate activism project, into a "daily deals" business and called it Groupon.

Now, the company emails around 150 million people every day with the chance to buy a money-off coupon for a local business, and it has set its sights on changing the world.

Mr Mason says it could "reshape local commerce"; sceptics say it is a fad that could disappear after local merchants and consumers have tried it a few times.

The company is labour intensive, employing 11,500 people around the world. That's a lot of people relying on this being a sustainable business.

The investors who bought into the flotation last November, or who acquired stock on the open market since then, knowingly signed up to a certain amount of risk. But did they sign up to "a certain amount of chaos"?

No, said Howard Smith, a Pennsylvania attorney who launched a class action lawsuit against Groupon this week, claiming the flotation prospectus last year was a misleading document, negligently prepared, amounting to securities fraud. The suit is designed to uncover what happened, he says, and to get compensation for investors who have been burned.

Nor is his lawsuit the first. Since the 30 March restatement bombshell, more than half-a-dozen suits have emerged, vying to become the main class action against Groupon, its executives and advisers. Messrs Lefkofsky and Mason are named personally, along with the chief financial officer, Jason Child, who was hired from Amazon, Ernst & Young, Groupon's auditor, the investment banks who organised the float, led by Morgan Stanley, plus the rest of Groupon's board.

Last night, Groupon's shares languished at $13.60, far below the $20 float price. They fell 17 per cent in a single day after the restatement. The company suffered an operating loss in the final quarter of 2011, not the profit analysts had expected and been led to believe.

The restatement was alarming for two reasons. First, an apparently technical adjustment relating to customer refunds set alarm bells ringing. Groupon had underestimated the number of unsatisfied customers who would return their money-off coupons. Mr Child declared that this was because Groupon has moved into new kinds of deals, such as for expensive holidays, which will be more prone to customer dispute. But investors now have to worry that those people who thought Groupon is a fad might be right.

Second, the company confessed that its internal systems were so weak that finance staff were going through paperwork by hand and reconciling accounts manually for weeks after the end of the period. It is hiring more staff and has brought in KPMG to try to build the robust accounting controls mandated by the Sarbanes-Oxley law. If they can't get it right by the end of the year, Groupon could be delisted.

The debate among analysts has now moved to whether Groupon is properly accounting for cashflows, or whether its results are flattered because there is a lag between getting cash from customers who buy coupons and paying the local merchants for the service. It may also have to write down the value of acquisitions in Europe.

The Securities and Exchange Commission (SEC) is looking into the debacle. The regulator has tussled with Groupon over its controversial accounting policies almost since day one. The first iteration of the flotation prospectus last summer contained a range of unusual accounting metrics, in which Groupon downplayed marketing expenses as if they were one-time investments rather than a perennial cost. The SEC got Groupon to keep to more normal accounting in the end.

The chairman also got himself into trouble with the SEC for predicting that Groupon would be "wildly profitable".

The prospectus revealed how Mr Lefkofsky and his family had cashed out $382m from Groupon, even before it turned a single penny in profit.

He has used the money to raise his profile in the Chicago business community. This included helping to organise and pay for the inauguration celebrations of the city's new mayor, former White House chief of staff Rahm Emanuel, and last year became a part-owner of one of its most famous skyscrapers, the Wrigley Building.

Recent investors who got caught up in his excitement are staring at losses, but – whatever happens next, and despite "a certain amount of chaos" – Groupon has already been wildly profitable for Mr Lefkofsky.

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