Groupon is essentially holding a portfolio of loans backed by the receivables of small businesses. If a business goes under, consumers will come back to Groupon for their money back. Unless Groupon is actually doing credit assessments on businesses that it chooses to feature, this is a big risk for Groupon.
The onerous terms for participating in Groupon also create an adverse selection problem. The most successful businesses don’t need Groupon for customer acquisition or financing.
The assumption is that nothing will go wrong and all of these “loans” will be paid back. (At least the subprime mortgage lenders were able to sell that risk off to Wall Street and AIG.)
Like the mortgage lenders, Groupon doesn’t know exactly how much risk it has piled up. Because some merchants track redemptions on paper, Groupon has no way of knowing how many unredeemed Groupons are outstanding. If a business goes under and the records are unavailable, every buyer of that Groupon could try to make a claim against it. (The risk is mitigated by the fact that a lot of redemption occurs within the first 60 days, but we don’t know how much.)
Google, with more than $36 billion in cash on hand, is uncomfortable enough with that risk that it dumps it onto Google Offers buyers. Groupon could mitigate this risk by changing its terms and conditions so that the consumer is responsible in case a merchant goes bankrupt.
Relying on float
Where does Groupon get all the money to give to these merchants? Credit cards—yours. Groupon gets paid within a couple of days by its banks. It then takes that money and gives it to the merchant in three chunks. From Groupon’s S-1:
Our merchant payment terms and revenue growth have provided us with operating cash flow to fund our working capital needs. Our merchant arrangements are generally structured such that we collect cash up front when our customers purchase Groupons and make payments to our merchants at a subsequent date. In North America, we typically pay our merchants in installments within sixty days after the Groupon is sold.
We use the operating cash flow provided by our merchant payment terms and revenue growth to fund our working capital needs. If we offer our merchants more favorable or accelerated payment terms or our revenue does not continue to grow in the future, our operating cash flow and results of operations could be adversely impacted and we may have to seek alternative financing to fund our working capital needs.
Translation: They’re using money from new deals to pay for previous deals. They need to keep growing revenue. As of March 31, they owed merchants $290.7 million.
In the agreement I’ve seen, the first installment is 33% in 5 days. If they have to pay merchants faster, that could lead to problems.
And Google might force that to happen. According to Google Offers’ payment terms, merchants receive 80% of their share in 4 days—more than twice as much, 1 day earlier.
There’s no way that was an accident.
If Groupon matches these payment terms, they’ll need cash faster and need to grow faster. (Google Offers accelerates the rate at which Groupon’s scheme has to draw in new suckers.) If Groupon doesn’t match, it gives Google a key differentiator to win deals. If those businesses go with Google’s more generous terms, that too will starve Groupon of the cash it needs to pay earlier merchants.
Now here’s the crazy part. Not only is Groupon effectively giving loans to merchants, but it also works the other way around. The merchant is on the hook for the entire value of those deals until Groupon pays the merchant back its portion. Unlike other loan providers, the merchant is making a short-term loan to Groupon. (Not technically, but effectively.) They buy inventory in advance of the Groupon run. They also serve the initial rush of customers. The business is in a hole before they get their 30- and 60-day Groupon payouts.
While the chances might be small, Groupon merchants should know that they’re taking on the risk of Groupon’s collapse. If Groupon collapses, a lot of small merchants could be left holding the bag.
If you know of a business that closed after running a Groupon or other daily deal, please send an email with the name of the business to firstname.lastname@example.org. And remember, correlation is not causation.
Photo credits: Rachel Lovinger and Rocky Agrawal.
Website: groupon.com Location: Chicago, Illinois, United States Founded: November 11, 2008 Funding: $1.14B
Groupon (www.groupon.com) features a daily deal on the best stuff to do, see, eat, and buy in more than 565 cities around the world. By promising businesses a minimum number of customers, Groupon can offer deals that aren’t available elsewhere.Information provided by CrunchBase
Really interesting read.