“Lets start having fun… lets get funky… let’s announce everything… let’s be WILDLY positive in our forecasts… lets take this thing to the extreme… if we get wacked [sic] on the ride down-who gives a shit… THE TIME TO GET RADICAL IS NOW… WE HAVE NOTHING TO LOSE…”
This is a quote from the dot-com era. It’s pretty much what you’d expect a novice executive to say back then, when it was all about money and not at all about creating something good. It was written in an email by the co-founder of a company called Starbelly.com, which labeled itself a B2B provider — back when people greeted that phrase with a straight face.
In early 2000, Starbelly sold itself to another company called Ha-Lo Industries for $240 million, much of which went to the author of those words, a man named Eric Lefkofsky. Not long after that transaction, Ha-Lo declared bankruptcy. Shareholders and others blamed the Starbelly deal, and a series of lawsuits ensued.
Eric Lefkofsky is the co-founder and chairman of Groupon, which filed last week for an IPO valuing the company at $30 billion, as well as its largest shareholder, with a pre-IPO 22% stake in the company. The other co-founders include Andrew Mason (8% stake), the cherubic public face of Groupon; and Bradley Keywell (7% stake), who also co-founded Starbelly with Lefkofsky. Before Starbelly, Keywell and Lefkofsky founded a sportswear company called Brandon Apparel.
So why should such an old quote matter? Everyone remembers things they said a decade or more ago they may regret today. And failure is hardly something to be ashamed of in tech; usually it’s heralded as a mark of having shot for the moon, something to be prized and not frowned upon.
But Groupon’s IPO has brought an uncomfortable spotlight onto Lefkofsky. While some attention focuses on his ambitions as an investor in tech startups, others see a “spotty history” and draw parallels between the past and the present. Lefkofsky’s track record, reflecting failures and successes, bears certain hallmarks: rapid revenue growth accompanied by big losses, a penchant to sell stock early on, and lawsuits filed by investors, lenders or customers who feel they have been wronged.
Lefkofsky began his first venture, athletic-apparel maker Brandon Apparel, which he and Keywell bought after graduating law school together, in 1994. “It ended up being a huge failure,” Lefkofsky wrote on his blog. At first, the company — like Groupon — saw fast growth, with revenue rising from $2 million to $20 million. But not fast enough to repay debts. “We over-leveraged the company and it eventually crumbled under the weight of that debt,” Lefkofsky wrote.
The risk of failure is inherent to entrepreneurialism. But Brandon Apparel’s tanking yielded a series of lawsuits. A lender, Johnson Bank, sued Lefkofsky and won a default judgment of $11 million. The former owner of Brandon reportedly sued the company, as did National Football League Properties and Major League Baseball Properties. The city of Columbus, Wisc., loaned Brandon $750,000 to create jobs in the city, but the company closed the plant not long after getting the loan and the city was forced to write off the loan. “They basically bailed out of Columbus, and that seems to be their ongoing tactic,” Columbus’s city attorney said at the time.
In March 1999, Lefkofsky and Keywell founded Starbelly.com, which sold promotional t-shirts and coffee mugs. In August 1999, Starbelly raised $8 million from Chase Capital and Flatiron Partners, a deal that valued it at $32 million — even though the company was on track to post a $2.5 million loss on $183,000 in revenues during its first six months of operation. In January 2000, Ha-Lo Industries, a promotional products company with five decades of experience, bought Starbelly — now ten months old — for $240 million. (Credit Suisse, one of Groupon’s underwriters, advised Ha-Lo on the deal.)
Lefkofsky and Keywell, who joined Ha-Lo as executives and directors, showed a knack for rapidly growing a company’s value despite significant losses. But again, it all came crashing down. Ha-Lo swung from a $1 million operating profit in 1999 to a $64 million operating loss in 2000, thanks to $8 million in payroll costs for Starbelly employees and $40 million in the amortization of goodwill from the Starbelly deal. In July 2001, Ha-Lo filed for bankruptcy (under a new management, the company later emerged from bankruptcy as Halo Branded Solutions). And again, lawsuits followed, including a class-action suit naming Lefkofsky as a defendant. Lefkofsky, it seems, is to lawsuits what Groupon is to coupons — he inspires groups into action.
Lefkofsky’s “funky” email surfaced in a shareholder lawsuit filed in the wake of Ha-Lo’s bankruptcy. It was first reported by Barron’s Bill Alpert in a 2007 column about the next company Lefkofsky founded, InnerWorkings. Alpert wrote a devastating piece that eerily prefigured the concerns surrounding Groupon’s IPO. He called InnerWorkings “a glorified broker of print jobs,” argued that Lefkofsky “has a history of busting investors after promising to radically transform bricks-and-mortar industries” and noted that InnerWorkings had tried to “obscure” Lefkofsky’s active involvement.
InnerWorkings (INWK), which provides print-procurement services for companies, went public in August 2006, selling 7 million shares at $9 a share. (The stock closed at $8.21 Wednesday.) Today, InnerWorkings is a company with annual revenue of $480 million. Echo Global Logistics (ECHO), a supply-chain management company Lefkofsky founded, went public in 2009 and trades slightly above its $14 a share offering price. Both companies are consistently profitable, both have operating margins of 3%. And both companies suggest Lefkofsky learned enough from his early missteps to build successful startups.
Yet InnerWorkings has two red flags that should concern Groupon investors.The first is InnerWorkings’ follow-on stock offering. In January 2007, when its stock was trading at 82% above its IPO price, InnerWorkings filed to sell another 8 million shares, but this time 5 million of the shares were being sold by insiders, with most of the shares sold by entities owned by and affiliated with Lefkofsky and his family. It was an unusual move: Most companies wait until a 6-month lockup period expires before offering more shares.
The other red flag for InnerWorkings involves a lawsuit filed by Sports Publishing LLC in 2008. Although the suit was withdrawn after InnerWorkings countersued, the complaint remains a bizarre read, accusing InnerWorkings and Lefkofsky of “racketeering” and “terrorist tactics.” Sports Publishing hired InnerWorkings to publish some 300 sports-themed titles and claimed it somehow ended up owing $2.5 million to its vendor.
That’s when things got weird. The complaint alleges,
InnerWorkings called these allegations “wildly absurd and fanciful.” And like the “funky” email Lefkofsky wrote at Ha-Lo, or the loan-and-leave action in Columbus,Wisc., you could say this is just one unfortunate incident in Lefkofsky’s pre-Groupon past. But it’s clear that lenders, investors and customers have at times been so convinced that Lefkofsky dealt with them in bad ways that it led them to seek remedy in court. That pattern is much darker than the typical stories of young entrepreneurs blowing up their ventures because of inexperience.
Yet even after Lefkofsky’s 18 years of experience as an entrepreneur, he still stumbled last week. After Bloomberg TV dug up some old dirt, Lefkofsky responded that Groupon would be “wildly profitable.” Now Groupon may need to refile its prospectus to clarify that heady prediction.
A new filing would also serve shareholders by clarifying Lefkofsky’s role at Groupon. If nothing else, the Sports Publishing lawsuit reveals that Lefkofsky may have been far more involved with InnerWorkings than its SEC filings indicated. In Groupon’s IPO filing, CEO Andrew Mason confessed he only created Groupon “to get Eric to stop bugging me.” Groupon may be thriving because of Mason’s management skills, but it’s still not clear how much control Lefkofsky has over the company.
That question should concern investors because Lefkofsky and his family have already cashed out $382 million from Groupon before the IPO filing. (Keywell and his family cashed out $156 million, Andrew Mason, $10 million). The risk is that Groupon will follow in InnerWorkings’ footsteps and start trading with a small float. Then a few months later, after demand has pushed up the stock price, insiders will unload more shares in a follow-on offering. That could weigh down Groupon’s longer term price, by putting more shares into the market than demand can meet. Lefkofsky and other insiders control voting rights, so any investors who don’t like it will have little power to agitate for change.
In the debate that has arisen around the Groupon IPO, bulls and bears are arguing over whether Groupon is another Amazon, which took on years of massive losses to build a big “moat” that fended off competition. But there is another key difference between Amazon and Groupon: Amazon (AMZN) founder Jeff Bezos has a brilliant instinct for navigating risk, as he made clear in comments during Amazon’s shareholder meeting on Tuesday. Few Amazon shareholders are angry with Bezos: the stock has returned 12,400% since its 1997 IPO.
Lefkofsky, who like Bezos began his entrepreneurial adventures in 1994, is equally intimate with risk, but with a track record nowhere nearly as impressive. He knows how to generate big revenue through even bigger losses, often to destructive effect. Lefkofsky summarizes his credo as “you might as well fail fast.” And, apparently, cash out fast.
That ethic may be fine in the world of private equity, where investors usually have enough net worth and sophistication to stomach such risk. But it’s another matter entirely in the public markets, where middle class investors can be seduced by the allure of a hot tech IPO.
A close look Lefkofsky’s track record shows that, while he’s learned from early failures, he’s not the new Bezos. Groupon’s IPO prospectus should raise several red flags in a sensible investor’s mind. Factor in Lefkofsky’s checkered past, and this IPO is waving more red flags than a May Day parade.
Clarification: An earlier version of this story incorrectly stated that insider selling in a follow-on offering could dilute existing shareholders.