What really happened at LivingSocial?

Yesterday morning, news leaked that the company had raised $110 million in new financing. Seemed to be a long-awaited hallelujah moment for the daily deal company, particularly after Amazon.com (AMZN) significantly wrote down its LivingSocial investment in recent quarterly earning reports.

But the storm clouds came quickly, when a research group called PrivCo claimed that the financing actually was convertible debt that wiped out the value of founder and employee liquidity and included a whole rash of onerous terms. PrivCo also claimed that the round was “emergency” round of funding that staved off imminent bankruptcy.

Multiple investor sources took issue with the PrivCo report during background conversations earlier this morning, and now Fortune has obtained a memo that LivingSocial CEO Tim O’Shaughnessy just issued to employees. Here it is, in its entirety:

Hey folks,

In light of a recent report on our financing round that contained significant inaccuracies and errors, I wanted to provide some additional details on yesterday’s round. 

If you’ve seen some of that misinformation, here’s the real story:

• This was not an emergency round. We received our first term sheet on December 23^rd, nearly two months ago, and this has been an organized, thought-out process.
  
• This was an equity round, not a debt infusion.
  
• There was no re-pricing of investor shares from previous rounds.
  
• There were no warrants issued as part of this round.
  
• There were no “double-digit” cash dividends.  (Typical of many financing rounds, including our own past rounds, there was a nominal 3% dividend for a class of shares.)
  
• There is no “4x liquidation preference.”  (Once again, typical of almost all venture rounds, there is a liquidation preference, but it slides up or down based on a key metric and gets nowhere near 4x.)
  
• The quotes from a “senior LivingSocial communication executive” are straight up fiction.
  
• Two of the three investors listed on the PrivCo site as participating in the round didn’t participate, and one isn’t even an investor in the company.
  

On valuation, people always seem to be overly enamored with market value, which has puzzled me because as a private company, there is no liquid market on which to buy and sell shares, so a valuation is established without any degree of market efficiency. In short, it’s an educated guess between the company and a set of investors at one particular snapshot in time. 

But nevertheless here goes. Yes, this was a down round, which I’m sure is not a shock to anyone. Our main comp in the market is down significantly from when we last fundraised.  In this round, we sold 7.5% of the company for $110mm.  Although there were some bells and whistles associated with those shares, as mentioned above, this should give you some idea of the current valuation of the company. 

So how does this round impact employee stock? In short, some, but not much. Basically, the preference stack is a little higher now.  At any valuation over $1B, though, we clear that stack by quite a bit. For comparison, our major competitor’s market cap is now $3.9B. In the event of an IPO, all preferred stock becomes common stock, and the preference stack goes away. 

We are a company that does over half a billion in revenue. If we stay diligent, we hope to turn the corner to become profitable soon. Thanks to this round, we have significantly more capital to be able to be opportunistic and drive the future growth of the business. 

Hopefully this will help clear up any questions you may have or get on yesterday’s round. Now it’s back to executing on our plan.

~ Tim

This is a pretty damning indictment of PrivCo, which regularly distributes information on private company financings. I managed to reach PrivCo CEO Sam Hamadeh, but said he’d call me right back. Hasn’t happened yet. Will update if and when I hear from him.

UPDATE: Just got off the phone with Hamadeh, who is standing by his original report. He says O’Shaughnessy is misleading his own employees, and that classifying the round as “equity” is a technicality given all of the debt-like provisions PrivCo continues to believe were attached. He also says that PrivCo spoke with a LivingSocial spokesman prior to publishing, and sent him a draft of the report with a request for any needed corrections. When nothing came back four hours later, PrivCo published.

“I don’t think the real story here is the details of the financing,” Hamadeh said. “It’s what’s going to happen to the little guys, all of the merchants who are really the company’s unsecured creditors, if LivingSocial goes bankrupt… You’ll see that we were right in six or nine months.”

Worth noting that if O’Shaughnessy really misled his investors — in a memo that almost certainly was vetted by company attorneys — he would be opening both himself and the company to major liabilities.

But have no fear. There is indeed a way to settle this he-said/he-said once and for all — find the filing that LivingSocial sent to the Delaware Division of Corporations. Check back shortly…

UPDATE II: I have just begun skimming through LivingSocial’s charter filing with Delaware. It’s long, but this round clearly was preferred stock (i.e., equity). This is in stark contract to what PrivCo reported, when it claimed that “EQUITY or stock was NOT issued today.”

Moreover, the filing says that participants “shall be entitled to receive cumulative dividends at the rate of three percent.” Again, PrivCo had claimed “Double-digit annual cash dividends.”

The filing does not identify investors in the new round, but Fortune has learned that they included existing backers Amazon and Revolution. Among those insiders not participating were Grotech Ventures, Lightspeed Venture Partners and T. Rowe Price.

Also worth noting that I spoke with a source close to the company, who tells me that the competing term sheet was at the same valuation as what insiders offered, but that company decided to stick with its current investors. The prospective investor was said to be a “familiar name,” but not a venture capital firm. That same source insists LivingSocial was not days or weeks away from a bankruptcy filing, adding that it had around $28 million in cash at its February low point and was on plan to steadily increase that number even without the new financing. Had that figure not increased, and had no new investment been forthcoming, it still could have survived for several more months.

Below is the entire Delaware filing:

[scribd id=126637328 key=key-1carufp7n4gt6ty1jhln mode=scroll]

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