LivingSocial was forced to make large concessions to persuade some of its biggest investors to plow another $110 million into the second-largest daily-deal company, analysts and investors said on Friday.
Analysts say those investors secured advantageous terms potentially at the expense of LivingSocial's other backers. The nature of those terms shed new light on an investment that Chief Executive Tim O'Shaughnessy declared on Wednesday "a tremendous vote of confidence in our business."
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For their $110 million, investors got special preferred securities that pay a 3 percent annual dividend, and almost guarantee that they get money before any proceeds from a sale of the company or an initial public offering go to earlier investors, according to a recently updated certificate of incorporation for LivingSocial viewed by Reuters.
The deal also requires LivingSocial to repay some or all of the money from the latest round of financing in four years, if there has not been a liquidity event - such as a sale or IPO. That measure, which protects their investment, would require 75 percent of the holders of the new securities, known as Series G, to vote for repayment, the certificate shows.
"The investors took their pound of flesh for LivingSocial to get this money," Sam Hamadeh of PrivCo, a research firm focused on private companies, said on Friday.
Like larger rival Groupon , LivingSocial and its rivals have suffered from a rapid loss of popularity of "daily deals" - deep discounts sold on the Internet on everything from spa treatments to dining.
LivingSocial raised hundreds of millions of dollars from Amazon.com Inc and venture capital firms to chase Groupon in the once-hot business. Then Groupon went public in 2011 and subsequently lost about two-thirds of its market value, putting pressure on LivingSocial's own valuation.
In a research report on Wednesday, Hamadeh described the deal as "emergency debt financing." O'Shaughnessy disputed PrivCo's report, so Hamadeh has since updated his research to show that the deal was equity, not debt.
"We wanted to clarify that," Hamadeh said on Friday. "But it's about as debt-like as you can get. They had to give up a lot."
Amazon and LivingSocial declined to comment for this story on Friday.
$3 BILLION VALUATION DROP?
In the latest round, LivingSocial sold 7.5 percent of the company for $110 million. That suggests the company is worth almost $1.5 billion now. In an earlier round of financing, the company was valued at roughly $4.5 billion.
"Yes, this was a down round, which I'm sure is not a shock to anyone," the CEO wrote. "Our main comp (comparison) in the market is down significantly from when we last fundraised."
Taking into account the special rights that the new Series G securities grant to their holders, the valuation is likely lower than $1.5 billion. That is because the preferred shares will effectively give the holders a stake in the company that is larger than 7.5 percent, in most future scenarios.
The Series G securities include a so-called liquidation preference, O'Shaughnessy noted in the memo.
Liquidation preferences, common in later rounds of venture capital financing, give investors the right to get back at least their original investment in the case of a liquidity event.
In the case of LivingSocial, a preference of one times the investment would mean Series G holders get $110 million back from a liquidity event, before other investors receive any proceeds. PrivCo said the round included liquidation preferences up to "several times" the $110 million.
O'Shaughnessy said in his memo that the preference was nowhere near the four times suggested in PrivCo's report, but conceded that it "slides up or down" based on a metric tied to LivingSocial's financial performance. He did not elaborate.
"Those investors are looking for some downside protection," said Lou Kerner, managing partner of The Social Internet Fund, which invests in rapidly growing social and mobile companies.
(Reporting by Alistair Barr; editing by Edwin Chan and Prudence Crowther)