At IPO-ready LivingSocial, you get the deals — and it gets the riches

August 6, 2011

LivingSocial had wrapped up its most lucrative month ever, and its four founders were sprawled around an Ikea conference table with their investors in a brick-walled office above the Hooters in Chinatown.

It was a bright July morning in 2009. The initial business was building widgets for Facebook, leveraging its customer base of hundreds of millions of users. The group downed Starbucks coffee and noshed on cookies while working through the agenda.

Then chief executive Tim O’Shaughnessy, flanked by Tige Savage, a key investor on the company’s board, dropped a bomb: What if they abandoned it all to make a big bet on something called the vouchers business?

Mostly silence.

This bold turn would propel the company beyond building cool gizmos. The just-emerging daily-deals trade would mean hiring salespeople. Selling to merchants. Selling to customers. Retail.

“It was completely different from the apps business, which was our bread and butter,” co-founder Eddie Frederick said.“The daily deals didn’t really leverage our existing resources.”

They dedicated one developer and one salesperson to the project and launched the business that LivingSocial’s millions of subscribers use today. You know the drill: Once you sign up, you get an e-mail each day with an offer — say $30 worth of Indian food for $15. You buy the deal with a credit card. LivingSocial then gives you a voucher, which you use to settle up with the merchant once you’ve had your curry.

After two years and scads of deals, LivingSocial is preparing for an initial public stock offering that analysts say could raise $1 billion.

With coupons? Really?

Well, there’s more. LivingSocial and its larger rival Groupon have pioneered a new form of local advertising, one that exploits the massive scale of the Internet to drive customers into brick-and-mortar businesses.

In no time, the company has become the most aggressive private employer in the District — adding 600 jobs in less than two years. The churn has turned heads in Maryland and Virginia, where officials are hungry to create jobs.

LivingSocial’s reach has extended worldwide, with 40 million subscribers in 25 countries (to Groupon’s 43) from Asia to Western Europe to South America. Its global growth is fueled mostly by acquisitions. Last week, for instance, it snapped up a South Korean company with 2 million members and 600 employees.

When LivingSocial begins selling shares to the public, a process expected to be put in motion as early as this week, O’Shaughnessy, 29, and his team will become multimillionaires — on paper at least. Investors who put $100,000 into LivingSocial just a year ago could hold shares worth as much as $5 million, depending on how the company is valued.

It all snapped into place at the “Hooters meeting,” as it is known among LivingSocial insiders. The founders had been on a quest for a business with blockbuster potential. With the daily deals, they thought they had it.

Despite LivingSocial’s meteoric rise, skeptics are taking a wait-and-see approach to a valuation in the billions. After all, competitors crop up daily. Consumers might feel bombarded by e-mails. Merchants could soon resent the steep discounts.

“There is a tremendous amount of opportunity. But this is the pie-in-the-sky stuff,” said Peter Krasilovsky, an industry analyst at market-research firm BIA/Kelsey. “We don’t have a track record for their success in this area.”

The founders

Co-founders Frederick, Val Aleksenko and Aaron Batalion met O’Shaughnessy at Revolution Health, a Web site funded by AOL co-founder Steve Case. They bonded over beers and brainstorms at the Brickskeller, the now-shuttered saloon known for its vast brew selection.

“Nights and weekends, we would drink beers and spin around [ideas of] what can we go do, what can we build?” Batalion said. “And one of the things we came upon was Facebook.”

The social network had launched in Mark Zuckerberg’s Harvard dorm room in 2004 but was quickly adding millions of users and captivating technologists — not to mention investors hungry for the next Google — from Silicon Valley and beyond. In May 2007, the company opened its platform to outside developers.

Big brands such as Disney and its sports subsidiary, ESPN, were shelling out substantial sums to technologists who could connect them to Facebook. So the four set up a consultancy with O’Shaughnessy as the chief executive. He reeled in the customers; the others wrote the code.

“Without those four guys, this wouldn’t have worked,” Savage said. “It’s unusual. It’s a very complementary team. We loved the team. We bet on the guys.”

Frederick, 30, has a knack for luring crowds to Web sites — a constant struggle for Internet start-ups. With a thick head of long hair and an open-neck shirt, he typifies the company culture, which is one step removed from a dorm room. His is a deeply analytical mind known to crunch numbers into tangible results.

Aleksenko, at 39 the oldest of the four, hails from Ukraine. With a rich accent and unassuming demeanor, he’s the shy infrastructure guy who keeps the Web operations humming as millions of users pour in daily.

Batalion, 31, who sprinkles conversations with references to “scale,” has a reputation for growing a business not by pouring fuel on the fire but by drenching it until an inferno roars.

The four geeks immediately grasped Facebook’s potential. With its immense scale — Facebook now has 750 million users spending 700 billion minutes a month on its site — the social-network phenom is the 21st-century version of the Interstate highway system, creating thousands of new business opportunities by virtue of its size and reach. With a vast market reaching into nearly every U.S. household, it delivers an audience not seen since the heyday of television.

“The platform itself was incredible,” Aleksenko said.

The four were building a profitable business that brought in several millions of dollars a year.

“They were really easy apps for us to crank out,” Frederick said. “Some of these apps we would build in a couple days and make like 50k.”

For many people, that would’ve been enough. But they wanted a business with scale, one with explosive growth and revenue.

Aleksenko put it this way: “Do we want to make a few million for ourselves next year or potentially make way more in four or five years?”

They made the call outside a restaurant in San Diego in December 2007. O’Shaughnessy would close out their existing contracts in a month or two. No longer the middlemen, they would build their own businesses from the ground up and the apps to go with them.

“We wanted to play big,” Aleksenko said.

The investors

Tige Savage oozes technocrat.

Thin, neat and focused, he speaks in functional, precise sentences like the algorithms many of his businesses are built on. He uses words like “checkmark” and “orthogonal.”

Savage, 42, is a gatekeeper to the millions of dollars in venture capital money at Steve Case’s Revolution LLC, the investment firm on Washington’s Rhode Island Avenue where Savage serves as managing director.

“Steve and I were in the chairs, and Tim sat on the couch,” said Savage, recalling a meeting in Case’s 10th floor office.

“He knew Steve and I were Facebook users. So he brought his little white Mac laptop and opened it up and said: ‘I think there’s something going on here. And here’s why.’ He presented it in a very clear case.”

Even so, Savage was most intrigued by the four founders’ compatibility and their broader ambition to tap the information shared on Facebook to connect users with relevant advertisers.

“He didn’t overpromise,” Savage said. “He was just very thoughtful.”

Savage and Case pledged their financial support when the time was right.

O’Shaughnessy, who is the son-in-law of Washington Post Co. Chairman Donald E. Graham, also made the pilgrimage to Grotech, Don Rainey’s venture capital firm in Tysons Corner.

Five minutes into the meeting, Rainey remembers thinking, “This guy is just like the first guy who made me a fortune.”

That was Chris Evans, whose start-up in the early 1990s put banner ads on Web sites. It was eventually worth $2.5 billion.

O’Shaughnessy was a dead ringer for him. “His attitude, instincts, the way he saw the world,” Rainey said. He said he realized that he had to give him whatever he wanted. “That’s what you do when you meet someone like that,” Rainey said. “I am going to give this guy money because I am not going to miss that train.”

O’Shaughnessy ran back to the company’s offices above an antiques shop on P Street NW and told his co-founders that they’d found their money man.

In July 2008, Revolution and Grotech were LivingSocial’s first institutional investors, eventually putting $5 million into the company — a sum that could be returned hundreds of times over.

The daily-deals business wouldn’t even emerge for another year. O’Shaughnessy and company sold investors on the promise of something called Pick Your Five, where users shared their favorite books, music and beer with friends. The company then sold advertising space to retailers.

Its audience rocketed from zero to 35 million people in three weeks, making it the most popular Facebook application until Zynga debuted its social game Farmville.

“The Pick Your Five thing was so viral and so explosive that the day before we launched it, we were kind of lost, and the day after we launched it, we were 100 percent focused,” Frederick said.

That breakthrough sent them looking for something bigger and better. The company acquired a small, plainly named outfit called Buy Your Friend a Drink — known as BYFAD among the founders. It wasn’t an obvious fit for a tech company at first. It distributed online vouchers for free drinks at local bars, which seized on the marketing opportunity. The entire process was bankrolled by the alcohol industry.

The side business taught the founders that online behavior could be leveraged to influence in-the-flesh decisions beyond bars. Why not sell bikes or photography classes or vacations? Savage and O’Shaughnessy were thinking nationally, even globally.

The others were skeptical.

Explosive growth
As they listened to the pitch above the Hooters that July day, Frederick, Batalion and Aleksenko were wary of dropping a proven business for one that was untested.

“For three founders who are from a technical background,” Aleksenko said, “it’s a big leap of faith.”

On July 27, 2009, the first deal sold 53 vouchers for a D.C. sushi restaurant, most of which were bought by friends, relatives or the founders themselves.

Within four months, the company was chasing Groupon, the Chicago-based market leader, which had launched sites in several cities and had begun amassing a sales force.

LivingSocial would need to quickly move into new cities and find subscribers who would buy vouchers to use at local businesses. Frederick was the expert at “user acquisition,” or the art of collecting the e-mails necessary to build a customer base.

“Whenever you have a really effective product like that, it’s a race to scale . . . raise more capital and fuel the machine,” Frederick said.

Frederick’s trick was to advertise in a city months before the site’s debut there, essentially buying customers cheaply before they got into a market brawl with the competition, Savage said.

By December 2009, the company had expanded into five U.S cities. A year later, it had entered 130. In July, thanks to acquisitions and majority ownership in other dealmakers, it counted 487 markets worldwide.

“We bet the company, and we went out and massively acquired the English-speaking world,” Savage said.

But the costs to scale also came fast and large. LivingSocial has hired as many as six or eight people a day, flying dozens at a time into the District for weekend interviews. Once hired, they return home to make deals with merchants face-to-face.

This boots-on-the-ground approach is one way in which the company’s leaders feel they’ve distinguished themselves from Groupon, where most of the sales force calls merchants from its Chicago-based headquarters.

In February 2010 — on a weekend Washingtonians will remember as Snowmageddon — Savage had an epiphany. They’d run a deal in Washington for brunch at the Kennedy Center and a spa deal in Seattle, “where you come in and get a juice and get your toenails painted.” It sold like gangbusters, and they made more in a day than the whole month before.

His aha moment, he said, was this: “Not only are we betting that there’s money in them thar hills, but we just hit our first vein of gold.’”

The competition

Groupon, of course, is running for those same hills. Executives at Groupon declined to comment for this article via a spokesman, citing a quiet period following their June 2 registration with the SEC to go public. In that filing, the company said that having its U.S. sales force concentrated in one office has proved a boon for productivity rather than a detriment, allowing it to quickly make decisions and changes.

LivingSocial has faced constant comparison to the older and bigger Groupon, not unlike a younger sibling trying to stand out.

LivingSocial’s executives and investors are quick to note the distinct facets of their business. In fact, although they concede that Groupon is the originator of daily deals, LivingSocial fancies itself the innovator.

Its variations on the ubiquitous daily deal e-mails, including an on-the-go service called Instant Deals and travel-specific discounts called Escapes, launched before Groupon unveiled similar services.

“Every business iterates,” O’Shaughnessy said. “In the technology space, the innovation cycles tend to be faster than in the physical, real world.”

Krasilovsky contends that turning the companies’ subscribers on to other products is the key to a sustainable business.

“It’s possible that if they don’t make the transition to a broader platform soon that the initial business model may fall flat,” he said. “I think that both companies have moved very responsibly to create a compelling extension of that business.”

But both business models also rely heavily on the satisfaction of local merchants. And the companies have been criticized by merchants and customers alike. There have been tales of restaurants overrun by coupon customers. Others have complained that the companies take too much of a cut from the deal. Some deals were marketed in the wrong geographic area. Some customers have complained about mix-ups when redeeming the coupons.

Ann Said, owner of Eco Safe Maids, a local cleaning service for upscale homeowners, said it took about a year from the time she submitted an online request to LivingSocial until the deal ran. And when it did, the deal was targeted at Northern Virginia customers, though Eco Safe’s clientele is concentrated in the District.

“We were a bit upset about it,” she said.

Both LivingSocial and Groupon make the bulk of their revenue by sharing in the price that customers pay for a voucher, typically collecting 30 to 50 percent off the top.

The future

O’Shaughnessy, now at the helm of the fastest-growing private business in Washington, sips a Diet Coke at his desk. The sparsely decorated office has two framed photos of him and his wife and a freezer full of ice cream with a large stuffed monkey on top.

The asphalt at New York Avenue and 14th Street NW radiates heat on a July afternoon. It’s the newest of five D.C. offices the company occupies as it adds square footage almost as fast as it adds people.

Outside O’Shaughnessy’s office, the LivingSocial troops beaver away, dressed in shorts and flip-flops, bicycles parked against walls. It’s a young operation, reflective of the young mavericks who founded it.

Mistakes?

“I would have been even more aggressive,” O’Shaughnessy said, referring to the days when LivingSocial was staking out cities to beat the competition to the spot. “Especially in those early months. I wish we had even gone harder . . . because a user that you could have gotten into your ecosystem or a city that you could have launched three months earlier, you can never acquire that user again.”

As he parries questions on going public, a public relations specialist sits nearby. The chief executive gives a polished answer, likely vetted by attorneys. The company could go four ways: expire, stay private and pay dividends, get bought or go public.

LivingSocial is down to two: getting bought or going public. We will see, he said.

Next to the door stands a makeshift wine rack with about a dozen bottles, mementos to cheer the company’s success. He has yet to be open them.

But the corks could come out soon.

On a shelf nearby is another gift: a clear engraved plaque.

It reads: “Today’s Mavericks. Tomorrow’s Millionaires.”

Steven Overly covers the business of technology, biotechnology and venture capital in the Washington region for The Washington Post and its weekly Capital Business publication. In that capacity, he has written about start-up struggles, investment trends and major drug discoveries.
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