A few weeks ago, when Mojocare fired 80 per cent of its workforce it raised eyebrows as the wellness company had seemingly been on the right trajectory, having raised $20.6 million barely a year ago. Behind the scenes, however, the unravelling had begun after investors detected irregularities in the financial statements that led them to believe the business model was not sustainable. Now, a shutdown appears imminent, too.
There has been a rash of well-funded start-ups — Zillingo, BharatPe, Trell, GoMechanic, and Byjus, to name a few — dropping the ball on corporate governance by inflating revenues and even failing to furnish financial results.
A system of rules, practices, and processes that govern the working of a company to ensure it remains trustworthy to current and prospective investors and other stakeholders, corporate governance is mandated for listed companies. Its absence has proved to be a drawback of the start-up ecosystem.
Byjus, for instance, has failed to post financial results for the last two years, tweaked its revenue recognition, and had a falling-out with non-family board members, leading to the exit of its auditor Deloitte Haskins & Sells and three board members.
While Byjus may still have a leg to stand on, GoMechanic has run into the ground. The car repair start-up, after admitting to financial reporting errors, including overstated revenues and fund diversion, fired nearly 70 per cent of its workforce and was eventually bought by Lifelong Group.
Euphoria and after
The governance lapses that are bringing a bad rap to the sector are being traced back to the euphoria phase that engulfed it a year and a half ago. Industry watchers and other experts lay the blame squarely on founders who prioritise funding and valuations over all else and investors who fail to do due diligence in their haste to jump on board.
Shriram Subramanian, founder and Managing Director, InGovern Research Services, cites a Warren Buffet quote to sum up the situation: “Only when the tide goes out do you learn who has been swimming naked”.
“The VCs are equally to blame as they just wanted to see valuations multiply, irrespective of whether the company has put in place basic process systems or the values are aligned,” he says.
Founders anxious to raise the next round of money tended to dress up their numbers to look good by hook or crook, says Nandu R Kumar, CEO of consulting firm ScaleX Business. This took the form of capitalising multiple expenses to shift expenses to the balance sheet and give a healthy spin to the profit/loss statement.
Kumar also points to the lax regulatory system for start-ups — the Registrar of Companies, for instance, does not review their numbers, he says. “This is also a reason for the issues we are seeing now, because founders knew they would be safe after just submitting [figures] to the ROC,” he says.
VC on the mat
On the flip side, coming down on VCs for their wrong calls, Sridhar Rampalli, Managing Partner of VC firm Pavestone Capital, says that despite having decent diligence processes, VCs rush to write cheques owing to their fear of missing out and their desire to create large businesses in a short time.
“Some VCs did not also negotiate to take seats on the board because they did not want the responsibility,” he says.
Worse, some even backed entrepreneurs with a questionable history of money management, he rues. “Investors should put in place control mechanisms and audit requirements.”
Mohandas Pai, Chairman, Aarin Capital, blames the very nature of the start-up ecosystem for the lapses. “The start-up market does not reward good behaviour, what it rewards is growth at all costs.” Since many of the founders are first-time entrepreneurs with zero or minimal corporate management experience, they fail to grasp the importance of governance issues as they chase business growth, he says.
All on board
Any course correction would depend on the willingness of investors and founders to learn from mistakes, Pai says. This includes recognising the need for functional boards, disciplined accounting, accurate reporting, and compliance.
InGovern’s Subramanian anticipates that some start-ups may shut shop amid this churn, and investors may back only those with a clear path to profitability and sound economics.
Rampalli says VCs would be better off judging founders not only on their ability to scale but also the genuineness of their intent. VCs should pay attention to how the businesses are being built, including examining the relevant business metrics.
Greater common good
On the hotly debated need for regulating start-ups, Pai says, “Regulation is not required as it is not public money. Corporate governance is between the company and the investors, not the public. It is up to the board of directors and investors to ensure good governance.”
Subramanian sounds a slightly different note, saying that though the loss is limited to investors in the case of unlisted companies, the number of people impacted — from customers to employees and more — is nevertheless large.
Hence, it won’t hurt unlisted companies to take a leaf out of the governance practices of listed companies, especially given that many start-ups nurse ambitions of a public offering and listing in the near future.