Deciphering corporate misgovernance at Indian startups

The latest turmoil at Byju’s has reignited concerns around corporate governance in India’s booming startup ecosystem.

The situation inside India’s darling ed-tech unicorn Byju’s, which was once valued at $22 billion, has been turning bleaker by the day owing to a range of issues the company has failed to address for over a year now. The latest blow to the unicorn came last week after big 4 auditor Deloitte resigned from its role mid-way citing a delay in financial statements and lack of cooperation from senior management, and three of its investors vacated board seats over difference in opinion about the firm’s operational affairs.

The latest turmoil at Byju’s, which was merely weeks earlier raided over suspected violations of foreign exchange laws, has reignited concerns around corporate governance and oversight in India’s booming startup ecosystem.

GoMechanic, another startup backed by Peak XV Partners (earlier known as Sequoia Capital India) whose representative recently stepped down from Byju’s board, had earlier this year fired 70 per cent of its staff after gross misreporting of financial statements was uncovered. Besides GoMechanic, Sequoia India’s other portfolio startups such as BharatPe, Trell, and Zilingo have also come under the spotlight for accounting irregularities in recent times.

Also Read | Govt, Google join forces to host Startup School 2023 next month

Whose fault is it anyway?

While Peak XV was reportedly exploring ways to shore up auditing at firms in the region after these financial lapses came to light, the lax implementation of norms and accounting irregularities have raised questions about the appetite of global investors to continue their bullishness on India Inc. Fingers have been pointed in all directions, but industry stakeholders agree that the ultimate onus lies on management.

“The founders are to be blamed, no doubt, because they are the ones managing day-to-day operations,” said Anil Joshi, a managing partner at Unicorn India Ventures.

Founders at times can be swayed by the competitive nature of India’s startup ecosystem, which witnessed laudable growth in the past decade, with substantial capital influx and a steady mushrooming of startup ventures across sectors. A total of 1,300 active tech start-ups were added in the past year alone.

When fraud was uncovered at his firm, GoMechanic co-founder Amit Bhasin had publicly admitted that the “passion to survive the intrinsic challenges of this sector, and manage capital,” caused errors in judgement as the company “followed growth at all costs, including in regard to financial reporting.”

Some stakeholders also blamed the naivety of first-time founders who don’t have the required expertise on corporate governance. “They miss out on building best practices for some functions in anticipation of high growth and scaling up,” Joshi opined. Diligence can also shore up operational costs, something profit-oriented founders may be averse to spending, he added.

Funding FOMO

India’s startup space saw funding upwards of $131 billion between 2014-22, as global venture capital firms clamored to fill their portfolios with promising Indian companies, as per data by Inc42.

“What happened in the last 2-3 years is that there was a lot of FOMO (fear of missing out) among the investors, where due diligence became less important and entering into a deal became more important,” reasoned Saurabh Garg, co-founder of proptech unicorn NoBroker.

Usually, early stage investments are based on a paper plan and trust, and VCs at this stage conduct background checks on founders and associated stakeholders to gauge investability. “At this point, investors only know so much about the business, if intentions are maligned, there’s nothing much that investors can do in the beginning,” Madan Padaki, co-founder of networking platform Global Alliance for Mass Entrepreneurship said.

This is followed by quarterly and yearly audits that are undertaken by third-party audit firms hired by company leadership. “The board is not responsible to investigate on an ongoing basis unless something formally is brought up with them, which is often through a whistleblower,” Peak XV, then Sequoia India, had cleared out in an open letter last year after many of its portfolio companies reported governance lapses.

Once irregularities are spotted, VCs take the help of forensic analysis to understand the gravity of the issue, market data platform Tracxn’s co-founder and CEO Neha Singh said. The routes these companies can take from there include pivoting the business to something more profitable, scaling down (which often includes large scale layoffs) and selling off the company to recover as much of lost funds as possible.

Current landscape

However, since last year, the Indian startup ecosystem has been engulfed by a funding winter as liquidity dried up, leading many to question the timing of the recent spate of revelations. Funding for Indian startups dropped by 33 per cent to $24 billion in 2022 as compared to the previous year though, according to a PwC India report. While there may not be a direct correlation, industry stakeholders agreed that the funding crunch may have a role to play.

“If VCs are doing lesser and lesser deals, they do spend more time making sure that their money is going in the right places,” explained Padaki.

NoBroker’s Garg agreed that the atmosphere is improving now that deals take longer to go through and VCs are encouraging sustainable growth. “It is ultimately on the founders to think how to be sustainable,” he added.

When asked about a probable impact of the cases on global investor sentiments towards the Indian startup ecosystem, industry experts underscored divided opinions.

“It definitely will have some impact. Of course India is a bright spot, but there are so many hurdles to investing in India,” said Padaki, adding that this could become another reason for investors to question the efficacy corporate governance in India.

Others like Garg said: “India is that cusp where any investor will find it hard to not be in this country”.