Wake-up call for start-ups

In December 2021, the company was valued at $285 million, and in early 2022, the founders were seeking a valuation of $1.2 billion. That’s precisely a 4.21x valuation in just a few months.But the cookie didn’t take too long to crumble. In one of his earlier media interviews, Amit Bhasin, co-founder of GoMechanic, had said their focus has been “consistency in quality of service and pricing.” What he missed out was that the focus has also been on consistently cooking its books to fetch even higher valuations.

In an astonishing statement that was uncannily similar to the one made by Satyam’s Ramalinga Raju way back in 2009, Bhasin confessed that the company neglected financial reporting norms. “We got carried away…we followed growth at all costs, including in regard to financial reporting, which we deeply regret.”The “regret” was certainly not voluntary, as it came only after SoftBank, with whom GoMechanic was pursuing a deal, appointed EY to do the due diligence. The EY report brought to the fore some glaring lapses in the company’s books of accounts and operations. EY raised several red flags, such as using fictitious garages to inflate sales numbers, selective payments to certain garage units, and discrepancies in revenue and user metrics, among others.A third-party forensic audit has now been initiated to find out whether this is the story of yet another start-up that took ‘fake it till you make it’ way too seriously. According to a report by Bloomberg, the company allegedly has 60 of the over 1,000 GoMechanic service centres violating accounting norms to overstate revenue and divert funds.

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The unfortunate episode also brings to sharp focus the loose corporate governance practices in many start-ups (remember Zilingo, BharatPe, Trell, etc) even though they are backed by marquee names such as Seqouia Capital, Tiger Global, and the like. Some of these start-ups are, of course, still engaged in a public battle where the focus is on mudslinging and digging up old accusations. But that’s another story.The lessons to be learnt are simple enough. Founders can’t delegate governance, which is imperative and not a matter of choice. But many start-ups are too obsessed with growth at all costs and forget to set up internal committees to keep a watch on accountability in a company’s decision-making processes.

There are other reasons for this. Founders are often young men and women driven by the passion to prove their idea was right and the desire to grow their companies to great heights. The lack of time, experience, and business competence, however, often plays the perfect foil to their passions and desires. As a result, corporate governance often takes the back seat and, at times, is even ignored in an anxiety to look at the ‘big picture’ of making the company ‘look attractive’ to the potential investor. Pressure from investors, coupled with promoters’ unbridled ambition to hit unicorn status at any cost, often leads to poor decision-making.

Besides, the start-up’s founders, being largely techies, come with a limited understanding of finance. Top that up with an investor who can’t see beyond the top line. For instance: Housing.com, a Mumbai-based start-up, faced massive problems due to lack of sound mentoring for founders, which made the company’s vision go haywire.In an insightful research paper, Elizabeth Pollman of the University of Pennsylvania Carey Law School, says despite the enormous social and economic impact of venture-backed start-ups, their internal governance receives scant attention. Longstanding theories of corporate ownership and governance do not capture the special features of start-ups. They can grow large with ownership shared by diverse participants, and they face issues that do not fit the dominant principal-agent paradigm of public corporations or the classic narrative of controlling shareholders in closely held corporations.

Pollman’s study shows that venture-backed start-ups involve heterogeneous shareholders in overlapping governance roles that give rise to vertical and horizontal tensions between founders, investors, executives, and employees. These tensions tend to multiply as the company matures and increases the number of participants with varied interests and claims. This framework of start-up governance offers new insight into issues of the current debate, including monitoring failures by start-up boards and late-stage governance complexity, and suggests that more attention should be paid to how corporate law principles apply in the start-up context.

Many say that the formal oversight structures should be set up later as at the early stage, the founders would need the liberty of innovating and experimenting without any hindrance of traditional set of rules. But that’s a faulty approach. The lack of an advisory board can lead to massive mismanagement, increases the probability of errors, and can lead to unchecked fraudulent behaviour and unethical practices. While board members are not expected to keep track of day-to-day operations, they need to ask good questions of management and have the information streams they can rely on so that they can monitor ethics or compliance problems and figure out how to handle them.The bottom line is that good governance, which means accountability, transparency, probity, and focus on sustainable success, must be embedded in an organisation early. There are many start-ups that are, in this regard, exemplary. But sometimes, a few rotten apples can really spoil the party.

The author can be reached at – shyamal.majumdar@expressindia.com