Reports of the founders of the automobile after-sales service startup GoMechanic admitting to having given false revenue figures in front of investors have gone viral. Investors such as SoftBank had found irregularities in the company's growth and revenue numbers while inspecting accounts before making an investment they had been planning in the firm. Experts with whom THE WEEK spoke to feel that forging numbers to have higher valuation in order to attract more investments is a very common strategy among many start ups.
“Exponential jumps in valuation without any significant financial or fundamental growth in the company is very common. The practice gets its acceptability from veteran founders and Venture Capital (VC) firms in the startup ecosystem itself. The startup industry operates with a notion that there is a need for a jump in valuation with a new round of funding. Keeping up in this valuation game is a skill a founder is expected to have in the market to survive,” Nandu R. Kumar, Founder, ScaleX Business Private Limited told THE WEEK.
He added that the funding rounds of comparable silicon valley references are used by many founders to justify valuation of an Indian startup. However, the fact that the rupee is a significantly weaker currency compared to the US dollar is often ignored. “The silicon valley textbook practices in valuation as well as investments may not be right fit for a market like India. First instance matrices like Lifetime Value (LTV) and retention ratio which are used to measure future value of a business may not be that relevant for the Indian market, where customers are more demanding and not loyal to a brand,” added Kumar.
This expert feels that e-commerce aggregators or marketplaces using GMV (Gross Merchandise Value) as a valuation driver can often be misleading. “For a business in which an app-based aggregator like GoMechanic is into the GMV is just an indicator of its market reach. Often the thin margin they charge as a platform fee or commission is the topline and real indicator of future profitability. However, when it comes to valuing a startup, the GMV is given an unproportionate importance. As a founder, you are forced to give importance to GMV and not on profitability, because that's what the market demands” remarked Kumar.
Agrees Harish Bijoor, Business and Brand-strategy expert and Founder, Harish Bijoor Consults Inc. “I do believe startup founders live a pressure-cooker life. The pressures are many. It comes in from investors, employees, business partners, banks and more. Founders at times buckle in and take the "patli galli" route. And the end result is a disaster. Like this one is. Inflating revenues, profits and even losses and expenses are routes many take. Sadly a keen firm and ongoing audit process is a good control technique to use,” remarked Bijoor.
Market analysts felt that often start up founders get caught between two realities—their concept not being shaped as they imagined and not being able to meet the expectations of investors. This is what led them to deceive their investors. “Though the concept of GoMechanic was novel and futuristic, the founders violated ethics and broke the trust of their investors. Following ethics and having a proper value system are very important for a company's growth. There is always competition among investors to give fuel to an idea that has the potential to grow. As soon as they find one, they are in a hurry to invest and don't get adequate time to do proper due diligence and understand the values and ethics the entrepreneurs possess,” pointed out Aditya Mishra, MD and CEO at CIEL HR.
He added that startups like GoMechanic with founders with great educational backgrounds that are backed by top investors fail because of over-ambitiousness. “Founders project a hyper-growth in their pitch and show highly optimistic figures, and investors believe in these projections. But investors become impatient when the venture doesn’t deliver these numbers. Several companies successfully went for an IPO but failed after listing because of this reason,” said Mishra.
There is a broad consensus among market experts that over optimistic business plan for better valuation and the pressure to meet the expectations are root cause of such issues. In the drive to meet the business targets, the financial discipline and the internal controls are not given the due importance. “Such disclosures as regards inflated revenue numbers, non-existent garages raise a serious concerns over the corporate governance oversight and internal controls. The accounting standards would require either restatement or detailed disclosures as regards prior period errors depending on the accounting framework applicable to the Company. Under Companies Act 2013, the central government, income tax, or any other statutory body can with the approval of the tribunal require the company to reopen its accounts and file the corrected accounts. The company also has an option of voluntarily reopening and recasting its accounts by obtaining a tribunal order and filling the revised accounts after correcting the errors,” observed Prashant Daftary, Partner, N.A. Shah Associates.
Experts further agree that a successful business requires a good balance of self-assurance, risk tolerance, self-discipline, determination, and competitiveness. The emphasis should be on entrepreneurial education, which aims to increase employability by transferring skill sets that are valued by the labor market. “When developing a business model, a startup must analyze its surroundings to make sure that neither existing rivals nor potential newcomers would endanger the firm. If a business concept has high entry barriers, it will be able to sustain itself over time. An expert can offer details on the existing and upcoming laws that may influence the company model. By doing so, the founder will be able to allow enough room in the business plan for modifications that will be necessary to bring the company's operations in line with the new requirements. Founders must make sure there are enough finances on hand to go through any trying times,” remarked Krishna Kumar, CEO, Learnbay.
This expert is of the view that funds should be managed by entrepreneurs so that they are distributed wisely and a cash flow statement is a crucial tool because it gives businesses early warning of a drop in sales brought on by adjustments to external variables. “Management should make sure that any debts owed by consumers are collected as soon as possible to avoid cash flow problems. Capital purchases should be paid for throughout the asset's life rather than all at once by the startup. Entrepreneurs sometimes commit the error of predicting rapid development for their companies without considering market risks. A lot of the presumptions in a business plan are made under ideal circumstances without taking into account how the market, laws, investor preferences, and competitors' actions could change. Entrepreneurs need to develop the habit of putting aside capital for a backup plan, which would take over if any of these variables changed significantly,” said Krishna Kumar.