Startup governance: Audits in focus amid financial irregularities at new-age ventures

Some of the auditors have in recent weeks made presentations to venture capital funds showing how their previous audits unearthed financial irregularities such as inflated revenue at startups, said a venture investor who has seen such presentations. These investors and industry executives did not name the firms individually as the conversations are private.

“With rising incidents of company mismanagement, this has obviously become a common dialogue for founders and investors. Besides taking longer to close the due diligence process before an investment, these discussions have taken place in the past several weeks to ensure problems — by mistake or on intent — are spotted sooner than later,” a partner at an early-stage venture fund said.

While corporate governance has been a top matter of discussion over the past year, the latest incident of Mojocare founders confessing to its investors on inflating revenue has underlined the need to keep a close watch on the operations of startups. A prominent angel investor told ET he is in talks with two consulting firms to conduct an audit at some of his portfolio firms even though they are in early stages of operation.

Venture-funded startups like BharatPe, Byju’s, Zilingo, Rahul Yadav’s 4B Networks and Trell are among companies that have allegedly had governance issues in the last one year.

“Everyone is cautious about what might be happening even in early-stage firms and it’s better to get it checked in early stages given the current state of affairs. There are portfolio startups for whom we are considering starting an audit,” the person mentioned above said.

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“There have been presentations made by some of the Big 4 firms to venture fund partners clearly showing how some of the startups have either misreported or mis-recognised revenues. While in a few cases it was genuine oversight by young founders, it has been brought to the attention of the VC firms that this could become problematic down the line,” a top executive at a firm that does due diligence for VCs told ET, on the condition of anonymity.This executive indicated that over the last year, especially since cooling down of the venture investment ecosystem, VCs have been insistent on deeper due diligence processes.

“Earlier, during the boom period, cheques were signed with a sense of urgency because there were a number of takers for a single asset … now that situation has changed. Also, since the blow up of startups like GoMechanic, Trell, etc., investors want to take their sweet time before finalising deals,” the person added.

To be sure, these discussions and presentations don’t necessarily mean a fund is running audits across its portfolio firm. “But this underscores how everyone — consulting firms, investors — are spending more time and effort to ensure startups are being run with the correct governance framework,” one of the sources mentioned above said.

“These presentations never spell out the name of the companies previously audited and where lapses have been found, but there are enough indications to figure out who these examples are potentially.”

ET had reported in April that risk capital investors were being more stringent in their assessment of potential investments both in terms of analysing business models and in conducting deeper due diligence. The ongoing slowdown in startup funding is also adding to investors being extra cautious on diligence before allocating capital to new firms.

It is difficult to uncover wilful fraud, which is designed to evade detection, an executive at a VC firm pointed out. “It’s hard to uncover it, unless a whistle-blower comes forward, or a due diligence exercise throws up a discrepancy. Very often, investors are deliberately misled,” the executive said.

“As we know, fraud detection and diligence is the job of forensic audit firms and diligence firms, and we have always engaged Big 4 auditors for all portfolio companies where financial diligence is conducted,” the investor said.