On January 7, 2009, the founder of Satyam Computer Services issued a letter admitting that he had been cooking the books. On January 19, 2022, the founder of GoMechanic admitted to grave errors in financial reporting in a LinkedIn post.

Soon, the post was edited to remove the word ‘grave’, but the damage had already been done.

Satyam had cooked the books to camouflage a diversion of funds. GoMechanic has allegedly done the same as the promoters have been accused of yielding to one of the easiest temptations in the start-up world: “Chase revenues at any cost to get valuations”.

No one seems to remind start-up promoters that the revenues must be chased ethically. Byjus apparently delayed reporting its results for over a year to report revenue as per accounting standards.

The GoMechanic episode comes amidst news of recession, layoffs and a generally gloomy outlook all over. The company is reportedly letting go of 70 per cent of its staff, and a forensic audit is being done to ascertain the extent of the grave errors in financial reporting.

Inflating revenues

It has been reported that GoMechanic created more than 60 false garages with the sole purpose of inflating revenues.

It has also been reported that the erstwhile auditors of GoMechanic had issued a qualified report on the financial statements in 2020.

The caveats apparently were: not holding that period’s annual general meeting within the stipulated time, not maintaining inventory records for receipts and issuance of goods directly received by customers, and not maintaining formal documentation to map services rendered by the automobile workshops to end-customers.

Mature companies must comply with a long list of accounting and corporate governance norms.

Words and catch-phrases like Ind AS, CSR, ESG and independent directors are a part of their daily routine. Start-ups generally do not bother too much about putting in place robust processes for accounting and governance compliance in the first few years of their existence.

The finance personnel in many start-ups spend more time on MIS reporting than on complying with the provisions of the Accounting Standards, the Companies Act or GST laws.

The promoters always appear to be in talks with the next set of investors for funding.

They look at revenue numbers only when the earlier investors seek to exit at 3x times or when the new investors insist on a certain revenue metric to be met. It is at this stage that they are prepared to do anything to get to that revenue target. Accounting standards can wait.

Independent observers?

It is time for the investors in start-ups to appoint independent observers (IOs). The job of the IOs would be somewhat akin to that of independent directors. IO’s would interact with the start-ups founders, employees, bankers, auditors and consultants and investors.

The purpose of these interactions would be to get a general assurance that there are no red flags that need to be corrected. The fees of the IOs should be paid for by the investors and not the start-up. It should be made clear that it is not the job of the IO to discover a grave accounting error but to highlight the error if he comes to know of it through his interactions.

IOs should be given a term of three years after which they would mandatorily rotate. The only caution that the investors need to take is to ensure that the person being appointed does not become a party to the problem. Valuations in some start-ups can be dizzying and the related monetary benefits tempting.

Promoters in start-ups may also be a bit wary of IOs who ask all the right questions. Independent observers may not eliminate accounting and governance misdemeanours at start-ups but it would certainly assist in minimising them.

The writer is a chartered accountant

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