Accounting practices at start-ups in India come under the scanner

Where valuation has overpowered value and revenue recognition is a grey area, new accounting metrics is seeing new-age ventures jump through hoops

Valuation obsession, investor pressure, and unethical practices by founders may be blamed for some of the recent misadventures of certain start-ups. They have, however, also taken the lid off the complex accounting practices and challenges these new-age ventures are just getting to grips with.

With so much money sloshing around the system, funding rounds got bigger and bigger. Critics say that left start-ups with money to burn and no need to show how they would ever turn in a profit.

“In the new-age economy, new business models are coming up. There is a lot of complexity around many areas, requiring significant judgement calls. People often go wrong with the right interpretation of accounting,” said a senior partner at one of the Big Four advisory firms.

Revenue recognition, for instance, becomes a grey area, with companies often having to decide between gross revenue and net revenue.

Take for example, you are selling goods on your platform. Does that make you the principal or an agent? It is not a straightforward call.

“There could be a huge difference between the two and the funding will depend on what your revenues are. It is a big area of debate,” added the senior partner.

Often, an incorrect interpretation is not always intentional. Experts, however, suggest that start-ups must seek the right advice when wracked with self-doubt.

Sometimes “passions get the better of” companies chasing growth at all costs, leading to a bust-up like GoMechanic’s - not the first one in the list of start-up stories gone astray.

New accounting metrics are also getting introduced by some of these companies. With employee stock ownership plans becoming popular in the start-up world, companies often hide this cost when calculating the earnings before interest, tax, depreciation, amortisation (Ebitda). It is then referred to as ‘adjustable Ebitda’.

“These are what we describe as non-generally accepted accounting principles. While it is not illegal, it does not render an accurate picture either. Ultimately, the financial statement gives a headline-grabbing number,” says Shriram Subramanian, founder and managing director, InGovern Research Services.

Are start-ups unable to access the best accounting advice?

Subramanian says while small accounting firms may not have the obligatory wherewithal, large firms could be restricted by the scope of audit.

 

GoMechanic, for instance, had two of the Big Four audit firms as its assessor and yet stepped on a landmine.

“These firms do statutory audits, relying on management numbers. A large auditor would rather lose a client than stake its reputation,” says Subramanian.

Deloitte, for example, took 18 months to sign off the numbers of Byju’s annual results, he points out.

However, analysts feel while start-up founders may be great at innovation, they lack the experience and the market savoir faire. Add to that the mad chase for a bloated valuation, which back-burners corporate governance.

“Funding pressure gets into issues of integrity. Financial reporting is not a priority. Start-ups don’t want to jump through hoops. They do not want to rise from the ranks,” says a partner at another one of the Big Four advisory firms.

Industry watchers feel investors, too, must share the blame for such crash-and-burns.

“Are these funds not aware of what is going on at these companies? Of course, they are. Everyone wants value maximisation. They are okay with some lapses (if they go unnoticed),” says Sonam Chandwani, managing partner, KS Legal & Associates.

The US venture capital (VC) firm, Sequoia, recently told firms in its portfolio it had “zero tolerance” for financial irregularities, reaffirming the policy after governance lapses at GoMechanic.

“Valuation has become the benchmark; it has overpowered value. The sole raison d’être of companies was that they would become profitable at some point in time. Now they are never intended to be profitable,” observes Subramanian.

A Bengaluru-based start-up after a year of struggle raised Rs 83 million in the first round of funding recently. Immediately after, the VC funnelling money insisted the company move its office to a more “glamorous” location. The start-up did just that, spending prohibitively on dressing up its office to pander to investor wants.

An industry expert says that the founder could well have pushed back and chosen to focus on growing the business.

But Chandwani has the last word: “There is the unicorn temptation. This bubble is yet to burst.”