The Art of a Good Unicorn: ‘VC investments have gone up, but diligence mindset has not changed'

Hindustan Times

14-05-2025

The unravelling of the BluSmart-Gensol fiasco provides a lot of food for thought. There's a sense of anger when one sees what the Jaggi brothers did with Gensol. But, there's also a sense of sadness that a company, which one thought could solve the problems in the cab-hailing space — timeliness, cleanliness and environmental sustainability — was being run into the ground due to the sheer greed of the founders. A similar case is BYJU's, whose downfall can be attributed to the founder; a company which could have really taken India's EdTech landscape to the next level in the long run.
Where do we go from here? What are the lessons for investors, diligence fraternity and so on? We try to find answers to all these questions in a conversation with Tarun Bhatia, regional managing director and co-head of APAC - Kroll. Edited excerpts:
What really is left of Gensol?
Bhatia: It's disappointing to continue to come across fiascos where investors, customers and other stakeholders have to suffer because of the misdeeds of a few. In the case of Gensol, which is a listed company, and considering I'm a firm believer in the market being the king, the market has spoken, leading to the company being down around 85% from its price before the unravelling. With a complete loss of trust and limited reliability on financial numbers, I don't think there's any institutional demand. I think whatever is left is barebones.
What red flags could the forensic accounting department of some entity have spotted early on in Gensol or BluSmart that might have averted this crisis? Were the alarm bells not ringing?
Bhatia: I think the role of auditors or any other form of compliance becomes key. Most companies, especially listed ones, are expected to have the necessary checks and balances in place with aspects, like the balance sheet and the cash flow of the company, operating independently of undue influence from the promoters.
A challenge directly plaguing the broader Indian ecosystem is fairly opaque holding structures where it's difficult to know who the ultimate beneficial owner in India is. Related party transactions are another challenge, which we come across in 50% of the fraud investigations that we undertake, though the size and scale may vary. BluSmart has had some level of venture investments and understanding the relationship it had with its parent company should have been an important checkbox to mark. The lifestyle of the promoters often gets missed, which was a fairly big red flag in this instance. While there may be forensic accounting taking place now at BluSmart, which would get into the nitty-gritty, looking at the big picture, there needs to be a lot more checks and balances which were flouted in this case and which, unfortunately, colours the entire industry.
When it comes to BluSmart, the VCs must have done their due diligence, of which there are two kinds: financial and legal. So, how could something, like this, be missed? From the SEBI order, one might understand this was a multilayered transaction and not naiveté. It was a full-blown conspiracy to evade the eyes and vigilance of SEBI. The words that SEBI has used are very harsh, deeming this to be a complete breakdown of corporate governance.
Bhatia: Keeping in mind how much I respect the Indian VC community and how the VC/PE investment culture has grown to hit almost two decades, I see how the ticket sizes for VC investments have gone up, but the diligence mindset has not changed at a VC level. So, there are a lot of early-stage transactions where there's an innovative idea by founders, a lot of focus goes into the idea behind it and there is some degree of checks on the people behind it. But, if the idea is very exciting, it's inversely proportional in terms of the diligence around the founders, whereas, in a more mature growth-stage company, the checks are much deeper. A lot of reliance is given very early on to whatever the founder is saying. Any financial diligence in an early-stage company seems to centre largely around conviction in the founders.
The lesson for VCs is that they have to go beyond product or technical capabilities. But, isn't that what the VC model actually is: branding themselves as founder-first? But, that doesn't shield them from doing the required diligence.
Bhatia: The early-stage model is about taking a bet on 20 ideas with only 1 succeeding. One would hope that the ones that didn't succeed were business plans which failed and not due to governance issues. The double whammy here is that the one idea that succeeded in that portfolio had significant governance issues. Much of the diligence and checks can be done in-house without having to use a third party. As one's portfolio company scales and grows, one has to ensure that the governance risks are monitored in sync at that scale. Misdeeds seem to be taking place in those companies growing very fast and where a lot of focus post-investment is on growth, marketing, efficiency and profitability. Those companies might have a broader view that governance is important and that a reputed auditor would be engaged with, but there's limited effort to ensure there's an effective governance framework. The mindset has to be that these operators are running a company, no longer a startup.
Companies keep growing and governance is barely catching up. Putting in Independent Directors is not a solution in and of itself.
What could the solution be? Take Zepto, for instance, which has tremendous growth and relatively younger founders, so there might be some naiveté. How can one prepare the company structure and the Board while taking care of technical capabilities? Are those conversations happening with investors or are they only relegated to burn rate or competition or growth metrics or performance metrics? I don't think there's enough focus on corporate governance, because there's a resounding message that good governance is equal to a good company.
Bhatia: A lot of language does focus on growth, the next round of capital, exits and more. But, that's the reality of the industry. Any investment industry works on an exit philosophy. Almost 80% of the time goes on just the first two points of an agenda, rather than asking difficult questions, like shrinking margins or increasing costs or talent exodus. An HR leadership exit could raise as many questions as a CFO's exit.
In the case of D2C companies, one has to ascertain how strong the mechanisms are to protect against any leakage of information, especially when consumer data is involved. A cyber-breach is no longer an extraordinary event.
There are a lot of buzzwords and not enough focus on the implementation or monitoring of frameworks. A lot of companies are talking about whistle-blowing, since SEBI has been encouraging that, but not much happens with the complaints that do come forward.
What are the lessons for VC investors? Do they have no role to play? Do they just have to accept the mistakes or lapses in decision-making? Is the entire blame going to the promoters fair, especially when VCs claim to work closely with companies to take them from Point A to Point B?
Bhatia: One wouldn't want investors to run their company. Investors are taking a bet on the business idea and the people. If they start asking questions about every commercial decision that a company is taking, it's not very efficient. So, I don't want to be too harsh on investors with regard to what they were doing and why they were not aware of certain misdeeds. With investments in so many companies, there can't be the same level of scrutiny.
In cases, like Gensol/BluSmart and BYJU's, the size had increased materially. While the business scale had changed, the thinking around governance was still as if this were a small startup. The last role to be filled up in any KMP (key management personnel) is the chief compliance officer, which seems to be evident in these cases. There are instances where the auditor is changing every year and that's public information, so it's surprising that it was not looked into even at the first level of screening.
The disclosure around related-party transactions has improved, but one has to question where the money is going, what the ownership structure looks like and more. That level of scrutiny is not taking place. Even speaking to people who are not founders provides insights. It's important to diversify information access.
There have been limitations on the number of Board seats one could occupy, but there need to be more cultural changes with regard to the way a Board functions.
Where do we go from here, in terms of diligence? This is not the first or last unravelling of a scam in the startup ecosystem. But, does something, like this, have material implications on the fundraising diligence level exercised by incoming investors to India?
Bhatia: In terms of data related to litigation and disputes, there's a lot more information publicly available, even in a user-friendly manner, more so than in other developed markets. India has taken multiple steps to ensure that the quality of information disclosure levels is better. But, debacles, like this, take us backwards. This creates mistrust, especially around all EV or EV financing companies. The next round of entrepreneurs, especially in these sectors, will go through significant scrutiny and the sector may see some slowdown, at least temporarily, in access to funding, both formal equity and lending.
There's a lot of dry powder in India and huge investment potential, but events like this, in a short period of time, raise question marks.
How important is cybersecurity and auditing the trail integrity in assuring regulators and lenders there is operational transparency?
Bhatia: One of the stumbling blocks in diligence when dealing with B2C and B2B startups is that people feel their job is to spend money on cybersecurity. People spend on heavier doors and fatter locks and, then, leave the door ajar. There's a lot of tech spend on security and there are instances when everybody in the company has access to all the data, which could lead to leakage of information. Furthermore, very few companies have an incident response mechanism.
What are the steps a financial advisory firm ought to take if brought in to support litigation or asset recovery in a cross-party multi-stakeholder case like this?
Bhatia: Introducing more intermediaries does not solve problems. If anything, it creates more barriers. Today, there is greater accountability in terms of disclosing any wrongdoing that's identified. The broader accountability of running the business transparently has to be on the stakeholders, the company management and the Board. The challenge in our ecosystem is that once litigation is afoot, it's a long winding road. To create better confidence in the Indian ecosystem, put investors, the Board and management under greater accountability.
How can businesses protect themselves when one party in its operational ecosystem is under investigation or loses creditworthiness?
Bhatia: It comes down to reliance on that party. Businesses which run on brand will find it hard to recover. One major risk is depending on one vendor or one customer, so reducing dependence is critical.
If the promoter is not even listening to their own investors, what really remains of IDs?
Bhatia: Currently, it's very difficult to find an ID. The number of IDs in the market is coming down, due to factors, like potential liability or scrutiny. But, I don't think they could be purely relied on due to their level of authority. So, investors or other parties should stop taking refuge behind IDs. Difficult questions have to be asked no matter what.
What should be the ideal communication frequency or set of questions between an investor and the portfolio company?
Bhatia: While there isn't a golden rule, there are quarterly Board Meetings or monthly touchpoints with respect to information sharing. As information comes, one has to look at how much scrutiny it is processed with.
Say a promoter has made mistakes and there are corporate governance lapses. Can they declare themselves bankrupt? What remains of the promoter?
Bhatia: Culturally, if anyone is out there to defraud or make a quick buck, that cannot be stopped. It's about how early that can be caught. Promoters have to set the bar for themselves.
When things like this occur, what are the implications on the broader ecosystem?
Bhatia: The short-term impact is that promoters in early-stage companies will face more scrutiny, because BluSmart will be fresh on people's minds. This new breed of entrepreneurs needs to be ready with answers. I do think this dampens the broader lens of corporate governance in India. The country is still not seen as a very well-governed ecosystem by global institutional investors. While fraud occurs worldwide, it's about the frequency of it and the actions post these debacles. Every 'BluSmart' will take us a couple of steps backwards.
(Shrija Agrawal is a business journalist. The views expressed are personal.)
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