Startup reality check: Founders and VCs face accountability wake-up call
Startup reality check: Founders and VCs face accountability wake-up call
Indian startup Byju's Alpha is yet another prime example of startup fraud, but the blame does not solely rest on the founders
Indian startup Byju's Alpha, which was the highest valued Indian startup last year at $22 billion, is facing allegations that it transferred $533 million to an unknown fund registered to a Florida pancake house. "This case involves the transfer and concealment of over half a billion dollars by a borrower that has less than $1 million of remaining assets to satisfy over $1 billion in debt," said lawyers for the lenders, represented by agency Glas Trust. In a July legal filing to a Miami court, the lenders said that they lent the company $1.2 billion in November 2021.
According to court documents, Byju's wired the money to Camshaft Capital, established in 2020 and led by 26-year-old William Morton, who recently embarked on an "extravagant spending spree," purchasing Ferraris, Lamborghinis, and Rolls Royces. Byju’s creditors are seeking to recover the funds it lent to the company after saying that the company refused to make a $40 million interest payment.
Byju's, founded in 2011, has raised over $6 billion to date. In 2015, it launched its remote learning app, and in 2018, became a unicorn, and even officially sponsored the 2022 World Cup. In April, authorities raided its office in Bangalore on suspicion of foreign exchange violations, and in May, creditors filed a lawsuit in the U.S. alleging that it had not made payments and had violated the terms of their loan agreement.
This year, Byju’s acknowledged a loss of $327 million - 17 times higher than the previous year. Deloitte, the company's auditor, quit in June due to long-delayed submissions of financial reports, and three board members resigned shortly after. The company's latest valuation by its largest investor stood at $5.1 billion.
Executives are facing legal action
This is another disturbing story in a year that has seen many high-profile startups crash. Charlie Javice, the founder and former CEO of financial assistance startup Frank, was arrested on charges of falsifying customer data. Sam Bankman-Fried is in custody for defrauding investors and mishandling customer funds through his crypto empire, FTX. Senior executive at Celsius, Roni Cohen-Pavon, recently admitted to fraud and price manipulation, while his boss, Alex Mashinsky, is facing ongoing legal proceedings. Carlos Watson, founder of Ozy Media, was arrested for fraud, Rishi Shah, co-founder of startup Outcome Health, was found guilty of defrauding clients and investors, the founders of insurtech Vesttoo were accused of fraud, Ilit Raz, founder of Joonko, resigned following fraud allegations, and a judge sentenced Elizabeth Holmes, the disgraced founder of Theranos, to 11 years in prison for defrauding investors.
This is a short list of founders and executives facing allegations of fraud, and represents a significant shift. In the past decade, many companies have gone up in flames, but their founders didn’t face the consequences of the enormous loss of value, although some saw in their behavior significant failings, at times, even systematic and deliberate violations of rules and regulations. Perhaps the two standout examples of this are Adam Neumann, who left WeWork with a massive compensation package and now leads a new company that has already been valued as a unicorn in its first funding round, and co-founder and former CEO of Uber Travis Kalanick, who quickly founded a new startup which also became a unicorn.
The two companies and their founders promised more than they could ever deliver, and it was okay because in the tech sector, big promises had become an inherent part of basic operating principles. Ideas like "disruption" are often used to excuse excess and justify behavior that skirts regulation and proper governance. However, the same behavior that was once considered acceptable is now being met with consequences. The general shift in attitudes can be seen in the warning issued by the Federal Trade Commission (FTC) in February.
The unprecedented warning, entitled "Keep your AI claims in check," reminds founders, developers, and others that they should be mindful of what they promise. "Are you exaggerating what your AI product can do?" they wrote, "Or even claiming that it can do something beyond the current capabilities of any AI or automated technology?... Does the product actually use AI at all?" Alongside these general questions, the FTC warned that they will take action if they find that false promises and descriptions fall under the category of "science fiction."
A calculated risk or inflated valuation?
These are welcome changes, but they address only some of the factors that have enabled the rise of irresponsible founders. One such enabler has been venture capitalists. Over the years, VCs have portrayed themselves as taking big risks in aggressive pursuit of value creation. The ideas they back promise to change the world (for us) and provide significant returns (for them). The media has cultivated the notion that VCs are made up of exceptional talent, capable of identifying what others cannot. For example, Forbes created the "Midas List" of venture capitalists, implying a touch of gold.
Research, however, offers another perspective. One study found, for instance, that venture capitalists tend to chase trends in coordination, meaning they do not identify unique investments, that they invest in specific founder profiles (men with specific ties to particular universities), and they often inflate valuations, regardless of how problematic the business model is. An analysis in 2021, for example, found that 90% of U.S. startups valued at over a billion dollars would not be profitable. So, perhaps it's time to acknowledge the truth: venture capitalists are not made up of exceptionally wise individuals - they just have more capital, connections, and, importantly, almost no shame.
From a business standpoint, this works out well. As startups explode, entire industries - like crypto - are exposed, public companies crash, and venture capitalists continue to thrive. How? They get in early, buy large chunks at a fraction of the value, inflate valuations, and then sell to the public and make profits. Along the way, they collect management fees. If we've learned anything from recent revelations about the startup world, it's that not only does the status of founders need to be called into question, but also that of venture capitalists.
Updated: A previous version of this story mistakenly included Adam Neumann among entrepreneurs who’d been accused of deliberately breaking the law.
