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High Stakes and Hard Falls: The Dark Side of the Startup Ecosystem

This virtuous cycle of investment and success was supposed to fuel explosive growth in the number and scale of startups. While it did exactly that, it also attracted frauds into the industry.

In 2003, a then-19-year-old Stanford chemical and electrical engineering drop-out Elizabeth Holmes, founded a blood testing start-up called Theranos. It then went on to raise more than $700 million from venture capitalists and private investors, resulting in a valuation of more than $9 billion at its peak in 2013 and 2014. 

In May 2019, former Wall Street trader Sam Bankman-Fried and ex-Google employee Gary Wang founded a cryptocurrency exchange FTX. In January 2022, the startup was valued at an eye-watering $32 billion

Huge, right?

In India, GoMechanic quickly gained popularity upon its inception. This garage services startup had everything it needed to lead the industry, including the benefit of being a first-mover, founders from IIM Ahmedabad, interest or investments from prominent venture capitalists, a solid customer foundation, and a network of almost 1,000 garages in 40 cities.

Meanwhile, the entertainment and social media influencer Logan Paul ventured into CryptoZoo, an NFT, DeFi platform, and Metaverse where Zookeepers can Collect and Breed exotic animal hybrids that yield $ZOO on the blockchain. And like the others, it garnered significant attention.

But do you know what’s common in all these three startups?

Well, they had a pretty bad downfall. Also, this relates to something called “SCAM”.  

And this is exactly what we will be talking about in this deep dive. We will explore the extent of the issues surrounding these scam-ridden startups, delving into just how severe the repercussions can be and the magnitude of the problem within the startup ecosystem.

The Startup Scam Spectrum

Frauds and startups have long been intertwined in the same complex web. While fraudulent startups existed in the past, their numbers were comparatively fewer. 

Historically, startup founders approached their ventures with a genuine intent: identify a real-world problem and develop a product or service to address it. This solution-centric approach not only facilitated the resolution of significant issues but also made fundraising comparatively easier.

Take Silicon Valley for instance. Since the 1980s, it has been the epicenter of venture capital. The Valley's model of venture capital thrives on the flexibility of human capital deployment. It attracts a diverse pool of potential entrepreneurs and employees from around the world, both from large conglomerates and small pioneering firms. 

As these top venture capitalists realize exceptionally high returns, they draw more investors to the fray. This influx of funds means that more startups could secure capital to launch and scale their operations, increasing the likelihood of successful outcomes and high returns. In turn, these successes attract even more investments into the venture capital sphere.

Now, this virtuous cycle of investment and success not only fuels explosive growth in the number and scale of startups it also attracts frauds into the industry who just want to raise capital and then burn that capital without actually building a product or service. 

For example, Holmes of Theranos faked the results of the blood tests for a long time before she was exposed. Similarly, at HeadSpin, founder Manish Lachwani, exaggerated the company's revenue figures by almost more than four times. Lachwani also falsely claimed major corporations like Apple and American Express as customers, misrepresented financial losses as profits, used company funds for speculative tech stock investments, and fabricated invoices to conceal these actions.

India's Startup Scandals

India is known globally for its vibrant startup ecosystem, which is the world’s third-largest. But like the rest of the world, India also has its fair share of startup frauds. 

GoMechanic, as mentioned in this article's beginning, is one example of such a startup. GoMechanic was in the process of bagging $75-80 million in Series D funding led by SoftBank’s Vision Fund and Malaysia's Khazanah Nasional, with other participants involved. 

However, during due diligence by EY, hired by SoftBank, significant irregularities were uncovered. EY's report revealed potential accounting violations at about 60 of GoMechanic's 1,000+ service centers, involving overstated revenues and misdirected funds. 

Consequently, SoftBank and other potential investors withdrew from the deal upon learning about these discrepancies. They informed also GoMechanic's existing backers, including Sequoia, Tiger Global Management, Orios Venture Partners, and Chiratae Ventures. 

GoMechanic's co-founder, Amit Bhasin, admitted to these financial missteps in a LinkedIn post.

“As entrepreneurs, we identify problems, come up with solutions, and explore every opportunity to grow those solutions to meet unmet needs. But in this instance, we got carried away. Our passion to survive the intrinsic challenges of this sector, and manage capital, took the better of us and we made errors in judgment as we followed growth at all costs, including in regard to financial reporting, which we deeply regret.”

Additionally, here’s what some of the major investors of the company said in a joint statement, as per a report by Mint.

“The investors of GoMechanic were recently made aware by the company’s founders of the serious inaccuracies in the company’s financial reporting. We are deeply distressed by the fact that the founders knowingly misstated facts, including but not limited to the inflation of revenue, which the founders have acknowledged. All of this was kept from investors. The investors have jointly appointed a third-party firm to investigate the matter in detail, and we will be working together to determine the next steps.”

Furthermore, the Delhi Police's Economic Offences Wing has filed an FIR against the four cofounders and top managers of GoMechanic, following allegations of fraud and cheating.

The complaint was lodged by key investors including Orios Venture Partners, Sequoia Capital, and Chiratae Ventures. Surprisingly, the FIR reveals that the alleged fraud at GoMechanic dates back to 2017, during the company's initial discussions with investors for seed funding. 

Another example of such a startup scam is Stayzilla. In 2017, Stayzilla founder, Yogendra Vasupal, was arrested on charges of fraud after Jigsaw Advertising and Solutions, a former client, claimed Stayzilla had failed to pay dues amounting to INR 1.69 crore. 

But GoMechanic and Stayzilla are not the only such cases in India. Startups like BahartPe, Zillingo, Trell, etc. are also on the list.

Beyond the Funding Freeze

While frauds and scams, exclusively, in startups are a problem to solve urgently. There is another bad actor who needs attention too.

But to fully grasp the scope of this issue, it's essential to understand the environment in which this actor operates.

It is no news that the startup ecosystem in India is currently experiencing what is referred to as a "funding winter." The once-abundant unicorns—startups valued at over $1 billion—are becoming increasingly rare. Last year, there were just two unicorns; while, just two years ago, there were 45 unicorn startups.

In fact, according to a report by the Economic Times, there’s a shift in investor behavior towards greater caution and selectivity. Despite India maintaining its position as a large venture market globally, the volume of venture funding has regressed to levels not seen since before 2017. 

Source: Economic Times

Venture capital investments have plummeted dramatically, falling to $11 billion in 2023, a massive decrease from the $42 billion recorded in 2021. 

Now, imagine, you’re a startup founder in India with a idea that you want to take to the next level. However, as mentioned above, the funding environment isn’t that great, currently. But one day, you come across this advertisement about some startup convention happening in a few days. Also, this event claims to be the world’s biggest funding event. 

Wouldn’t you be excited? 

Well, something similar happened in India last year. 

In March 2023, hundreds of aspiring entrepreneurs gathered in Noida for the World Startup Convention (WSC), which billed itself as the "world's biggest funding festival." Held over three days in March, eager startup founders attended with the aim of networking with business leaders and hoping that their 15-minute pitches would bag them funding.

But in reality, people barely saw any investors. In fact, according to Inc42, the scenes at the venue on the opening day of WSC were chaotic. 

“On arrival we saw angry crowds, the organisers being shielded by police and none of the fanfare that had been promised over the months in social media campaigns.” 

While many attendees shelled about INR 8,000 for a three-day pass of the event, the stakes were higher for sponsors. For instance, a Bengaluru-based D2C brand invested over INR 50 lakh to sponsor the event.

Addressing Scams in a Mature Ecosystem

Fraudulent activities are an unfortunate reality in the startup ecosystem, both in India and globally. But as the startup ecosystem advances, one might expect the occurrence of such scams to decrease. But despite the startup ecosystem becoming mature enough with advancements in technology, involvement of high-caliber investors, and the presence of genuinely innovative companies, the persistence of fraud at a high intensity remains a critical issue that demands immediate attention.

Let’s take WSC for example again. With high-profile personalities such as Ankur Warikoo, Raj Shamani, Chetan Bhagat, and Prafull Billore involved in promoting the event, it raises questions about the level of due diligence exercised. Were these influencers unaware of the potential discrepancies? 

But then, again, on the brighter side, regardless of the circumstances or the severity of the issue, there are solutions to address the persistent problem of fraudulent startups. The solutions involve us, the consumers, the investors, the government, and public figures. And that’s exactly what we are going to be exploring in one of our upcoming articles. 

Until then, keep a tap on the ecosystem and stay alert for any signs of such fraud.

Edited by Harshajit Sarmah