SUMMARY
SIDBI is said to have questioned AIFs where it is a limited partner about the potential fraud at GoMechanic, according to sources
Among the key backers of GoMechanic, Orios Venture Partners is the second-largest institutional stakeholder, with Sequoia Capital being the largest stakeholder in the company
According to AIF founders that Inc42 has spoken to, SIDBI has so far never looked to question fund managers on their due diligence process or investment decisions
Even as startup investments have become a real opportunity for high net worth individuals and institutional investors, incidents such as the GoMechanic fraud and the liquidation of Zilingo have dampened the enthusiasm considerably.
Limited partners in funds, including the likes of Small Industries Development Bank of India (SIDBI) which invests in alternative investment funds (AIFs) are now grilling VCs about their due diligence process and why certain irregularities escaped attention for so long.
Sources close to a SEBI-registered AIF with SIDBI backing have told Inc42 that the regulatory body has questioned some VCs that had backed GoMechanic in the past.
This after some investors such as Mumbai-based Orios Venture Partners, which holds about a 17.14% stake in the startup, had already written down their investment in GoMechanic.
While a loss on the books is not unprecedented for VCs given the rate of failure of startups, the questions from SIDBI raises potential implications on startup fundraising, LP disclosure norms and greater scrutiny from government agencies.
Of course, given that SIDBI invests in AIFs through the Fund of Funds (FOF) and other dedicated government funds, the larger question is how such scrutiny might hurt the Indian startup story.
SIDBI Scrutiny Amid GoMechanic Fraud
While SIDBI is not the only LP asking questions, the fact is that the Finance Ministry has jurisdiction over the bank and as such VCs are concerned about the potential regulatory overhang from SIDBI’s involvement.
Last July, SEBI had reportedly conducted surprise checks at the offices of 20+ AIFs, including private equity (PE) funds and hedge funds, to check if they were in compliance with certain aspects of the securities laws.
The current matter involving GoMechanic is complicated by the fact that at least one founder of the company has admitted to the fraud publicly. This makes it easy for LPs to question VCs directly, whereas in previous cases such as BharatPe, Zilingo or even Trell, the individuals involved have defended themselves against allegations of fraud. This also gives authorities bigger teeth in any potential action against GoMechanic.
GoMechanic cofounder Amit Bhasin publicly admitted to committing “errors in judgement” in financial reporting while trying to pursue growth in a chain of events which started with the startup firing 70% of its staff. GoMechanic’s management inflated sales and underreported costs incurred to secure a higher valuation, as per the investors in the company that Inc42 has spoken to.
GoMechanic, the startup’s investors and SIDBI did not respond to questions from Inc42 about the details sought by the government-backed MSME-focussed bank.
“This opens the door for SIDBI and other LPs to ask questions about our other investments. And SIDBI’s connection means there is a government connection. It could seriously impact even those founders that have been building their business honestly,” a Delhi-based early stage investor told Inc42.
In 2022, the Fund of Funds for Startups (FFS) committed INR 7,980 Cr to 99 alternative investment funds. Of the total amount committed, INR 3,400 Cr was disbursed to 72 AIFs, which in turn made investments worth INR 14,077 Cr in 791 startups,
Investors Brace For Losses
Among the key backers of GoMechanic, Orios Venture Partners is the second-largest institutional stakeholder, with Sequoia Capital being the largest stakeholder in the company.
According to reports about the written down investment, Orios’ exposure from Fund II was 7.79% of the committed corpus, at last round’s valuation and the assets represented around 1.27x of the fund’s multiple on invested capital (MOIC).
Investors, including Sequoia India, have initiated a forensic audit of the startup’s books to understand the true picture of the fraud. Both KPMG and PwC had conducted audits in the startup in previous years, but did not report any discrepancies.
Besides Sequoia India and Orios, GoMechanic has investors such as Tiger Global, Chiratae Ventures and has raised more than $55 Mn since inception till 2021. Further, it has also raised debt from the likes of Stride Ventures, which is said to be managing the potential exit opportunities for investors.
Due Diligence Becomes An LP Problem
According to AIF founders that Inc42 has spoken to, SIDBI has so far never looked to question fund managers on their due diligence process or investment decisions. “SIDBI might have an ear in the investment committee, but they never interfered with the decisions as a policy. I believe this has been a policy for the past several years,” said the founder of a Chennai-based SIDBI-backed AIF, requesting anonymity.
However, the founder added that SIDBI is just like any other LP at any other VC fund, who would want to hold fund managers accountable for any lapses.
LP confidence has been severely dented by the potential fraud at GoMechanic, and other due diligence-related issues since early 2022 at startups such as BharatPe, Zilingo, Trell and a slew of corporate governance problems at startups where investors are on the board.
Further, the likes of Infra.Market and WazirX have seen probes from tax and economic offences authorities. Founders have been accused of mismanaging VC funds either by reckless expansion into new verticals or overhiring.
While the global macroeconomic slowdown had already brought in the startup funding winter, these potentially damaging issues and the involvement of government-backed LPs threaten to strain the funding outlook further.
