Why integrity matters in the startup ecosystem

What if we ran a poll. Since the next round of funding is not so readily available, what should hyper-funded Indian startups focus on? The list of responses will likely include operating profits, unit economics, product differentiation and customer habit. The hyper-funding of 2014 and 2015 ruined all of the above and it is time to go back to the basics. Yet, the Achilles heel for hyper-funded Indian startups might be something else. Something that we least suspect. The carcinogenic effects of hyper-funding have caused a cancer that could eat us hollow and not allow the body to recover to a healthy state. It’s the integrity cancer.

Here are some symptoms of this brand of cancer that is killing the integrity corpuscles that lasting companies rely on. (Disclaimer: all stories narrated below have been told to the author by the entrepreneur, investor or employee at respective startup. For every story told here, there are many others that are not.)

Stealing trade secrets and intellectual property

A dying startup decides to pivot and enter a space that is about to get hyper-funded. A few employees from the startup leave and join the top-funded startup in the space, then return after a couple of months with trade secrets, code and customer database. The startup and the employees get sued. For all practical purposes, nothing happens. It comes up in diligence by a global fund. A reputed law firm writes an opinion letter giving them a clean chit and the investment goes through. This results in two companies with the same playbook, now both losing money in a fight to death, growing as fast as possible to get the next round of funding.

Money laundering by company officers

Senior management of a startup create new companies that provide services to their hyper-funded startup. The startup loses money through its nose while the service provider makes great margins. The service provider compensates its shareholders through dividends and individuals through fees. In similar news, relatives of the founder of a large e-commerce company become sellers on the platform, get tipped off about when the company will sell at negative gross margins, and sell to the e-commerce company at a higher price only to buy back in bulk at a lower price.

Willful lies and misrepresentation to press

A VC firm struggling to return money to its investors after seven to eight years finds a portfolio company in a space that is tipped to be on the radar of global investors due to a hyper-funded Chinese equivalent. VC invests $5 million at a certain valuation. Startup issues a press release announcing twice the investment amount at a 50 percent higher valuation. Entrepreneur loves it because competitors get scared off due to the stated valuation and fund-raise. VC loves it because they are able to demonstrate greater multiples on mark-to-market as they look to raise a new fund. Both work together to tweak the story to the liking of the global investor and pitch their startup as the top choice. In one such occasion, the reporter involved is a relative of the entrepreneur.

Material conflict of interest

A global fund makes a horrible investment that goes south due to bad habits created by hyper-funding too soon. Instead of writing off the investment, gives it a lease of life to then merge it into a portfolio company whose founder was an angel in the bad investment. The acquiring company gets to set a high valuation for the stock swap thus pegging the valuation for future rounds. The angel and fund get shares in the acquiring company instead of writing off their investment. The press laps it up as a top exit while there are no synergies between the businesses. The conflict of interest of these mutual shareholders messes things up for all the other shareholders on both sides.

Posing as investor to steal ideas

An influential angel investor looking to start a new company in a certain market space goes to an existing startup operating in that space. He poses as investor, gets all details including alternate company names they looked at. He buys the domain for one of those names, starts a competing business and raises seed money the size of a Series A. A similar story plays out with a VC. A VC firm with a term sheet out to a startup continues to take a close look at competitors without revealing that they have a term sheet out, even when asked about conflicts. A deal is announced a few weeks later. VC does not reply to emails of competitors who got the short end of the stick. Non-disclosure agreements are no longer used in the country because enforceability is a joke.

Founders abandon startup, pose it as acquired

Entrepreneurs burn crores within months in B2B logistics space to build capacity. With a couple of months of cash left and no follow-on funding in sight, they continue to race off the cliff. After the operations are forced to shut down, delivery boys vandalise the office and steal assets. The founders take the remaining money out of the bank and transfer it to their personal bank accounts. Newspaper headlines reveal that the startup has been acquired by another logistics player, except no shareholders see any cash or stock in the “acquiring” company. Founders get employed with acquiring company at top salaries, transfer intellectual property and assets.

Unfulfilled promises for stock option

Entrepreneur hires people with verbal commitments of stock options. The options do not get granted despite two subsequent funding rounds, each resulting in an uptick of stock price and significant risk reduction. Employee continues to work hard in order to “earn” the committed options. Eventually, when expresses discontent, is offered stock options priced at current value – 15x jump from the time of joining. The options are expressed as a rupee value that is fraction of the salary, that too calculated on the share value of investors’ preferred stock. Employee knows he got deceived, makes a mental note to leave the company after maximising his salary and learning. Talks to his batchmates in other hyper-funded startups and learns that this is usual, pledges to start a company as founder and play the same game – sell shares rabidly to investors, not grant shares to employees, get on panels and talk about how Indian employees do not value stock options. Young graduates working in these startups learn to believe that this is how startups are built and founders get rich and famous. They repeat the feat with the next idea that is likely to get hyper-funded.

As you read through these, did you have a moment where you paused and thought ‘hey, this happened to me!’ or ‘hey, I know exactly what you are talking about!’ or ‘hey, I know a friend who…’? I have been talking about this in my last three keynotes at events involving investors and entrepreneurs. The acknowledgment from the audience is unanimous. One in six die of cancer worldwide. I would speculate that more hyper-funded Indian startups than that suffer from integrity cancer. Since hyper-funded startups are the largest source of inspiration for the new breed of tech entrepreneurs, integrity cancer is spreading beyond the boundaries of the host and into the ecosystem. The signs of the illness are now reaching back to global investors, those who arguably started it all. Their reaction is same as a tourist who once visited and fell in love. Getting vitals checked.

The Delhi-NCR launch event of my book The Golden Tap – The inside stories of hyper-funded Indian startups, was hosted at Investopad Gurgaon by the CNBC Young Turks team led by Syna Dehnugara. We had three generations of entrepreneurs represented on a panel, one from each wave described in the book. Sanjeev Bikhchandani, Founder of Info Edge / Naukri.com, from the Internet wave. Deepinder Goyal, Founder of Zomato, from the globalisation wave. Ritesh Agarwal, Founder of OYO, from the smartphone wave. The contents of the panel became the year-in-review episode for the popular TV programme. As the set and camera started coming down at the end of the evening, Mint Editor R Sukumar spoke to the crowd. The end of his thought-provoking speech became my most memorable part of the evening as I look back.

He said that we all dreamt that one day technology businesses will become mainstream in India. It would be a new breed of businesses built on transparency and meritocracy, driven by knowledge and employee ownership. Businesses that solve the country’s problems without overheads, corruption or permits. It looks like technology businesses are here and here to stay. There is abundance of capital and entrepreneurs. But is this how we imagined it to be?

That question hit me hard. Indeed, I was one of those like Sukumar who dreamt the same dream when I started my company as a college student in 1999. I used to hear stories about the Infosys founders’ drivers and secretaries making money from stock options, how the company pays taxes, follows transparent accounting practices and no cash changes hands. And then I thought of all I had witnessed in 2014 and 2015. The new technology businesses are plagued by the same evils as the old businesses they rebel against. It is a newer version of the same old, only at technology scale now. Bigger, better, faster of the good and the bad.

For India to have a long and sustainable road for tech startups, where ideas and funding remain abundant, we need to get rid of the integrity cancer. In absence of an efficient legal system to hold us accountable, each of us needs to operate with integrity, blow the whistle when it happens to us and speak up when it happens to someone else. We need to hold ourselves and everyone around us to account. Not for any other reason except our own. Let’s not litter in our own house. Let’s build the immunity to counter the cancer before it kills us.

Here is the original article published on YourStory.com on March 2, 2016

Kashyap Deorah is author of The Golden Tap: The inside story of hyper-funded Indian startups