The Rise of Indian Startups, From Global Recognition And Funding To Deceptive Practices, 10 Ways In Which Startups Falsely Inflate Financial Performance For Investors

The Indian startup ecosystem has witnessed remarkable growth in recent years, garnering both global recognition and attracting substantial investments from leading venture capitalists. However, this outstanding success has come at a cost; it has been witnessed that there are some Indian startups have resorted to deceptive practices, thus misleading investors and distorting their financial performance. 

In the last couple of years, India has emerged as a hotbed for startups, driven by a favourable demographic dividend and technological advancements, adding to a vibrant entrepreneurial culture. Also, credit to the availability of a vast talent pool, increasing digital penetration, and government initiatives such as “Startup India” have fueled the startup ecosystem’s growth. 

Thus, Indian startups in recent years have gained substantial traction, achieving global recognition for their innovative ideas, disruptive business models, and scalable solutions.

The Phenomenal Rise of Indian Startups, Gaining Global Acclaim and Funding Success, 

Indian startups made global headlines, attracting attention from renowned venture capital firms and investors worldwide. The seemingly successful stories of companies like Flipkart, Ola, Paytm, Zomato, and Byju’s (although now much under financial strain) have much propelled India’s startup ecosystem onto the international stage. These startups have secured substantial funding rounds, often in the millions or billions of dollars, enabling them to scale rapidly and expand their operations.

However, herein comes the troubling part, while success and global acclaim rose and investors followed, so did the unveiling of deceptive practices and financial manipulations.

While many Indian startups have achieved genuine success, it is essential to acknowledge that some companies have engaged in deceptive practices to maintain their growth trajectory and attract investments. 

In fact, some startups have outrightly manipulated financial statements, misrepresented revenue figures, misallocated expenses, and employed creative accounting techniques. All of these practices are aimed at presenting a rosy picture of their financial performance and creating a sense of momentum and attractiveness for potential investors.

Here are some ways in which several startups have falsely inflated their financial performance for investors –

Revenue Manipulation,

One common method used by startups, exemplified by Byju’s, involves booking revenue that spans multiple years as a lump sum in a single year. For instance, if a two-year course is sold, the entire payment is recognized as revenue for the first year. Thus, this practice distorts the financial results and creates an inflated perception of the company’s performance.

Misallocation of Expenses,

Some startups, in an attempt to boost profits, exclude tech personnel salaries from the profit and loss account. Instead, they classify these expenses as part of the cost of developing intangible assets or software products, which are recorded on the balance sheet. 

This practice artificially inflates profits and fails to provide an accurate representation of the company’s operational costs.

Premature Sales Recognition,

Certain companies anticipate sales orders from repeat customers in the upcoming month and prematurely raise invoices on the last day of the previous month to meet sales targets. Recognizing revenue before actual purchase orders create a false impression of higher sales figures, potentially deceiving investors.

Consignment Sales,

Another deceptive tactic involves shipping products to an agent, often a related party, and treating it as a sale. By recording revenue for the consigned goods, startups inflate their financial performance without actually completing a genuine sale.

Misrepresentation of Advertising Expenses,

Some startups allocate a significant portion of their budget for advertisement expenses to inflate their revenue figures. For example, they might spend ₹120 to sell a product worth ₹100 but report to investors that they only spent ₹40, attributing the remaining ₹80 to branding expenses. 

This practice distorts the actual cost of customer acquisition and misrepresents the company’s financial position.

Revenue Recognition in Marketplaces,

For marketplace businesses, revenue should ideally be derived from transaction commissions. However, some startups record the entire Gross Merchandise Value (GMV) as revenue, disregarding the fact that only a portion represents their actual revenue. 

This practice results in an inflated revenue figure and misleads investors.

Manipulation of Expenses,

Startups may engage in creative accounting by categorizing normal expenses such as repairs, maintenance, and even interest payments on loans as capitalization into fixed assets. Additionally, they may capitalize tech salaries as software development costs instead of recording them as direct expenses. 

These tactics artificially inflate the value of assets and understate operating expenses.

Misleading Inclusion of Other Incomes,

In order to artificially boost revenue, some startups include rental incomes or interest income in their revenue figures. This practice creates a false impression of the company’s core operational performance, leading to a distorted understanding of its financial health.

Inventory Valuation Manipulation,

One common tactic startups employ is increasing the value of closing inventory. By doing so, they can show lower material purchases required to fulfil sales orders, thus artificially inflating profits. This technique inaccurately depicts the company’s cost structure and profitability.

Sales Inflation through Customer Loans,

Startups may offer loans to customers to incentivize product purchases, artificially inflating sales figures without actually receiving cash. This practice outright misrepresents the company’s revenue generation and creates a distorted perception of its financial performance.

Now, it is essential to note the repercussions of such practices, as the deceptive practices adopted by some startups in India have significant consequences. 

• They not only deceive investors but also erode trust in the overall startup ecosystem. 
• When investors end up basing their decisions on false or inflated financial data, the resulting investments may not align with the actual value and potential of the companies.
•  Moreover, such deceptive practices can harm the reputation of Indian startups and create scepticism among investors for the entire startup ecosystem, thus impacting the long-term sustainability and growth of the ecosystem.

What This Calls For

For the Indian startup ecosystem to maintain its positive trajectory, it becomes imperative to address and mitigate any deceptive practices, thus ushering in the need for increased scrutiny and tighter regulations to promote transparency to prevent misleading financial reporting and fraudulent activities. 

It becomes equally essential for investors to conduct thorough due diligence, scrutinize financial statements, and demand clarity and accountability from startups.

Moreover, there is a need for a robust framework that promotes ethical practices, disclosure standards and financial transparency by government bodies, industry associations, and regulatory authorities.

The Last Bit, While the rise of Indian startups and their global recognition are undoubtedly incredible for the country’s entrepreneurial potential and innovation, however, at the same time, it is also crucial to recognise that certain startups have indeed engaged in deceptive practices by distorting their financial performance to attract investments. 

Startups that resort to fraudulent practices in order to inflate their financial performance end up not only deceiving investors, but also lead to a distorted understanding of the startup’s true health and potential. 

Thus, investors need to be vigilant and perform thorough due diligence to identify such deceptive tactics that a startup may have taken and make informed investment decisions. At the same time, transparency and compliance to ethical financial reporting practices are essential for promoting trust in the startup ecosystem in India.