BluSmart - deemed to have been the golden child of India’s electric vehicle revolution - was a startup with which no one could have imagined such crises in the face of such great PR machinery and the founders wanting to fix the problems prevalent in India’s cab-hailing market. The fallout from the Gensol debacle comes on the heels of earlier governance issues at companies, like Paytm Payments Bank and BYJU’s, and underlines a very worrying trend: the regulatory apparatus has actually failed to keep pace with the rapid evolution of India’s startup landscape.

What led to BluSmart having to abruptly suspend their operations in Mumbai, Bengaluru and Delhi-NCR? What lessons can be drawn from debacles, such as this? A lightly-edited conversation with Shriram Subramanian, Founder & MD - InGovern Research Services, and Romit Dey, Partner of M&A and Restructuring - AP & Partners, follows:

What red flags could have been spotted early on, when it comes to the Gensol-BluSmart setup?

Subramanian: One of the main indicators for anyone choosing to study this setup in detail is the fact that there were too many related-party transactions. Another indicator was that the company was always in the social media spotlight, with influencers talking up the stock, the company putting out order book numbers and being press-friendly. There was more of a PR focus rather than an actual delivery of numbers. Plus, the company was always fundraising either by itself or by related parties and management bandwidth was not known.

Another worrying element was that no institutional investor held shares, even though it was a ₹4000 crore market cap company. Something of that size would have been on the radar of institutional investors, leading them to dig deep and do research. Something like this usually happens even when the company is around ₹1000 crores, so if nobody in that cohort owns shares when it’s at ₹4000 crores, they might have already red-flagged it.

What were the specific SEBI regulations that were allegedly violated in this case? And how common is the misuse of public funds, when it comes to listed entities?

Dey: The SEBI regulations, which were violated, were unlawful trade practice regulations and LODR. Having gone through the order to see the extent of violations reported, the crux of the matter is the misuse of funds which were allocated for buying EVs and which were obtained as a loan from large public-sector NBFCs, such as PFC and IREDA. However, one should be mindful that this is only an interim order and SEBI has ordered a forensic audit to be done of the records of the company and its related parties. But, the revelations in the interim order, itself, are quite startling.

There are allegations that the promoter submitted a no-objection certificate and a conduct certificate purportedly given by PFC and IREDA & when these two entities were questioned, they denied providing such certificates. Furthermore, there was a violation of the disclosure norms under LODR, where the company notified the stock exchanges about receiving orders for its EVs from its Maharashtra plant, but according to the investigation, there were no final orders, just expressions of interest or MoUs without any indication of price. The company seemed to, also, be falsely claiming to operate a factory at an address where none existed.

SEBI seems to indicate that the funds obtained from PFC and IREDA, through a conduit of the EV manufacturing entity and layered transactions, were diverted to related-parties and for the personal use of promoters. This is gross negligence in terms of the fiduciary duty of the promoter towards public shareholders, keeping in mind promoters of a listed company have a greater duty towards shareholders, because it’s the interest of the public at large affected. Instead of realizing their responsibilities, the promoters used company money for their own benefit, as opposed to the stated end-use. And the company, which had declared a stock split, has been asked to stop that. So, there would be a penalty and SEBI can, also, take the Independent Directors to task, if it’s found that the IDs were not doing their job properly.

Essentially, it’s a full-blown scam: treating public funds as a personal fiefdom. What does it say about the intent of the promoters? They weren’t naive when all this was happening, this was well-contrived and so, they have to be taken to task. Should the penalties for something, like this, be much higher, so that it serves as a good kind of example for the entire startup ecosystem?

Subramanian: We have to segregate the corporate governance matters at BluSmart from that at Gensol. The funds raised by Gensol from IREDA and PDF were channelised to partly fund BluSmart and partly, for the enrichment of the promoters.

Dey: Embezzlement of funds is a criminal offence. Fraud has a civil consequence and a criminal consequence. In some cases, like BYJU’s or GoMechanic, the ED has come after the founders. To prevent fraud, regulators shouldn’t leave it at just imposing penalties or abstaining the promoters from the market, they should put them behind bars. As of yet, there have been no allegations of corporate governance lapses at BluSmart, but things have escalated and if media reports are to be believed, there’s an offer of complete buyout of BluSmart with the condition that the promoters step away.

One interesting thing happening is that the people running the show at BluSmart are being hailed as saviours and people who should be shielded from what was taking place at Gensol. Should that happen or should one consider that BluSmart can’t really position itself as naive or innocent? Ultimately, it’s the consumer who is suffering. Similarly, in the case of BYJU’s, because of the greed of the promoter, a company with so many employees came to a standstill and once again, the greed of the promoters has burned a well-run company to the ground. Should BluSmart be shielded from Gensol or could its management team have been a bit more vigilant?

Dey: Assuming the shareholders have the same kind of rights one sees in other PE/VC investments, the investors have a right to inspect and audit. In the case of what came to light, when there might be fraud, there might be a clawback of promoter shares or unvested shares. Investors at BluSmart are likely to do a forensic audit and if something is found wrong, action will be taken in accordance with the shareholder agreement.

Sometimes, with startups, there’s a perception that while the founders are technically proficient, they need smart people on the Board to run the company well. How can investors assess whether a Board is truly independent and not just rubber-stamping founder decisions?

Subramanian: Even the best institutional investors are not privy to the conversations that take place in the boardroom or the conversations between IDs (Independent Directors) and promoters. Even if board meetings are held over video calls, the IDs are not given any real powers or heard by the promoters. In the case of Gensol, one ID, who had resigned, remarked that he had been trying to reach the promoter for a long time to no luck, because he was concerned about the debt situation. When that’s happening, the responsibility of the ID is to flag the matter to SEBI or to investors or to resign then and there.

So, the viewpoint emerging is that penalties are not enough. What kind of punishment would really serve as an example to the entire ecosystem at large, both for the promoters and for the IDs?

Subramanian: SEBI’s current reaction is fairly lax. Barring someone from holding directorships and raising securities will not cut it. This is a case of blatant fraud and forgery. The IPC sections should be invoked and PFC should immediately file a police complaint to put the promoters behind bars.

Dey: Our markets and our regulators are not as mature as the US markets. As more of these cases come to light, the markets will mature.

In the US, there have been high-profile cases, like FTX and Theranos and the promoters of both companies have already been jailed. In India, the judiciary and the investigating agencies don’t have that much strength to close a case very fast. So, I think swiftness of action is called for and they should go after the personal assets of the promoters.

What do you think is the level of transparency to be expected from startups receiving funding, especially from public or large institutional investors?

Dey: 99% of startups are private companies, so they’re not really regulated by SEBI disclosure norms. As is typical in a shareholder’s agreement with investors, there are information rights, where investors can seek information, such as unaudited financial statements or about the business plan, inspection rights and audit rights to inspect the books of the company or have their own auditors audit the company. Investors, also, have affirmative voting rights where for instance, if there’s a capital expenditure above the threshold of ₹50 lakhs, the consent of the investors would be needed. So, there are a lot of rights and protections for investors and they’ve become more proactive. That’s how it’s playing out after 2021 or 2022. From a promoter standpoint, one needs to understand that what investors are seeking will lead to good corporate governance practices being followed in a company. This will add to a valuation at a later stage.

When some of these revelations take place with regard to companies, like BYJU’s or BluSmart or BharatPe, it comes across as a bigger shock to the fraternity and consumer space at large, because these are companies where the PR narratives have been so heavy and where these companies have been deemed to be the messiahs and saviours of the Indian startup ecosystem. So, how can one cut through all the media hype to understand the real risks? Is the PR narrative actually harming rather than helping the ecosystem?

Subramanian: Using words like “startup saviour” or “startup icon” is just for the sake of awards. At the end of the day, one has to run a business, make money for investors and keep all the stakeholders happy. When there are lapses, employees lose their livelihoods and investors lose money. The founder has to be accountable.

Dey: One has to be able to see through the clutter. Beyond awards or conferences, one has to go through accounts, records, Board reports and more to understand what a company is doing right.

Does this debacle point to a broader ecosystem risk and a wider problem for India’s startups? What could be the lessons for both founders and investors?

Subramanian: No matter what and no matter where, there are good apples and bad apples. The lesson for founders, even in a small company, is to ensure sustainability and grow slow and steady. Working towards building a long-term company that will outlive one’s legacy is the way to go. Many of the marquee brands that have lasted for more than 100 years are nimble, have good management and have adopted good corporate governance practices.

The lesson for investors is to dig deeper. Investors shouldn’t go with the FOMO factor. There are tons of investment opportunities, so there’s no need to rush to invest in a company just because it’s “hot”. One should look at the ethics and ethos of the promoter, even if business is good.

Dey: I don’t think the startup ecosystem or the investment climate will get impacted too much. Many startup founders are doing good work and are very driven to solve real-life problems and build lasting institutions. Right now, India’s one of the few bright spots in the world economy.

But, again, this is not the last instance of corporate fraud that we’ll be hearing about. Some founders will continue to do wrong, either under pressure to give returns to investors or to raise valuations or wanting to earn a quick buck. However, all of it will eventually lead to the evolution of our ecosystem, regulations and the Indian corporate market.

(Shrija Agrawal is a business journalist. The views expressed are personal)