The devil is in the details for Byju's: Five red flags from financial auditor's notes

File image of Byju's founder Byju Raveendran.

India’s most valuable startup is in pain. Till about a year back, one would mostly hear of its big-bang acquisitions and an unquenchable thirst to raise funding.

Of course, Byju’s also found itself embroiled in allegations of aggressive sales practices every now and then. But the company’s deal-making blitz tended to steal the headlines more often.

Yet, the last six months have seen the tide turn against the company as factors like the year-long delay in filing of FY21 annual report, a large number of layoffs, and fundraising issues spooked the stakeholders.

“It can’t be tougher than this. And if this can’t break us, I can tell you nothing else will,” Byju Raveendran, founder of the eponymous $23-billion company, told Moneycontrol earlier. He has had sleepless nights as questions have been raised about the operations of India's most valuable startup.

Its auditor, big four accounting firm Deloitte, had refused to sign off on the company’s financials because of certain revenue recognition practices. After those holes were fixed over thousands of extra work hours, the auditor made some searing commentary while signing off on the edtech company’s financials.

Also read: Byju’s logs in surprise fall in FY21 revenue, losses widen 20 times

Here are five problems that came through from the audit notes:

Revenue recognition issues

Byju’s recorded a surprise fall in its revenue in FY21 when many internet companies saw their incomes rise multi-fold due to a rise in digital adoption. According to the edtech company, this happened because its auditor mandated a deferral of 40 percent of revenues to subsequent years. In effect, this led to a revenue entry that was 67 percent lower.

But why was the revenue recognition deferred in the first place? Two reasons. Firstly, the auditor pointed out that revenue can be recognised in the subscription business model only after the service is delivered.

For example, if an educational course is sold for a two-year duration and the customer pays the entire amount upfront, the company can’t count the entire amount as revenue in the first year.

“Revenues from transfer of products to certain customers made under deferred payment terms and totalling to Rs 1,156.27 crores (based on consideration that the Parent is entitled for such transfers) has not been recognised because on the point of these transfers the Parent did not meet the criteria that it was probable it will collect the consideration to which it is entitled,” the auditor noted.

The second problem is more complicated. In cases where customers take a loan from Byju’s financing partners to pay for its courses and study materials, the company has acted as a guarantor. This means the company would be liable to make the loan repayments when a customer defaults on their installments.

Cash burn in WhiteHat Jr

Byju’s acquired a 74 percent stake in edtech company WhiteHat Jr for Rs 1,327 crore in 2020. According to the audit notes, Whitehat Jr has contributed Rs 326.66 crore of total revenue and loss of Rs 1,548.76 crore to the loss before tax from operations of the company.

“WhiteHat Junior has been a challenge on the cost side. Solving its customer acquisition cost is the only business challenge we have,” Byju Raveendran told Moneycontrol.

In June, WhiteHat laid off 280-300 employees, after over 800 employees tendered their resignations in May amid mass layoffs, restructuring, and shutdowns in the edtech sector.

Moneycontrol earlier reported that employees from the sales and marketing team were largely impacted by this round of layoffs. These layoffs took place both in India and other geographies where the company operates.

Bloated ESOP programme

Byju’s granted 23,952 employee stock options in FY21 which cost the company Rs 465 crore. Interestingly, ESOPs just contributed to Rs 25 lakh in the previous financial year.

This also indicates that the company might have been seriously preparing to go for an initial public offering (IPO) in FY21. Several tech start-ups who went public last year granted large amounts of ESOPs to their founders and top executives before hitting the bourses. For example, Policybazaar granted Rs 1,044 crore of ESOPs to top managers, Paytm granted Rs 567 crore and Zomato’s ESOP grants to top executives came in at Rs 779 crore.

Weak internal controls

According to sources, the Byju’s auditor had to put in around 3,000-3,500 extra hours of work to make the revisions in its revenue recognition for FY21. That exercise certainly did not come cheap. In its notes, Deloitte said, “ For the year ended 31 March 2021, Statutory audit fees includes Rs 3.5 crore towards the additional effort incurred in the audit consequent to material weaknesses observed in internal controls.”

Meanwhile, the Directorate General of GST Intelligence (Authority) finalised an investigation on February 18, 2021 against books supplied during the period July 2017 to October 2020. This has resulted in payment of GST of Rs 96.17 crores, interest of Rs. 27.95 crores and penalty of Rs 14.43 crores. The authority concluded the investigation without issuing show cause notice since the GST liability was accepted and paid by Byju’s.

Incomplete Aakash transaction

Byju’s signed an agreement to acquire engineering and medical entrance coaching institute Aakash in a billion-dollar deal last year. As per the terms of the agreement for acquisition, Byju’s was to pay Aakash’s shareholders Blackstone Rs 1,983 crore in June. This deadline had been deferred to September 23. According to sources, this delay in payment was because of a regulatory change regarding international M&A transactions mandated by the RBI.

In total, the edtech unicorn has settled Rs 2,830 crore of payments and is yet to pay dues of around Rs 4,000 crore. Around Rs 2,000 crore will be paid only after the merger which is awaiting an approval from the NCLT, according to the auditor’s notes.