VCs in wait-and-watch mode as startups brace for second-order impact of ED searches at Byju’s offices

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The recent searches by the Enforcement Directorate (ED) at the offices of Byju's, India's most valued startup, have put venture capital and private equity investors in a wait-and-watch mode, as the country's startup ecosystem prepares for potential repercussions.

“This has been expected for some time because of the way the company is structured with overseas subsidiaries. He (founder and CEO Byju Raveendran) has been running the show from Dubai and the US. He has told investors that this is a routine search and that he is co-operating. Such events shake the confidence of any investor,” said an investor requesting anonymity.

“It is true that Byju’s is India’s most valued startup but it has been problematic for a while with a unique set of issues. So I am not sure if this will have a cascading effect on the ecosystem,” the investor added.

Byju's did not comment.

Startups, especially the ones that have raised large sums of overseas funds over the last 10 years and have significant businesses outside India, might face more scrutiny with respect to their trail of money from investors, industry observers told Moneycontrol.

"During such searches, even if your books appear clean, these people end up finding something or the other," said Anirudh Malpani, founder, Malpani Ventures, highlighting the potential repercussions of the ED’s searches on Byju's.

‘Significant chunk of revenues from overseas ops’

Explaining the specific concerns around Byju's case, Malpani added: "The company has a significant chunk of its revenue from overseas operations, which will be scrutinised during the investigation and this will prompt some fear among similar companies and their investors. I can say from first-hand experience that the RBI has become extremely careful, scrupulous and critical about monitoring foreign-exchange inflows and outflows.”

On April 29, the ED released a statement saying it searched three locations in Bengaluru, related to Byju Raveendran and his company, Think & Learn Private Limited, which runs Byju’s under the provisions of the Foreign Exchange Management Act (FEMA). These searches led to the seizure of incriminating documents and digital data, ED said.

“I am not sure whether this is new information and this will spook people. Most of the negatives have been factored in for Byju’s. The fact that they don’t file their financial statements on time is known. Hedge-fund type investors have anyway pulled back from India last year and edtech firms have already seen an impact,” said another investor, requesting anonymity.

“The searches will spook people if something criminal or sinister emerges in the coming weeks,” he said.

ED searches at the offices of India’s most-valued startup have added yet another unfavourable chapter in India’s startup ecosystem. In the last 18 months, at least four startups having Indian origins— BharatPe, Trell, Zilingo and GoMechanic — have all come under fire for alleged misconduct and frauds. All these companies, along with Byju’s, have Sequoia Capital as one of their biggest investors.

ED is said to be further investigating Byju’s and has not taken any immediate action against the company and Raveendran yet. Founders and investors remain divided on whether the searches will have any immediate impact on routine operations at Byju’s and its much-awaited fund-raise.

‘Fund-raise talks on track’

According to a person close to the company, the fund-raise "deliberations are on track". If the deal happens, it will be the second flat funding round to be raised by Byju's in the last eight months, highlighting investors' concerns over the startup's valuation.

While some believe that this will spook Byju’s existing and forthcoming investors, others believe since the ED has not filed any direct allegation against the company, its shareholders may not immediately be worried about routine operations.

Another investor, who spoke to Moneycontrol on condition of anonymity, said: “There have been searches at startup offices in the past and that has not hit regular operations much. But the fact that he is evasive is worrying. That raises questions. Is he hiding something? This might be concerning them.”

In the past, e-commerce giant Flipkart had come under the scanner of the ED  for alleged violations of regulations under FEMA.

In a statement, the ED said that Byju’s has not prepared its financial statements since the financial year 2020-21 and has not got the accounts audited, which is mandatory and hence the genuineness of the figures provided by the company are being cross-examined with the banks.

The financial probe agency also said that Raveendran remained evasive. However, he assured employees in a mail on the same day that Byju’s is fully cooperating with the authorities.

ED's searches have become the latest setback for Byju's, which is renegotiating terms with its creditors (of term loan B), after having defaulted on certain conditions, including monthly business updates, hiring a CFO, and increasing the interest rate on the loan.

Byju's, however, hired Vedanta's executive Ajay Goel as its CFO in April.

Byju's had raised a term loan B (TLB) of $1.2 billion from a clutch of investors in 2021, one of the largest for Indian startups. The company also offered to increase the rate of interest on its $1.2 billion TLB as part of renegotiating its debt-financing arrangements. Creditors were also seeking prepayment of $200 million, according to a media report.