No supervision: a startup fraud in its heyday and its unraveling

After Manish Lachwani founded Silicon Valley software startup HeadSpin in 2015, nearly quadrupled the company’s revenue and falsely claimed companies like Apple and American Express were customers. He showed gains where there were losses. He used HeadSpin’s money to make risky trades in technology stocks. And he created fake invoices to cover it all up.

What was especially breathtaking was how easily Mr. Lachwani, now 48, accomplished all that.

While HeadSpin had raised $117 million from top tech investors – including GV, the venture capital arm of Google’s parent company Alphabet; and Iconiq Capital, which helps manage Mark Zuckerberg’s billions — it had no chief financial officer, no human resources department and was never audited.

Mr. Lachwani used that lack of oversight to paint a rosier picture of HeadSpin’s growth. Even though key investors knew the startup’s financials were inaccurate, they chose to invest anyway, ultimately propelling HeadSpin to a 2020 valuation of $1.1 billion, according to Mr. Lachwani’s lawyers. When the investors pushed Mr. Lachwani to add a chief financial officer and share more details about the company’s finances, he simply brushed them off.

These details emerged this month files in the United States District Court for the Northern District of California after Mr. Lachwani pleaded guilty three cases of fraud in April. He will be sentenced next month, with a maximum penalty of 20 years in prison for each charge.

HeadSpin’s lack of control is part of an increasingly apparent pattern among Silicon Valley startups that have run into trouble. Over the past decade, tech startup investors were so eager to back successful companies that many often overlooked reckless behavior and gave up important controls like board seats, all in the service of rapid growth and disruption. When founders then took the “fake it till you make it” ethos too far, their investors were often oblivious or helpless.

FTX, the cryptocurrency exchange that went bankrupt last year, had a three-person board with barely any influence over the company, kept its finances on QuickBooks, and used a small, little-known accounting firm. Theranos, the failed blood testing company, has gone without financial audits for six years. The founders of those companies have been convicted of fraud.

Now, amid a shakeout of startups, more frauds have come to light. The founder of university aid company Frank, the internet connectivity start-up, has been charged Wolkenbrink has been indicted, and the social media app IRL has been investigated And indicted. Last month, Mike Rothenberg, a Silicon Valley investor, was found guilty on 21 charges of fraud and money laundering. On Monday, Trevor Milton, founder of electric car company Nikola, was sentenced to four years in prison for lying about Nikola’s technological capabilities.

“The governance got a little loose during the bubble,” says Healy Jones, vice president of financial strategy at Kruze Consulting, a provider of financial services for startups. Lately, Mr. Jones said, he has noticed venture firms doing more due diligence on potential investments, but “they probably shouldn’t get a gold star for fulfilling their job description.”

Through a lawyer, Mr. Lachwani declined to comment.

Rajeev Butani, who took over as CEO of HeadSpin in 2020, said in a statement that the company’s board took immediate action after Mr. Lachwani’s conduct was discovered that year and cooperated with the government investigation.

“We are grateful to our customers who have supported us throughout the journey,” Mr Butani added.

Mr. Lachwani started HeadSpin in Palo Alto, California, in 2015 after selling his previous company, Appurify, to Google. Companies use HeadSpin technology to test and monitor their apps in different regions and on different devices. The start-up quickly attracted funding from investors such as SV Angel, Felicis and GV.

Red flags soon arose. HeadSpin’s financial statements often came months late or not at all, investors said in legal filings. The company’s finance department consisted of one external accountant who worked largely from home using QuickBooks, a basic system designed for small businesses. HeadSpin had no human resources department or organizational chart and was not audited.

Around 2015, Mr. Lachwani saw an opportunity to capitalize on HeadSpin’s cash reserves. “It is extremely sad to see money yielding very low interest,” he wrote in an email that year to Karim Faris, an investor at GV who served on HeadSpin’s board.

Mr Faris advised Mr Lachwani to keep the money in “very conservative and liquid instruments”. But over the next few years, Mr. Lachwani used HeadSpin’s money to buy stock and options in technology companies, including Snap, Roku and Tesla, according to bank statements filed as part of the case. At some point, he sent Mr. Faris a bank statement that showed the money was in cash and cash equivalents, according to Mr. Faris’ statement.

A GV spokeswoman declined to comment.

In 2017, Mr. Lachwani overstated HeadSpin’s revenues to investors by including revenue from customer contracts that had not yet been completed and a contract that had been canceled, he said in his plea agreement.

HeadSpin’s investors tried to exert influence but failed. Mr. Faris and Nikesh Arora, HeadSpin’s chairman, each provided a list of candidates for the chief financial officer appointment, they said in statements. Iconiq urged Mr. Lachwani to add more controls, according to claims made in a presentation included in a court filing.

Mr. Lachwani resisted Iconiq’s demands, resulting in “a rift between them” that led the founder to want to return Iconiq’s investment, the presentation said. Mr. Lachwani never hired a chief financial officer.

Iconiq and Mr. Arora did not respond to requests for comment.

HeadSpin’s accountant, Sana Okmyanskaya, said in a statement that Mr Lachwani had instructed her to add income from new contracts to the company’s books. When she asked to see the contracts, he ignored her.

“He appeared to be very busy and often worked late into the night,” she said in the statement.

Mr. Lachwani sometimes sent Ms. Okmyanskaya invoices that he altered to include money that was never invoiced, his lawyers said in a filing. Ms Okmyanskaya, who did not respond to a request for comment, said in her statement that he had also lied to her about the details of contracts to explain inconsistencies.

In 2019, Mr. Lachwani cashed out $2.5 million of his own shares in HeadSpin and sold them to an investor.

Investors poured more money into HeadSpin in 2020, valuing it at $1.1 billion. By then, Stefanos Loukakos, a technical director, had joined the company as a senior vice president and discovered Mr. Lachwani’s pattern of misrepresentations.

In March, Mr Loukakos shared his concerns with Mr Arora in a slide of 16 presentation, which was later filed in court. For example, Mr. Lachwani had claimed that HeadSpin had more than 20,000 devices on its network, but Mr. Loukakos had discovered that the actual number was closer to 2,000. When Mr. Loukakos asked an engineer about the discrepancy on Slack, the engineer responded: “lol ask manish.”

Mr. Loukakos’ presentation also included text messages showing Mr. Lachwani cursing and abruptly firing employees, including one employee who was in the middle of a video call with a customer.

The HeadSpin board has started an investigation. Mr Lachwani resigned in May 2020 and agreed to return $1.9 million of the $2.5 million he had paid out. The company restructured its finances and returned money to investors who wanted out.

HeadSpin continues to work. The time has come in March announced new funding of an undisclosed amount from Atlassian Ventures. An external auditor estimated the company’s valuation at $302 million, more than 70 percent below its 2020 valuation.

Ahead of his sentencing next month, Mr Lachwani’s lawyers argued for a lesser sentence. Despite Mr. Lachwani’s misrepresentations, they said, none of HeadSpin’s investors actually lost money.

“Mr. Lachwani did not have to say false or misleading things to create a successful company,” his lawyers wrote, “but he did.”