US Government Goes After Startup CEO For Fraud For Fooling Investors With Inflated Revenue

US Government Goes After Startup CEO For Fraud For Fooling Investors With Inflated Revenue


Credit: iStock / LightFieldStudios, https://www.istockphoto.com/portfolio/LightFieldStudios?mediatype=photography

The FBI on Wednesday arrested Manish Lachwani, co-founder and former CEO of the Silicon Valley-based mobile app testing company Headspin, on charges of securities and wire fraud and for bilking investors out of as much as $80 million, according to the Department of Justice.

Charges stemmed from Lachwani’s years of fundraising for his mobile app and allegedly scheming to inflate Headspin’s valuation.

There has been an explosion of billion-dollar tech firms or unicorns, according to a report in The Stack. Since January, more than two unicorns have been born every day, Dealroom reported. Tech company valuations have ballooned to more than $35 trillion cumulatively. That’s more than the entire U.S. GDP of $20.81 trillion in 2020.

The Securities and Exchange Commission complaint, filed in the U.S. District Court for the Northern District of California, alleges that Lachwani falsely inflated Headspin’s valuation to more than $1 billion and doctored its internal sales records. He controlled all important aspects of HeadSpin’s financial and sales operations, inflating the value of customer deals and fraudulently treating potential deals as if they were guaranteed future payments. The complaint alleges that Lachwani created fake invoices and altered real invoices to make it look like customers had been billed higher amounts. He allegedly enriched himself selling $2.5 million of his HeadSpin shares in a fundraising round during which he made misrepresentations to an existing HeadSpin investor. The fraud came to light after the company’s board of directors ordered an internal investigation that revealed issues with HeadSpin’s reporting of customer deals.

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Lachwani allegedly overstated Headspin’s annual recurring revenue — a key metric for evaluating the success of companies that provide software as a service — by approximately $51 to $55 million, the DOJ reported.

The company’s financial statements were reviewed by an auditing firm in May 2020.  According to the complaint, the review concluded that Headspin’s cumulative revenues through the first half of 2020 totaled $26.3 million, not the $95.3 million originally reported by the company.

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At its inception, Headspin raised $11 million through the sale of Series A preferred shares. In April 2017 to May 2018, Headspin raised about $24.7 million selling promissory notes convertible into future Series B preferred stock.  In September and October 2018, Headspin raised $20 million dollars in the sale of Series B preferred shares.  The fourth fundraising round from November 2019 to early 2020 raised $60 million in sales of Series C preferred shares.  

During Headspin’s Series B fundraising round, investors agreed to buy shares at prices that valued the company at $500 million dollars. By late 2019, during the Series C, investors agreed to buy shares at prices that valued the company at $1.1 billion. The complaint alleged that after the company discovered the overstated revenue and recapitalized the company’s investors, the valuation of the company dropped to $300 million.

“We allege that Lachwani misled investors into believing that HeadSpin had achieved a ‘unicorn’ valuation by winning hundreds of lucrative deals, including many with Silicon Valley’s biggest and most high profile companies,” said Monique C. Winkler, associate regional director of the SEC’s San Francisco Regional Office. “Companies and their executives must tell the truth when speaking about financial metrics that are material to the value of the business.”

If convicted of wire fraud, Lachwani faces up to 20 years in prison and $250,000 fine. If convicted of securities fraud, he faces up to 20 years in prison and a fine of $5,000,000.

Photo credit: iStock / LightFieldStudios