I have a 16Kw generac generator. The unit starts then the engine overspeeds but does not shutdown. The engine starts to exhaust white smoke. I shut it down after only a matter of 2 or 3 seconds for fear of doing more damage.

SOURCE: Generac Guardian 15kW Generator

That sounds just about right, if the relay contacts get welded together it sometimes takes out the driver on the printed circuit board. As you found out, 12vdc from 23 to 194 makes the transfer switch move to the Generator position, relay not energized makes the ATS move to the Normal position.

You can make a nice test function by installing a 10 amp contact switch in series with either the N1 or N2 terminals. When the switch is open the generator thinks the Normal power has failed.

Regards,
Carl

SOURCE: Generac 4456 does not start on power loss

I install and work on these everyday. If you hooked up the transfer switch you probable have a control wire wrong. check the utility power sense wire. That lets it no when to start in auto. it could be a relay or fuses. or a control board.

SOURCE: 10kw Generac Guardian not cranking, shows rpm sense loss

Sounds like Generator mode switch should be "ON".

SOURCE: Generac control wires

older model Generac only haver 4 control wires:
N1
N2
23
194
if it is the included wiring harness the wires should have their numbers stamped on the jacketing and a sticker should designate the proper screw to mount it to in both the ATS and the generator housing. hooking these wires up incorrectly often results in blown fuses and/or damage to the control board in the generator.

SOURCE: When utility power goes out, the transfer switch doesn't transfer

Call an electrician.