Resilience was the defining narrative of the Indian start-up economy in 2023, but the slew of corporate malfeasance incidents definitely dimmed the shine of our achievements. Although India now comfortably ranks in the upper echelons of the global start-up ecosystem, if the domestic ecosystem isn’t able to deliver on its promise of long-lasting resilience, its foundation will crumble, swiftly and catastrophically. That is why investors would do well to discharge one of their critical responsibilities – corporate governance.
In 2023, allegations of corporate misgovernance were levied against quite a few well-funded start-ups, taking the ecosystem by storm. While some founders admitted to allowing their ambitions to get ahead of themselves, others have remained staunchly defensive. It’s futile to discuss the validity of these charges or the motivations behind these actions; what we should be doing is asking how did the other parties involved including investors, auditors, and the board fail to notice financial or compliance discrepancies of such magnitude? Has the pursuit of peak valuations blinded us to the need for good judgement?
Governance challenges have brought even vaunted unicorns to their knees. Ambitious, poorly planned growth has led to the collapse of some of the world's most highly valued start-ups. These issues have emerged primarily when managements have failed to look at the bigger picture and abandon a long term vision in favour of short term boosts to revenue. Shortcuts are taken, and slip-ups occur, with the end result being the use of weak balance sheets, questionable accounting methods or delays in publishing financial statements. Once these are uncovered, brand reputation suffers a setback, for both founders and investors, and companies that arrived on the scene with a bang fade away with a whimper.
How Can Investors Ensure Good Governance
Investors, especially those on an institutional level, are obligated to take on the role of active owners. This includes engaging with the companies they invest in, utilising their voting rights, and participating in shareholder meetings. You would think that considering their interests, investors would be the champions of corporate governance. There are occasions where a fundamental conflict of interest – regarding the timeframe of desired outcomes – makes the investor–corporate governance relationship fraught with clouded decision-making and multiple agendas. Investors could have shorter-term priorities – exits for example – and, therefore, their focus could be on boosting metrics influencing valuations. Corporate governance is long-term, revolving around establishing mechanisms, rules, practices, and systems to guide the company to sustainability. The dichotomy points to why a company’s core interests may not always align with the interests of its investors. Robust corporate governance necessitates a separation of individual interest and the establishment of independent objectivity into decision-making.
Another hurdle to keep sight of is a fragmented cap table. The cap table functions as a ledger, documenting the ownership distribution within the company. During the early stages, managing a fragmented cap table might be within the realm of possibility. However, as the start-up expands and scales, the administrative workload expands. Each investor has their own individual mandate to pursue and desired financial outcome to obtain over their respective investment horizon/period. This has the potential to create significant friction among the investors over their respective priorities and, between the investors and the founders over their goals for the company.
In times of challenging decision-making, investors need to clarify the direction of the company. Investors will need to set aside individual priorities to lay down the right track for the entrepreneurial team. Constant monitoring of regulatory compliance, timely and thorough external audits, and the appointment of qualified accounting entities ensure accurate and prompt reporting. Any irregularity will raise questions about both the company and the investor’s integrity and may even cause legal liabilities. Being removed from managerial decisions, investors should review decisions and stand as an objective counterpoint to the management.
It is quite fundamental for investors to seek transparent financial reporting, underscore the significance of ethics and compliance, and instil financial discipline. Every responsible and experienced investor seeks MIS from the company and at the very least, focuses on statutory compliances. Parallelly, they should progressively prioritise long-term value creation over short-term profit chasing. Both start-ups and investors need to take heed – while pursuing immediate returns appears alluring; ethical, sustainable growth leads to lasting success.
The board plays a key role, including in the context of a private company where there is no “minority” shareholder, and all shareholders are represented in the boardroom. The board has to provide essential advice and guidance to company leadership during periods of growth and change. It serves as a vital check and balance for major company decisions, ensuring they align with the best interests of all stakeholders. Being part of the board does not mean that one has no role to play and no questions to ask. Most management sagas are an important lesson in the blowbacks of opaque decision-making.
Messy power struggles (recently, a premier tech disruptor was witness to this) occur when lapses in communication emerge and transparent decision-making takes a back seat. The board is not keyed in on important decisions, the top management fails to take into account the interests of all stakeholders, and talk of risky and self-destructive behaviour makes the rounds. These situations highlight how crucial it is for the board to meet regularly and consistently.
Let's also take a quick look at the chain of events that precipitated the collapse of one of the apex financial institutions for start-ups. From a corporate governance perspective, the challenges faced by the bank seem to have stemmed not from bad loans or debts but rather from inattention to the nature of its portfolio. Reports indicate that the bank heavily invested in government securities, considering it a secure choice. However, when interest rates were raised, the value of these securities decreased. Inefficiencies in risk management and a misguided belief in the invulnerability of the chosen asset class ultimately led the bank to troubled waters.
Corporate Governance in India
The solution to ensuring an ethical business culture lies in the pillars of our corporate ecosystem. Recognizing this, Start-up India has established the MAARG (Mentorship, Advisory, Assistance, Resilience, and Growth) Portal as a crucial resource for start-ups in search of guidance on corporate governance. The Securities and Exchange Board of India (SEBI), the principal regulatory authority, has also implemented numerous initiatives and guidelines to elevate governance practices. To inject transparency and accountability, the Companies Act (2013) directs companies to form a board of directors, 10–15 per cent of which needs to be constituted by independent directors. With the implementation of sound governance practices, the Indian economy will open the doors to sustainable growth and economic prosperity. Be it communication, decision-making, or relationship-building, corporate governance is the integral building block for a resilient ecosystem.
Views are personal. The author is the founder of Winpe, and Board Member, Senior Advisor, PE industry