Lifting startups from the governance hole

Founders must prioritise governance from the outset rather than deferring it until just before the IPO if they want to create long-term value

Startups attract our attention either when, based on their rising valuations, they are celebrated, or when their valuations come crashing down. Three years ago, the music did not stop, and valuations kept soaring. Every other day, a new soonicorn (a valuation of between $500 million and $1 billion/ Rs 4,000-Rs 8,000 crore) or a unicorn (a startup with a valuation of over $1 billion, or Rs 8,000 crore) was anointed. And now, suddenly, it seems all the chairs have been removed.

Why has the mood soured? The uncomplicated explanation is that the valuations moved in lockstep with the flow of funds. As the fiscal taps opened, money flowed and asset prices escalated, including those of startups. Once this tide turned, money became expensive, and valuations dropped. This is at best a partial explanation, as it suggests that macro headwinds and tailwinds, rather than the startups themselves, create their destiny. 

Many factors explain the success and failure of startups — some within their control, while some outside their influence. But one thing startups, as an asset class, can do is to is to increase focus on governance, as absence of this, in large part, accounts for the business breakdowns — Siply, BharatPe, Trell, GoMechanic, Byju’s, Mojocare, Zilingo, ZestMoney, etc.

Even as startup governance remains in a dark space, the governance in listed companies is somewhat better. This is validated through the G20/OECD Principles of Corporate Governance, and the scorecard that has been developed by Institutional Investor Advisory Services (IiAS, the firm where I work), jointly with the International Finance Corporation and BSE Ltd. IiAS’ annual assessment based on the scores of the S&P BSE 100 index constituents, which account for over 70 per cent of total market capitalisation, is a proxy for the governance practices of corporate India. The scores have been inching up over the past six years.

This seems to be in sharp contrast to startups that “are completely new to the regulatory world when they list,” according to Cyril Shroff, managing partner at Cyril Amarchand Shroff, a law firm. These, he adds, “comes at them in terms of a tsunami of regulations, related-party transactions, semi-scrutiny, proxy advisors and things that they had never factored in. So, in the first six months of listing, they get a massive shock in terms of what comes through. They thought it was just about getting market cap, and they realised this comes with conditions attached. That is something which they don’t realise.”

Akash Prakash, a fund manager with Amansa Capital, voiced a similar view, holding their investors equally responsible. He says, “I’m actually astonished at some of the stuff that is taken as part of the game in private companies, which would never pass public (market) muster.”

This points to the focus startups and their investors place on being the first to identify a market, build out a product, and grab market share, paying insufficient attention to governance. Most see governance as something that comes in the way of doing business. They expect to concentrate on the governance aspects, closer to their initial public offering (IPO), or when the company reaches a particular size. In doing so, they fail to recognise that governance is a fundamental building block that will give investors the confidence to fund, suppliers the comfort to deal with the business, and talent the incentive to join and stay with the company.

The best way forward is to build out the business and the accompanying governance systems in parallel. This means appointing a fully functional board, a compliance team, and a financial reporting team.

The roles and responsibilities of each of these should be fit for purpose, and steadily expand with the business, getting closer to public market standards even before the company lists. For example, independent directors should be inducted onto the board, board committees constituted with a broader remit including risk, corporate social responsibility  and stakeholder management, the board and various committee agenda and functioning should be benchmarked to listed peers, undertaking board evaluation. Similarly, the compliance and finance teams can start to incorporate regulations that the larger listed companies adhere to too, along with their disclosure practices. These include related-party transactions, conflict of interest, and other behavioural codes, as well as risk practices with focus on asymmetric information sharing.

Waiting until just before the IPO implies neither does the company have the processes and systems in place, nor have these been internalised, leading to avoidable time being soaked up.  And while I have spoken about IPO, this approach is equally helpful as startups move from Series B to Series C and to further funding rounds.

Today, India has one of the largest and most vibrant startup ecosystems in the world — a testament to the country’s entrepreneurial spirit and its ability to foster innovation and growth. The best way to maintain our leadership position is for startups to adopt the best governance practices and build investor and stakeholder trust. This, no doubt, is as hard as building the commercial end of the business, but there is no better way to create long-term value.

The writer is with Institutional Investor Advisory Services of India Limited. The views are personal. @AmitTandon_In