Startup & family business governance

Boards must rely on and act upon early warning signals of behavioural aberrations beyond the boundaries of business sanity and neeyat

Some people hold a view that ideas on neeyat and governance are relevant only for well-established and listed companies. While the subject is relevant for them, governance is relevant also in startups and family-managed businesses. A metaphor might help to make the point succinctly — just as values and ethics must be addressed early on within families and schools, governance and business neeyat must be addressed early in startups and family businesses.

Enterprise is essential for national growth. Family businesses and small companies are the backbone of enterprise; sometimes I wonder whether they themselves realise how important they are. There are about 63 million enterprises registered with the government. Of these, a minuscule 20,000 have capital of more than Rs 10 crore. The media focuses on listed companies and startups. In terms of employment, income generation, and exports, the small and medium sectors are crucial. Several companies in India and overseas have been in the news for governance reasons in recent times: Unlisted startups (Byju’s and Paytm), listed companies (Zee and Religare), and foreign entities Tesla and Toyota Motors. Stuart Kirk wrote a piece in the Financial Times on January 27, 2024, wondering whether there was any correlation between better governance and company results. I responded by emphasising the obvious about the distinct and separate roles of the management and boards.

The kinetic energy of a company rests with the management, led by the chief executive officer (CEO). The management’s role is akin to the raw energy generated by the firing of fuel in the engine compartment of an automobile — innovative ideas pulsating with calorie-loads of human energy. To be effective, this energy needs channelising to the wheels of the automobile through the transmission: This is the role of the board. Boards and leadership groups are essential in channelising management ideas and energy for effective delivery to customer and community. A pleasurable car must have both a great engine and a matching transmission system. So too, an enterprise must have fine management with a great board. The board collaborates, yet provides a challenge to the management. It is not the board’s role to design or execute strategies and innovation, though individual directors may contribute through experience and debate.

Private-equity companies try to achieve the same effect. Since several private-equity executives have no hands-on business experience, the firms rely on experienced leaders as advisors. Why do some startup founders behave as though the private-equity providers should provide them money and let the founder do whatever he or she wants — BharatPe, Zilingo, Housing.com? Equally, the greed of some private-equity executives may pressure founders to grow exponentially. Sequoia is a respected and value-based private-equity firm, yet it considered ousting its former CEO Michael Moritz from the board chairmanship of a troubled fintech startup, Klarna, which it itself financed. Enterprise sans governance is prone to crashing.

Public markets provide a test of governance. Though imperfect, they are better than no test. India is proud that it has produced about 110 startup unicorns. Bravo. However, only 13 have faced the test of the public markets, accounting for just $1.5 billion out of a total of $4,200 billion; of the 13, only six are reported to generate positive operating cash flows, which is the most basic test of business acumen and success. All of these six positive-cash flow unicorns were founded around 2005, and have built an enterprise track record of almost two decades, and the average age of these six founders was 57 when they began. Startups often manage business for valuation. Family-managed businesses and startups have been combined in this piece about governance, though there are differences. For example, families manage businesses for legacy, with valuation as an outcome. An example of this, Beit Binzagr in Saudi Arabia, in a future column.

The innovative ideas in startups and family businesses would benefit by challenge and debate. Such action does not mean that the board is adversarial to management. As stated in my recent book (Inside the Boardroom, published by Rupa), behavioural aberrations beyond the boundaries of business sanity and neeyat must engage the attention of boards. If not, the question will continue to remain, what was the board doing?

In closing, a potentially controversial view. Courts rely on near-perfect proof and regulators rely on substantive evidence, but boards must rely on and act upon early warning signals. It is common that directors can hear the canary in the coalmine first.

The writer is an author. His new book, Embrace the Future: the soft science of business transformation, is due in February. Email:  rgopal@themindworks.me