Corporate Governance in Start-ups

From Byju's to Paytm, why are board members often mute spectators of a crisis?

India ranks third globally with over 75,000 startups with many achieving unicorn status.[1] However, governance concerns in high-profile startups like Byju’s, BharatPe, and Zilingo highlight the necessity for stringent governance measures.

Corporate governance is crucial to ensure ethical decision-making, transparency, and accountability thereby enabling relevant stakeholders to meet their respective objectives.[2] In India, where the startup ecosystem is growing rapidly, robust corporate governance is essential to ensure all issues of the stakeholders are adequately addressed.

Significance and Challenges

As of 2024, the Indian startup ecosystem recognizes the importance of corporate governance, yet challenges such as regulatory complexities, limited financial resources, and varying maturity levels persist. Unlike public companies, startups are not obligated to adopt corporate governance standards, often leading to its deprioritization.[3]

Good corporate governance requires a corporation to strike a balance between the needs of individuals and the needs of society as a whole,[4] as well as between economic and social concerns.[5] Stakeholders include the company's founders (promoters), investors (shareholders), employees (workers), and consumers (clients). It rests on four pillars: accountability, honesty, transparency, and responsibility.[6]

Governance Models

Lean Governance: This model reduces bureaucracy and administrative overhead by emphasizing efficiency, simplicity, and agility in performing core tasks. Lean governance principles promote quick experimentation, feedback loops, and iterative improvement, enabling startups to respond swiftly to market changes and client demands.[7]

Founder-Centric Governance: This model acknowledges the crucial role founders play in shaping the startup's vision, culture, and strategy by balancing the founder’s influence with accountability and transparency, often involving small teams or advisory councils that guide and supervise the founder-CEO. Such an advisory council can include the relevant stakeholders of the investors of a start-up. However, events at BharatPe demonstrate the limitations of this approach.[8]

Key Challenges in Implementing Corporate Governance: More often than not, corporate governance is not a priority for early and growth stage start-ups which are more concerned with surviving or expanding business. The following factors also impact prioritising corporate governance:

1. Limited Financial Resources: Startups often face financial constraints, hindering their ability to hire experienced board members or independent directors. This results in inadequate supervision, weak controls, and a lack of accountability, which can impede growth and success.

2. Inadequate Disclosure Practices: Private startups do not have the legal requirements for transparency and accountability that listed companies follow, leading to challenges for investors and other stakeholders. 

3. Conflict of Interest: Founders with significant stakes may prioritize personal gains over long- term value creation.

4. Ineffective Board Oversight: The board of directors of start-ups typically meet only for regulatory requirements and not from the perspective of overseeing the operations. As such, Boards often fail to question management decisions or provide strategic guidance, compromising the company's adherence to governance policies and its long-term sustainability.

Examples of Governance Failures:

1. BharatPe: Bharat Pe, a fintech start-up, faced governance issues after co-founder Ashneer Grover's abusive behavior and fraud allegations came to light via a leaked audio call, which resulted in the revelation of financial misconduct involving fake vendors and mismanagement on the part of the co-founder and his wife, acting as head of controls. This was a classic example of founders prioritizing their interest over the interest of the other stakeholders.

2. Byju's: Byju's, formerly regarded as the crown jewel of Indian startups, due to inadequate oversight procedures, internal complaints, most of which were disregarded or improperly escalated, faced a massive downfall. According to the experts, stronger governance procedures may have reduced these dangers. These mistakes show that a well-designed governance structure could have given board members, auditors, and whistleblowers a way to get involved before things got out of hand.

Future Directions and Recommendations:

1. Enhancing Transparency and Disclosure: Establish robust reporting and disclosure practices to ensure transparency and build investor confidence.

2. Strengthening Board Oversight: Boards to actively engage in overseeing management and providing strategic guidance, ensuring adherence to governance policies.

3. Implementing Ethical Management Practices: Adherence to high ethical standards and legal compliance is crucial for long-term sustainability.

4. Balancing Interests and Mitigating Conflicts: Governance mechanisms to align the interests of all stakeholders to promote long-term value creation.

The above suggestions can be considered at any stage of a start-up and may not be hindered by the limitations set out above.

Conclusion

While many startups are increasingly recognizing the importance of corporate governance, challenges such as limited resources, regulatory complexities, and varying maturity levels persist. By adopting best practices and learning from both successes and failures, startups can establish robust governance frameworks that promote sustainable growth and success. Future research and policy developments may focus on tailored governance strategies that cater to the unique requirements of startups, fostering a more resilient and trustworthy startup ecosystem.

1 India ranks globally 3rd in start-up ecosystem and also in terms of number of unicorns: Dr Jitendra Singh: Department of Science & Technology (DST), Government of India. Available at: https://dst.gov.in/india-ranks-globally-3rd-start-
ecosystem-and-also-terms-number-unicorns-dr-jitendra-singh.

2 McKenna, F. (2022) ‘a complete failure of corporate controls’: What investors and accountants missed in FTX’s audits,
CoinDesk Available at: https://www.coindesk.com/layer2/2022/11/18/a-complete-failure-of-corporate-controls-what-investors-and-accountants-missed-in-ftxs-audits/

3 Empers, P. A., Kaplan, S. N., & Mukharlyamov, V. (2016). What Do Private Equity Firms Say They Do? Journal of Financial Economics, 121(3), 449-476.

4 Paulo, S. (2020) Corporate governance for startups & scale-ups, IDB Invest. Available at:
https://idbinvest.org/sites/default/files/2021-04/IBGC Segmentos - Corporate Governance for Startups & Scale-Ups.pdf

5 Atkins, B. (2024) Why startups are increasingly prioritizing corporate governance as their businesses scale, Forbes. Available at: https://www.forbes.com/sites/betsyatkins/2021/04/12/why-startups-are-increasingly-prioritizing-corporate-governance-as-their-businesses-scale/?sh=335c380b5900

6 Kumar, A. (2019). Corporate governance challenges for start-ups in India.

7 Bhattacharya, S., & Ravi, S. (2021). The Impact of Corporate Governance on Firm Performance: Evidence from India.

8 Bhatia, S. (2020). Corporate Governance for Startups: Best Practices and Challenges. Journal of Entrepreneurship

9 Kaplan, Y. (2022) Good corporate governance policies and disclosure mechanisms in startup companies, SSRN. Availableat: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3983567