Founders’ Guide To Embedding Corporate Governance In Your Startup

With the recent stories of the lack of due diligence and corporate misgovernance spilling over to the mainstream, there is a general outcry that corporate governance needs to be strengthened in startups. The reports that have emerged, point to some serious lapses in this area. With more stories being unearthed every day, only time can tell There could be a few more cases that may be discovered that will dent the powerful story of Indian startups.

It is therefore incumbent on all the players – not necessarily the founders alone, to appreciate that this is a serious issue that needs to be addressed so that the reputation that the Indian startup ecosystem, so painstakingly built, is not sullied. 

The questions that beg to be answered are:

• Do founders have a nuanced appreciation for corporate governance?
• Where does the buck stop and how can the board create a culture for corporate governance?
• What are the consequences of misgovernance?
• What can founders do to strengthen governance processes?

I have tried to address this issue in a simplistic manner, however, to say that governance itself is a simple topic would be wrong. I have tried to understand the recent happenings and put them in a context that is easy to resonate with the tech ecosystem. 

What Is Corporate Governance?

Corporate governance could be defined as a set of processes and management practices that forms the bedrock of how organisations are managed. Composition of the board, disclosures, code of conduct, ethics, risk management, transparency of financial transactions, compliance, environmental and social Impact are but a few aspects that come to mind when one speaks of governance. 

Now, some of these are rational and therefore, should be implemented without any fuss or debate. However, the fact remains that they are not. The reasons behind that are multifold – lack of appreciation of what is kosher and what is not, lack of culture etc. In my assessment, the single-minded pursuit of aggressive growth at all costs and thereby relegating such issues to the back burner is perhaps the most pronounced cause for such lapses. 

At a fundamental level, governance is about doing things the right way, in every single transaction, practice, strategy, and process which is implemented by the company. It is elementary that every action that an organisation takes should stand scrutiny vis-à-vis the following:

• Is it the right thing to do?
• Does it follow well laid down principles, globally? For example, how are we recognising revenue? Do we have a revenue recognition policy that is in consonance with the GAAP (Generally Accepted Accounting Principles) of the geography we operate in? Are our expenses accounted for correctly? 
• Do we follow the right processes as far as expense management is concerned? Are we charging personal expenses to the company? Are we benefitting “related parties” without following proper processes and disclosures?
• Are we changing our revenue recognition policy? Are we changing our revenue model and is that being disclosed?
• Do we have a system of checks and balances to validate the numbers?
• Do our operations impact the environment?
• If we are working in a regulated industry, are we complying with the regulations?
• Do we have a system of making disclosures to the board on sensitive issues and changes to any such practice and seeking their consent?
• Do our employees have an appreciation of the same?

These are a few of the questions that every founder must answer and every board member needs to be cognizant of. There are certain aspects that fall in the realm of interpretation – for example, there could be a loophole in tax or certain regulations may be ambivalent and open to interpretation. A company, depending on its culture, may take an aggressive position (within the framework of the law) but even in such cases it is always advisable to understand the risk involved and for the sake of good order, keep the board informed. 

Looking Beyond

It would do good for founders to have some role models when it comes to governance and read about the practices and philosophies deployed by them. However, they may have to look beyond the startup universe for that because good governance is usually a sustained phenomenon. Companies that have been in business for decades could only qualify for the

same. In my view, the Tata Group in general but specifically under the stewardship of JRD Tata has been the epitome of good governance. Some leading IT services companies like Infosys could also be studied. One does not have to look far and toward the West for such role models. 

Founders will do well to remember that getting an up round (after passing through diligence) is not a validation that they are doing everything right. Many times, investments happen due to prevailing market sentiment and liquidity. This happens in spaces that are hot and market tailwinds compel investors to close transactions faster. However, such times don’t last forever. Often, when a fastidious investor comes in to write a big cheque, such transgressions come to light…..and it is too late in the day to course correct. 

How To Strengthen Governance?

From my experience, here are a few suggestions that will help strengthen governance in startups:

The Buck For Setting The Right Organisational Culture Stops With The Founders

If there is visible transparency and propriety in all actions taken by the founders, the organisation does fall in line without much propaganda. Remember, there is no such thing as a minor lapse of integrity. 

Track The Right Metrics

Track comprehensive and appropriate metrics that measure organisational health and its overall accountability to all stakeholders. I have used the word appropriate because many times the ecosystem of funds and founders have sadly, evolved vanity metrics that serve everyone’s immediate purpose but will not stand the test of time.

Spend Time On Revenue Recognition

Tech founders must spend time understanding how revenues are recognised, expense heads are accounted for, and cash flows are computed because ultimately if numbers do not add up, then your charisma, story, space, and traction will all come to nought.

Keep Personal At An Arm’s Length

Keep personal relationships and expenses at more than an arm’s length from your business. Hiring relatives to provide services should be avoided. However, if it can’t be, ensure that you create the right panel comprising external board members to decide on the same. Conflict of interest situations should be best avoided and it is always better to err on the side of caution.

Be Consistent

Follow consistency in reporting metrics and financials. For example, accounting policy should be robust and appropriate, and it cannot be tweaked to make your business look good. To be sure, if your business model undergoes a change, do revisit such policies but take expert opinion and board into confidence. 

Hire A Good CFO

Hire a good CFO and empower him to ask uncomfortable questions on pricing, margin, revenue recognition, and expense management to business folks. The CFO should have the final word on these aspects. 

Compensation

Ensure that the founders’ and key executives’ compensation is discussed and agreed upon with the board.

The Board of Directors is the custodian of good corporate governance. However, in most cases, the Board comprising mainly of VC investors meet once every 2 to 3 months and the discussion is mostly around business metrics, growth strategy, fundraising, and team building. There is a strong case to have them scrutinise some sample transactions and appoint an internal auditor or have an audit committee (beyond a certain size of the company). The board should have a model code of conduct deployed across their portfolio companies and spend quality time with the CFO to discuss the aforementioned issues. 

Governance issues could be catastrophic for businesses and history is witness to how large businesses like Enron or Arthur Andersen collapsed overnight. Back home, there have been examples like Yes Bank, Satyam or DHFL, which were once considered successful. Governance is a serious issue that cannot be delegated by founders and it needs the same degree of attention, if not more, as one would give to tracking business growth. 

Remember, as your business gets bigger, so does the scrutiny. And if you harbour ambitions of doing an IPO, you will have to pass a much stiffer test. Good governance is not an option.