Opinion | Corporate governance in start-ups

The concept of corporate governance often proves to be a stumbling block for start-ups, baffling even the brilliant, innovative minds that lead these start-ups. Corporate governance, briefly put, is the set of rules and procedure that governs the start-up and dictates how the entity and its affairs are controlled, managed and operated. The purpose primarily is to, balance the interests of the investors, management, employees and other stakeholders of the company in an objective and transparent manner. Higher the standards of corporate governance in your organisation, better are the internal checks and balances to curb mismanagement, conflict of interests, and misuse of company resources. Corporate governance also plays a crucial role in the public perception of a company and is a significant influencing factor in determining the intrinsic value of the asset. Much like how a clean room says a lot about a person, good corporate governance practices reveal a great deal about the company and its management. Good corporate governance practices in a company is an attractive asset to investors, who have the peace of mind of knowing that the company has its housekeeping in order. On the other side, lack of adequate governance practices in a company could be a matter of worry for global investors, whose statutory compliances and internal policies would require their portfolio companies to meet certain minimum standards.

The challenge that start-ups often face is in building an effective corporate governance game plan that corresponds with the stage of maturity of the start-up. Start-ups tend to adopt a “short term-long term” approach when it comes to drawing up their corporate governance game plan. However, we believe that it would be more efficient and effective to adopt a more evolutionary approach.

A start-up’s corporate governance practices and requirements need to organically evolve and grow as the startup evolves and grows. The underlying premise is that at each stage of its growth cycle, a start-up has different business requirements, different set of stakeholders, and varying legal compliances, that require differing corporate governance standards. The corporate governance requirements evolve with the growth of a startup, being influenced not just by the size of the company, but also by expectations of various stakeholders. Sometimes the evolution is just the by-product of the company’s growth and sometimes the progression is the outcome of a carefully tailored plan. We take a look at what a start-up could consider focusing on in terms of corporate governance at various stages of its growth cycle.

Inception: Most start-ups have a tough, uncertain, and chaotic infancy. With more fatal concerns like pending invoices, wavering clients, and perennial cash flow issues to deal with, it may be a little premature for your start-up to focus extensively on corporate governance. At this stage, it may be enough to adopt a ‘check the box’ approach and just meet all mandatory legal, financial and accounting requirements. You can avail of the services of external consultants who can handhold the start-up in compliances. You are then on the right side of law and can devote your time and efforts to the growth of your business.

Early stage investments: This is when you partner with angel investors and venture capital investors and the standards of your corporate governance need to go beyond mere compliance. Sophisticated investors like venture capital would expect to put in place strong corporate governance practices, to protect their investments and ensure that the business achieves its maximum potential. With the presence of nominees of investors, the board becomes stronger and more seasoned, which can monitor the actions of the management. All major decisions can be board-driven, with fair and adequate disclosures to the board including of any conflict of interest.

Private equity and strategic investments:

Your valuation is swelling, and you have received the big bucks from a variety of investors including the global private equity players and a few strategic investors. Corporate governance assumes utmost significance at this stage given the stakes involved. Institutional investors would have their own requirements including on being governed by, an approved business plan, and internal policies on prevention of money laundering and corruption. At this stage, the board should ideally include experts and independent directors. Matters of significance can be delegated to different expert committees like audit committee, investment committee and compensation committee, which will then be ratified by the board. The business would be managed by professionals and not entirely by the founders.

Road to an initial public offering (IPO) : If the Company proposes to go public, the importance of corporate governance goes without saying. Allegations of mis-management and loopholes in corporate governance could have a huge negative impact on the IPO prospects. The company would need to ensure that highest standards of governance is maintained at all levels. There has to be a dedicated team of experts formulating and implementing governance, management and ethics policies. Upon completion of listing, the company will anyway have to meet all legal requirements relating to governance and transparency, ensuring absolute protection of interests of public and retail shareholders.

Ganesh Prasad and Arun Scaria are, respectively, partner and associate partner at Khaitan & Co.

Comments are welcome at theirview@livemint.com