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Why startups end up in the governance soup

In the last three years, India’s market regulator, the Securities and Exchange Board of India (Sebi), initiated 150 new cases, on an average, every year for investigation in listed companies. (Photo: Mint)Premium
In the last three years, India’s market regulator, the Securities and Exchange Board of India (Sebi), initiated 150 new cases, on an average, every year for investigation in listed companies. (Photo: Mint)

  • There is a thin line that divides what it takes to disrupt and what it takes to destroy
  • No one can be sure if the endless burn results in super-profits. This phase creates a combination of capital depletion and soaring valuation—and the temptation to cross the line on ethics

In the last few months, there has been a spate of governance issues at startups centered on ‘related party’ transactions, creative accounting, incomplete disclosures, and knowingly violating the law. Layoffs have also attracted attention from time to time.

Every time an incident like this surfaces, the founder, who was probably adored and worshipped until then, is disparaged and vilified. In a sequence that plays to a pattern, such incidents trigger some well-intended but probably sweeping judgement around the culture at start-ups. The broader underlying question is how do you build and scale a start-up sustainably without compromising agility, entrepreneurial energy, and innovation.

We must also answer another question: are we judging startups with a different yardstick?

The rapidity with which the startup ecosystem in India has grown, and the extent to which many of the new-age companies have transformed our lives beyond imagination, has placed them in the spotlight. Therefore, every misdemeanour tends to get blown out of proportion. What’s been happening on the other side of the fence?

In the last three years, India’s market regulator, the Securities and Exchange Board of India (Sebi), initiated 150 new cases, on an average, every year for investigation in listed companies. These cases were around insider trading, price rigging, market manipulation and other violations of securities laws.

The extent of misappropriation and perfidy in high profile cases, which occurred under the watch of some of the most illustrious personalities in the corporate world, is quite shocking. These are in addition to nearly 4,000 disclosed whistleblower complaints at half the Nifty 50 companies in 2020-21. And the number of listed companies in India (less than 7,500) is a miniscule of the number of registered start-ups (+65000).

This is not to justify or condone any of the cavalier attitude to governance that some start-ups may have displayed, but to merely illustrate the fact that governance foul ups are not unique to startups.

Nature of the beast

The core purpose of a startup, and the very reason for its existence, is to disrupt the way a particular problem is being currently solved. The failure rate is so high that it calls for a strange mix of audacity, impudence, and risk taking to even venture down the path of entrepreneurship. While the risk and competitive pressure is intense, the rewards of success are also immense. Therefore, speed is of essence. Being thoughtful about every action and paying equal attention to everything is not as easy in a rough sea as it is in calm waters.

An obvious question is whether disruption and sustainability are fundamentally at odds. Sustainability at one level is about bottomline focus whereas disruption is often growth centric, and could involve long periods of capital burn. And no one can be absolutely sure if the endless burn would result in the company raking in super-profits at some point of time. This phase often creates a strange combination of capital depletion and soaring valuation. Startups are most vulnerable in this phase, and the temptation to cross the line on ethics and governance is the highest—the stakes are enormous for everyone involved.

Founders would have probably made a lot of sacrifices, and when they see everything slipping away, the urge to take that one little step in the wrong direction is huge. And that is one reason why it is so important for founders to have a few mentors they could completely trust and go to when faced with these dilemmas.

However, it is not right to brand every founder who runs a startup where there has been a governance failure as unethical. Most founders start with the right intent, but along the way they can become victims of their own stories.

If start-ups are by their very nature such crazy entities, is there a way to mitigate the risk?

I would argue that there are four building blocks of a sustainable business, namely, nature of founder ambition, ethics and governance, strategic clarity, and operational excellence. And none of these can be turned on with the flip of a switch.

Founder ambition

Ambition is an essential ingredient for accomplishing any worthy goal or cause, even in the social sector. At the same time, unbridled ambition has been the reason for the downfall of many a founder. There is the yin and the yang at play here. The same traits in founders that help create iconic products also result in the downfall of start-ups and their founders. Any downfall is attributed to these traits, but when the same traits result in success, they are given a different colour and called out as traits of great leadership.

Steve Jobs, according to many accounts, was an unlikeable person for the whole of his life, but there is probably no company more admired than Apple. If Apple hadn’t succeeded like it has or if the iPod had failed, probably many would have written about Jobs’ toxic behavior at work. The culture at Amazon is considered to be aggressive, and much has been written about it. Half of anyone who has ever worked at Amazon is likely to believe that the aggression is essential to the kind of disruption it is creating. Half the others might find it unhealthy.

There has been much discussion about the aggressive culture at some of the Indian startups, too. Aggression is a necessary, but not a sufficient requirement for winning in a high stakes game. There is a thin line that divides what it takes to disrupt and what it takes to destroy. The line between a collaborative culture and one of complacence is just as thin. In the midst of everything that’s happening, it doesn’t take very long to cross the line.

Despite everything that optimists might say, it is not easy for founders or anyone else for that matter to change their nature. However, a combination of self-awareness and access to mentors could help. But this doesn’t always work and some founders may be closed to feedback and advice. Therefore, if there is a need to change horses midstream, it needs to be done. We have seen some recent cases of this both in India and outside.

Therefore, the question is, can one even separate good ambition from the bad ambition? Or good aggression from bad aggression? How real is it to expect a founder to display the ambition needed to take a start-up to the heights of success, and at the same time not break any eggs along the way?

Or does this differentiation exist only in imagination?

Jim Collins has written about this in his bestselling book, From Good to Great, where he calls leaders with positive ambition as ‘Level 5 Leaders’. Sure shot indicators of positive founder ambition are ‘intent listening’ coupled with a disarming ability to say, ‘I think I’m wrong’. If you spot these in a founder, everything else falls in place after that. Founders who have these characteristics will also often place the interests of the company above their own interests, will in most situations be committed to doing the right thing, will communicate more transparently, and make the correct trade-offs in difficult situations. Positive ambition in turn creates a positive climate at the work place.

Ethics and governance

The next bedrock of a sustainable business is commitment to ethics and governance. And since many of the consequences of inadequate attention to governance often show up much later, the temptation to ignore them is quite strong. Commitment to good governance often starts with a deep realization that this is as much a question of business risk as it is about values.

There are two elements to governance: a belief it is important and two, putting the plumbing in place as you progress through the journey. And, if founders inherently believe in good governance (not just saying they believe in it to sound politically correct), then the plumbing invariably falls into place, especially if the founders have access to good advice. And even if there are a few hiccups and missteps along the way, there is unlikely to be a blowup.

With founder commitment, even elementary checks and balances can be made to work. In contrast, if the founders are not deeply committed to running companies ethically, even the most sophisticated mechanisms or checks and balances don’t seem to work. We have seen this at so many start-ups as well as public companies. Enron and Satyam had some of the most illustrious professionals on their boards and board committees. Both imploded spectacularly. And cases like these are not rare. The reality is that even when independent directors are appointed, most founders tend to nominate people like themselves. One would be shocked to see how much muck can accumulate under the noses of some of the smartest board members before it is discovered. This is not to say that having the right mechanisms isn’t important. It becomes even more important.

As a startup prepares to list and seek public money, the consequences of poor governance can be very damaging for the investors as well as the founders. However, governance matters at every stage and not just when the company starts attracting attention. A start-up’s attitude to governance does not fundamentally change as it prepares to go public. The thinking that governance can be fixed as the start-up prepares to go public is fundamentally flawed.

Clarity and efficiency

Both wild swings in strategy as well as strategic drift are signs of confusion. Strategic clarity is as much about character as it is about intellect.

Being able to hold your ground and stick to what you deeply believe is right, when everyone that matters is saying probably just the opposite, is a sign of strength of character.

It’s not easy to do that. A few wrong pivots can suck up a lot of capital, energy, and focus. But not making the right pivot is equally harmful.

Just as founder ambition has two sides, so does sticking to your conviction. But look around and you will figure out that many of the strategic shifts and pivots that some startups made in recent times appear quite obviously faulty to anyone who is unbiased. Often the pivots were made under one of the two conditions, namely, ambition gone overboard or a desperate attempt to get out of a hard place that itself was a result of pursuing the wrong kind of growth. Poor judgment on governance and ethics often starts here.

Reckless mergers and acquisitions is another indication of strategic confusion. Market and category expansion, without a strong proof of concept in an existing market or category, is a strategic risk that startups in their quest for rapid scale can expose themselves to.

The last leg of sustainability is operational efficiencies. Traditionally, a company’s revenue has to cover at least the variable cost. The fixed cost is expected to be covered as the business scales. However, some new age consumer internet businesses have relied on changing consumer behaviours through rewards and incentives, resulting in variable costs exceeding revenue by a huge margin. This is seen as an ‘investment’ that will result in huge profits when customers are hooked to the service or product, and willingly pay a higher price subsequently.

In some contexts, expectations of a permanent change in consumer behaviour are realistic and, in some others, it is a hallucination. Getting real about this is key to sustainability.

In conclusion, building a sustainable business is not about toning down ambition or entrepreneurial energy. It is not about creating a placid and tranquil work place where everyone loves everyone else. It is not about giving up thinking on how to outmanoeuvre competition. Both ambition and entrepreneurial energy are critical for bringing about positive change on scale. The same ambition that created Apple also created Amul and Aadhaar, and helped eradicate smallpox and polio. The principles of building a sustainable business should be seen as risk mitigation that enhances the probability of long-term success.

(T.N. Hari is the author of Pony to Unicorn and an advisor at The Fundamentum Partnership.)

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