This article is written by Shakchi Verma, Amity university Lucknow, 1st year LLM student, during an internship at LeDriot India.
KEYWORDS
- Corporate governance
- Startup
- Stakeholders
- ESG
- Innovative idea
INTRODUCTION
Corporate governance involves a set of interdependent relationships between a company’s management, board of directors, shareholders, and stakeholders. It is a clear structure of relationships between the company and its stakeholders which is primarily aimed at fostering responsibility and accountability while the overall performance of the company and its management is being monitored. It also gives assurance to those who are contributing to the capital of the company, that they can participate in its affairs and ensure its growth.
It is important to note that business does not exist in a vacuum; it consumes resources of the society. Customers and society at large are also stakeholders of the company. Therefore, startups have a duty towards their society and customers to act responsibly towards the environment or to contribute to the society. Therefore, the scope of CG in the current scenario is not limited to the general idea of governance; it has expanded to ethical practices and environmental issues aimed at preserving the environment for future generations, which is why it is called Environmental, Social and Governance (ESG).
Well-structured CG policies in a company can promote innovation, entrepreneurship, productivity and sustainable growth. These policies can also help a company obtain financing and affect the cost of capital. If investors are satisfied with the way a company is managed, the cost of capital is likely to be lower. It follows that the cost of capital is inversely proportional to the level of security provided to investors by effective corporate governance policies.
Startups are companies that are in the early stages of implementing an innovative idea. Startup founders often manage operations, growth, and strategy on their own and therefore need help in establishing the necessary structures for checks and balances due to various factors, such as the lack of adherence to guiding principles. However, strong and well-structured corporate governance policies are imperative for startups to access capital and foster innovation and growth.
The startup ecosystem is thriving in India. It is the third largest startup ecosystem, with over 117,718 recognized startups and 111 unicorns. An innovative or scalable business model, a dynamic environment, and the ability to scale rapidly can be hallmarks of startups. However, they often face severe resource constraints and require capital to scale their operations. In India, corporate governance frameworks are still in their infancy. They are mainly triggered in cases involving whistleblowers or when institutional or proactive investors take action to ensure the smooth running of the company.
This article examines the challenges faced by Indian startups in establishing robust corporate governance frameworks.
WHAT DO WE MEAN BY CORPORATE GOVERNANCE?
Corporate Governance: It is the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the differing interests of a company’s various stakeholders, such as shareholders, management, customers, suppliers, financiers, governments, and communities. Major elements of corporate governance are:
- Board of Directors: Such a board is overseen and responsible for management of the company and for acting in its best interest as far as its shareholders are concerned. The board appoints the CEO and often other top executives while making strategic decisions to ensure legal and ethical compliance of the company.
- Transparency and Accountability: Good corporate governance requires that management shall provide timely, accurate, and transparent information regarding the company’s finances and other important issues so that it provides stakeholders with an information input into their decisions.
- Shareholder Rights: Corporate governance practices enhance shareholder rights by having a stake in key policy-related decisions, such as electing members on the board and in voting for significant changes regarding the direction of the company.
- Risk Management: The company should have a mechanism whereby risks are ascertained and managed with measures that ensure the sustainability and stability of the company in the long run.
- Ethical Behavior: Companies operate in a manner that is ethical, means practices are in compliance with the laws and regulations of the jurisdictions in which it conducts its business activities.
Good governance practice will always promote trust among investors and stakeholders, contribute to long-term success, and steer away from corporate scandals or failures.
WHY IS CORPORATE GOVERNANCE IS IMPORTANT FOR STARTUPS?
Corporate governance is one of the most important aspects that startups often overlook and can make or break their business. A solid governance structure acts as a strategic roadmap to drive organizations towards sustainable growth while mitigating risks.
But why is this so important?
- Risk Mitigation: This is arguably the most direct and impactful role that corporate governance plays in startups. Implementing effective governance measures can protect your business from financial and management errors. For example, having a board equipped with a role matrix clearly defines decision-making responsibilities, thereby reducing the risk of hasty and uninformed decisions being made unilaterally. Regular financial and budget audits, as part of a strong governance framework, can identify potential problems early and keep your business on track.
- Stakeholder trust: A transparent and accountable corporate governance framework builds trust among stakeholders, whether investors, employees or customers. When stakeholders see that decisions are made wisely and not in a haphazard manner, their trust increases. This leads to increased investor engagement, higher employee satisfaction, and greater customer loyalty. Regular engagement and communication with shareholders can further strengthen this trust.
- Corporate Performance: Contrary to the belief that corporate governance is all about risk mitigation, it has been found that there is a direct correlation between good governance practices and superior corporate financial performance. An effective governance structure promotes smarter resource allocation, more refined strategic decisions, and improved operational efficiency—all factors that contribute to strong bottom lines.
- Corporate Social Responsibility: No businesses exist in isolation. Our actions have a profound impact beyond our office walls. Good corporate governance ensures that companies act ethically and responsibly towards their wider stakeholders, society and the environment. By taking the interests of employees, communities and the environment into account in their decision-making, startups can strengthen their role as responsible corporate citizens. This not only aligns with today’s conscious consumer trends, but also fulfils our obligation towards a sustainable future.
KEY CHALLENGES
- No formal governance structure: Startup founders are often members of close-knit teams and decision-making is generally informal. Board power is often centralized and concentrated. A shift from founder-led decision-making to a structured board of directors with independent oversight is necessary to ensure that shareholder interests are considered.
- Lack of clearly defined roles: Startups may sometimes need help in clearly defining the roles and powers of the board of directors, which can lead to confusion in management decisions. Board powers need to be clearly defined to ensure compliance with section 166 of the companies act 2013.
- Limited financial and resource constraints: Startups often struggle with available capital, which affects their ability to recruit experienced board members and establish strong internal controls.
- Lack of internal audits and segregation of duties can expose startups to legal risks, such as those arising from the provisions of the companies act 2013, which require the retention of accounting records for eight years.
- Founder Dominance and Conflicts of Interest: Founder dominance and potential conflicts of interest often give rise to conflicts between investors and founders. Founders may prioritize short-term growth or personal financial gain over long-term stability. Without adequate oversight, these conflicts can lead to breaches of fiduciary duty and attract legal action from shareholders.
- Inadequate reporting and disclosure practices: Private startups often ignore regulatory disclosure practices required of publicly traded entities, which can harm investor confidence and the cost of capital. Additionally, without adequate disclosure, startups can have difficulty attracting institutional investors.
- Regulatory and compliance barriers: Startup founders often operate on their own, often with little or no knowledge of the ever-changing regulatory landscape. This lack of expertise can lead to startups breaking the law, being fined, penalized, or, in the worst case, being liquidated.
EXAMPLES OF CORPORATE GOVERNANCE IN STARTUPS
- Byjus: Once a recognized unicorn, Byjus has come under intense scrutiny for financial irregularities and poor internal controls. The lack of strong internal controls and inadequate governance oversight has resulted in reputational damage and diminished investor confidence. This highlights the important role governance plays in mitigating risk, especially when businesses are growing rapidly.
- Airbnb: Airbnb’s sound governance policies, coupled with a strict whistleblowing policy, have allowed the company to grow from a bed and breakfast to thousands of properties around the world.
CONCLUSION
Corporate governance is not just another business discipline or a set of mandatory practices for startups; it is the compass that charts a startup’s journey from inception to long-term success. It provides an essential framework that not only ensures compliance with legal and regulatory requirements but also fosters a culture of good decision-making, transparency, and accountability. Even the most robust business models can falter without good corporate governance. This is precisely why startups need to prioritize governance from the get-go.
REFERENCES:
- Companies act 2013
- What Is Corporate Governance for Startups? | TRUiC
