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Why A Startup Should Make Governance A Priority?
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When an entrepreneur starts a business he wants to ensure what he is doing is worthwhile. This means his management style has to be fair and transparent and it should stay within the limits of the applicable law.
What is governance? It means the board, of a company, steps in to guide and monitor goals and values through policies and processes that are best suited for its business.
It is not your conventional buzz word in the startup circles. Rarely are you asked about the quality of corporate governance in your startup. It’s a word that is often misconstrued, as many people either don’t understand what it encompasses or they do not appreciate the importance of Governance. It’s assumed to be something related to management, companies, or investors.
Corporate governance gains more importance because the shareholders who invest money are different from the people who manage companies.
With brilliant entrepreneurs at the helm, the question of the necessity of a governance based framework (to have a Board), often arises. Truth be told, it is lonely at the top. With the right framework, the startup can push forward objectively. On the other hand, let’s not mix the framework with the stage of the enterprise as they differ in both definition and functionality.
For example in a start up enterprise, it is lot simpler, as the company grows, there’s rigour in that process. An audit committee and a compensation committee at the Board level is not probably required initially in a startup. But when it reaches a certain level, say beyond its series-A funding, these then have to be included.
It is important for the Board to administer adequate knowledge about the organization’s vision, current status and the regulations within which the enterprise operates and to create a successful framework.
Benefits All Stakeholders
In my view, any organization armed with the appropriate governance framework presents itself as being equally important for all stakeholders and investors in the organization alike.
The ethics of the founder, and the practices adopted by the organization to run their business, play a massive role in crafting its governance framework. It draws in on the fine balance of not only saying what is true, but that they relay the truth.
When investors participate in evaluating a company, they trust the entrepreneur and are vested in a budding business idea, along with perilous risks involved. They breathe easy when the company has the highest corporate governance, as it indicates that their money will be safe, utilized appropriately by the founders and that the amount of risk in the venture would reduce significantly.
A corporate governance framework includes several key points like appointing a reputable audit firm, a good internal audit, right legal counsel, a credible management team, and clearly laid down policies and processes. At the pinnacle of this framework foundation is a buy in from the management. Once that is garnered, worrying about compliance issues, become obsolete.
It is natural to gravitate to the Big 4 CA firms. It’s a given, considering that international investors know more about the Big 4 and that the expectation of quality governance of these firms are better tested than that of others.
On the other hand while it should deter one from signing up with other reputable CA firms or capable independent directors, precautions should be taken especially with independent directors in whose dictionary, the word “independence” needs redefining. The right director is the conscious keeper of the affairs of the companies. If to their knowledge the affairs of the business are conducted in an unsatisfactory manner, they will decline being on the board.
The real challenge here however is for startups to govern themselves. Unless the founder(s) believe that independent directors have to be independent and bring value, they will be added on only for the sake of legal government compliance.
Having said that, a company can still be greatly governed, without featuring a roster of big names, as independent directors.
A VC backed company CEO, was once posed a question by a member of the media, on whether he was ready to go IPO. The CEO replied saying that he was always ready internally and that once the market’s ripe they would go public. He further said that if they weren’t going public it was not because of some back office issue. But because of scale and market readiness.
I am not advocating compliance of SOX from day 1, but if in spirit, the framework and the guidelines are followed, they will go a long way in helping companies function better.
Governance In Start-ups
Now let us understand why many companies are not able to comply with this.
I would broadly classify 4 reasons for not being able to create governace: (1) Lack of awareness (2) Complete freedom (3) Autonomy 4) Fraud.
From my experience, I have observed that, the lack of awareness is the most common reason why most startups don’t adopt a good governance framework. Most startups typically think that governance is meant for big corporations and that it involves significant overhead with little return. Some don’t see governance as a priority. Some have the full intention of complying with the governance framework (where there is one in place), but don’t know what to do and how to go about doing it.
Governance is practiced daily. Often choosing the right advisor/partner (investors, independent board members, layers or CA firms) is key to getting on the path of governance. Once the intent is clear, and there is a willingness to do the business right, the implementation or drawing a framework is easy.
The other common reason for lack of governance is the fear of losing control. This fear is best categorized as a fear of the unknown. This category of thinking emphasizes on the false notion that set procedures and processes, would lead to a loss of autonomy or freedom. In reality, these processes help entrepreneurs run their business smoothly and efficiently.
Fearing the loss of autonomy occurs when a founder disapproves restrictions on his authority. But such authority can easily corrupt and there is no chance of calling out when the emperor is naked. Governance ensures that there is both accountability and transparency.
As a rule of thumb within the governance framework, there has to be minimum of 3 quotes obtained for large expenses, contracts should not be given to related parties, family members should not be engaged in business activities on undue terms, follow prudent accounting as per standard accounting practices, have makers and checkers split in various activities and a clear demarcation of responsibilities, are some of the ways to reduce the mistakes which may later find to be the root of a fraud. Fairness and transparency are two non-negotiable, key factors on which any governance framework should be built.
A more sinister scenario occurs when the founder intends to commit fraud. The IT giant, Satyam's, demise is a classic case in point. The consequences were for all to see. Therefore governance is required at all stages of your company, whether you are a startup, SME or a big corporate. My go to quote for corporate governance is: “Before doing anything ask a question, whatever I do now, if it comes in the newspaper tomorrow, can I stand by it? If the answer is “Yes,” then go ahead and do it.
The right governance framework covers the conflict of roles, interested party transactions, proper review mechanisms, accounting goof ups, financial engineering and everything else. On the other hand, we also have the example of Satyam who chalked up an award for best corporate governance a few years back before they were actually caught for, ‘how a company should not be run.’
A company should always strive to improve its transparency and accountability with its stakeholders. This leads to improved trust and confidence within the management team. A well-designed governance policy with proper implementation across the company helps one achieve this and improve the shareholder wealth. Lastly, like investor education, it is important to have education on governance within startups and even within large enterprises. The truth is unless a CEO commits to maintaining the highest level of governance, no amount of rules can make a difference.
The author, R Natarajan, is MD and CFO of Helion Ventures
The author, R Natarajan, is MD and CFO of Helion Ventures