This article was originally published on YourStory
In the fast-paced ever-changing world of startups, it is tempting to see corporate governance as a “necessary evil” – an overhead which impedes progress – but the truth of the matter is that good governance can be a powerful lever for value creation.
A lesson from Infosys
There is a facet of tech services bellwether Infosys that is rarely remembered nowadays.
When Infosys went public on the Indian stock market, it was not the largest IT services company in the country. Neither was it the fastest-growing or most profitable firm in its category.
Yet, its market valuation was higher than most of its peers and comparable to competitors that were much larger.
This “valuation premium” could be largely attributed to a single quality – excellent corporate governance. The founders and management of Infosys were fastidious about governance in all aspects of running the company.
Given the spate of the recent press around bad corporate governance and poor founder behavior in the Indian tech ecosystem, we might all benefit from taking a leaf from Infosys’ playbook to appreciate the value of good governance.
Admittedly, Infosys emerged and prospered in a vastly different milieu where founders had to perforce be frugal and diligent. But the lessons from Infosys are valid even today in the fast-paced world of startups with easy access to enormous amounts of capital and little to no oversight from investors or other stakeholders.
By their very nature, startups operate in a dynamic environment and constantly challenge conventional wisdom and reshape the business landscape. In the pursuit of growth, entrepreneurs may be tempted to view corporate governance as a necessary evil – a set of rules and practices that impose overheads, constrain creativity and hinder accelerated progress. However, this perspective is shortsighted.
There are some who believe that the recent spate of bad corporate governance is a result of excess funding in the system. That VCs not doing enough due diligence and exhorting founders to grow their startups at an unrealistic pace encourages bad behavior. But the fact of the matter is that if a founder is fundamentally honest, they will demonstrate strong ethics, values, and integrity irrespective of any external drivers. On the other hand, a dishonest founder will find his
way around any sort of regulation or governance measure. If a founder is a bad actor, no amount of corporate governance checks can help – even if the best auditors and most diligent investors are at the table, it is impossible to prevent dishonest practices. Let’s remember that when investments are made at an early stage, there is hardly any business to diligence. Even later-stage investors backing more mature companies can face negative surprises if there is malafide intent and willful fraud on the part of the founder.
So there is little point in advocating good corporate governance as a panacea for bad behavior.
On the other hand, when founders are fundamentally honest and well-meaning, properly-implemented corporate governance can serve as a powerful lever that not only safeguards the long-term health of a startup but also actively contributes to its growth and success.
Just as it did for Infosys.
In this post, we will explore various aspects of governance that are critical for startups and demonstrate how good governance practices can drive growth, stability, and long-term value creation.
A First-Principles Ecosystem Approach Towards Good Governance
At its essence, corporate governance is not just about a bunch of guidelines and regulations, it covers the entire system of rules, practices, and processes by which a company is directed and controlled.
For startups, establishing a solid foundation of corporate governance is crucial. Why?
Because it sets the tone for how the company will be managed and operated in its formative years and beyond. The foundational blocks that are laid down at inception become the structure around which the entire organization is built block by block over the long term. They set the tone and culture for all decisions and objectives from that point.
To build a strong governance framework, startups must begin by addressing some fundamental aspects. These aspects need to be driven by first-principles thinking rather than by following a cookie-cutter approach and need to be grounded in the values that the founders would like to run the company by and the broad business and market context in which they operate.
By applying first principles thinking to corporate governance, startups can create effective and tailor-made governance frameworks that address their unique needs and circumstances. Rather than simply adopting generic best practices or attempting to mimic the governance structures of
established organizations, startups should critically analyze the underlying principles and objectives of good governance. This includes prioritizing transparency, accountability, stakeholder engagement, and continuous improvement while adapting these principles to the specific context of the startup. By doing so, they can develop a governance model that not only aligns with their strategic goals but also drives innovation and sustainable growth.
An effective governance structure is inclusive and adopts an “ecosystem” approach by involving and balancing the interests of all stakeholders – founders, shareholders, employees, customers, partners, financiers, government, and the broad community. It needs to be grounded in transparency and accountability and encourage ethical behavior and integrity which needs to be enshrined as non-negotiable facets of the company.
These principles set the foundation for corporate governance that drives startup value creation. But how do they translate into practice? Let’s explore how startups can create value through effective corporate governance. Rather than being a prescriptive document, I hope to draw from my personal experience as a founder of Eka Software to drive home some key points, some strategic and others tactical.
Fundamental Ingredients of Good Governance
It is essential to ensure that there are certain fundamental principles that are enshrined in the company right from the get-go.
#1 Draft a Shareholders Agreement
I recall my initial meeting with an early investor. After we agreed on the investment following 24 hours of discussions, he contacted me suggesting that we document our agreement. This was new territory for me. Not wanting to appear uninformed, I consulted with my cousin, a Supreme Court lawyer, who advised drafting a shareholders agreement.
This agreement proved invaluable in navigating challenging times as we progressed through various stages of building Eka, a vertical software company focused on the global commodities market. Therefore, whether you are a co-founder starting up with bootstrapped resources or with investors, it is best to draft a shareholders agreement.
A shareholders agreement is a crucial document that outlines the rights and responsibilities of shareholders, as well as the terms and conditions governing their relationship with the company. From the outset, even if a startup is bootstrapped or has just two co-founders, drafting a shareholders agreement can help prevent conflicts and provide a clear roadmap for decision-making during challenging times. In the case of Eka, having a well-drafted shareholders agreement proved invaluable in navigating the complexities of the business.
#2. Hold Regular Board Meetings
While board meetings are a statutory requirement, they should not be treated as mere box-ticking exercises. Instead, startups should view board meetings as valuable opportunities to engage with directors, communicate company strategy and operations, discuss risks, and solicit input.
In the case of Eka, we benefited enormously from our directors who guided us to make many good decisions that gave us long-term gains.
#3. Prioritize Statutory Compliance
Upon relocating to Bangalore to develop the product, I realized my knowledge of company law was quite limited. We established an early framework for a statutory compliance checklist to be circulated to the board every quarter without fail. Hiring a director of finance within the first 15-member team was beneficial. As a founder, I would spend a day every quarter ensuring all compliance requirements were met.
Statutory compliance is a critical aspect of good governance, ensuring that startups adhere to the legal and regulatory requirements of their jurisdiction. To this end, it is essential for startups to establish a robust compliance framework, regularly review and update their practices, and involve the board in oversight. For Eka, hiring a director of finance early on and dedicating time to review compliance matters each quarter has been instrumental in maintaining a strong governance foundation. It has helped us avoid committing mistakes related to compliance that could have cost the company heavily at a later stage.
#4. Complete Book Closures and Audits Promptly
The best practice is to complete the yearly audit within 30 days of the year’s closure and try to maintain the same cadence at a quarterly level to the extent possible as public companies follow. This is more straightforward during the early days but can become more complex and time-consuming as the company grows and includes multiple entities. Nevertheless, it is advisable to strive to complete audits within 30 days. Maintaining this cadence also ensures that the company is unlikely to miss filing returns within the statutory time window.
#5. Establish Revenue Recognition and Procurement Policies from the Start
Revenue recognition is often a complex issue. We casually discuss ARR and revenue, but in the books of accounts, they differ significantly. Hiring a director of finance early on is helpful but more importantly, having a clear idea about revenue recognition serves as a totem pole around which the company’s entire financial plan and budget can be set up. This can result in a predictable financial strategy that supports the company’s growth and stability. Equally, it ensures that there are no last-minute surprises and ad-hoc decisions around revenue that could lead to major problems at a later date. It is a good practice to treat this as a living document that is reviewed and updated every year as the business matures.
Tactical Tips Around Good Governance
While the points listed above are strategic in nature and need careful thought and consideration, there are a few tactical points around good corporate governance that are relatively easier to implement but can bestow enormous benefits to the organization.
#1. Seek Professional Advice on Jurisdiction for Company Incorporation
Although I started the company while based in Singapore, we sought legal advice on jurisdiction, prompted by insights from my senior partner and investors’ experiences. The expense of this consultation in Singapore was initially daunting, making me question its necessity as my focus should be on building the business. In retrospect, this professional advice was invaluable.
When building companies for the global market, it is essential to balance local regulations and the country of incorporation. Understanding the short and long-term implications of the chosen structure is crucial, especially as your company scales.
When incorporating a company, it is essential to consider the potential implications of the chosen jurisdiction on business operations, regulatory requirements, and future growth. By consulting with legal professionals and leveraging the insights of experienced partners and investors, startups can make informed decisions that optimize their corporate structure for long-term success. In the case of Eka, seeking professional advice and understanding the short and long-term implications of this decision proved to be a wise investment as it helped us optimize various aspects of compliance.
# 2. Send Monthly Updates to Investors
Regularly sending monthly updates and maintaining consistent communication with board members and other shareholders is a practice that always helps companies along multiple levels.. By maintaining regular communication with board members and providing updates on company performance, startups can foster strong relationships that facilitate strategic and operational guidance in a timely manner rather than waiting for quarterly or annual board meetings to involve the board members and other shareholders. Transparency and timely updates can also help build confidence in the company especially when times are tough.
#3. Communicate and Implement all Codes, Policies, and Procedures in Word and Spirit
Establishing well-defined policies and procedures is key to maintaining accountability and transparency. Thinking through and documenting policies around code of conduct, conflict of interest, disclosures, insider trading, etc might seem like overkill for a young organization but even if many of these documents are merely placeholders to start with, memorializing them even in a relatively crude form sends out a clear message to the entire organization that the company is committed to these values and policies. It prevents ad-hocism and arbitrary
decision-making that can often lead companies into gray areas. As the organization matures, these policies and procedures can be fleshed out and expanded to suit the company’s culture and imperatives. It is also important to have clear disclosures about family members involved in the company and angel investments made by the founders. Many founders are also angel investors, and disclosing investments to the board is essential. Occasionally, during the early days, family members may assist in critical functions, and it is crucial to obtain investor approval in these cases. As a company grows, it is vital to bring professionals into the finance function, and related companies should be disclosed.
#4. Do not Ignore Risk Management
Startup life is full of uncertainties. Managing risks and ensuring compliance with relevant laws and regulations play a crucial role in the success of any startup. By incorporating best practices in corporate governance, startups can proactively address potential issues and maintain a strong foundation for growth.
Startups need to regularly evaluate potential risks, including operational, financial, strategic, and environmental factors. This process helps prioritize risks based on their likelihood and impact. Once risks are proactively identified, create an actionable plan to mitigate them in a risk management plan. This includes defining roles and responsibilities, setting deadlines, and allocating resources.
The risk management plan should also provide for a system of checks and balances that can be progressively introduced as the company matures – this should cover aspects such as independent board members and specialized committees for audit and compensation. Continuously monitor the effectiveness of risk management strategies. Learn from experience and make adjustments as needed to stay on top of emerging risks.
#5. Inform the Board about Your Holidays and Travel Plans
While this may seem minor, it is good governance to keep the board informed about personal activities and travel plans, especially during the early days when there is critical keyman risk around the founders. Informing the board of your schedule allows members to assist with arranging meetings or introductions that could be slotted in if convenient.
In summary, companies with exceptional corporate governance demonstrate a range of best practices that contribute to their sustained success. By embracing these principles and practices, startups and established organizations alike can leverage corporate governance as a powerful tool for growth, innovation, and long-term value creation. Good corporate governance enhances investor confidence, improves decision-making processes, and helps mitigate risks and conflicts of interest.
As the tech ecosystem continues to evolve, it is crucial for founders and investors to recognize the importance of good governance and actively incorporate it into their strategic planning and decision-making processes.
Exemplars like Infosys have set the tone around good governance and demonstrated how it has benefited the organization. It is now time for the next generation of tech companies to emulate these best practices and serve as inspirational references for future generations. It is time for startup founders to boldly pick up the baton and work hand-in-hand with investors to establish good corporate governance as a key ingredient of company culture and leverage it to deliver value creation to all stakeholders in the ecosystem.