Mint Explainer: Why good corporate-governance practices are crucial for startups

Several startups allegedly witnessed unethical behaviour from founders, clashes between founders and investors, and financial irregularities, leading to the ouster of founders such as Ashneer Grover from BharatPe and Rahul Yadav from Housing.com, or the liquidation of the business, as in the case of Zilingo.

Investors and concerned citizens soon began to demand that these entities adopt better corporate-governance practices. The Confederation of Indian Industry (CII) recently released a corporate-governance charter for startups, since the existing corporate governance codes of the Securities and Exchange Board of India (Sebi) and those enshrined in the Companies Act, 2013 apply to large, listed companies.

Mint takes a closer look at the importance of good governance practices at startups.

Why has the CII released a corporate-governance charter?

Over the past few years, mainly after the pandemic, the startup world has been rocked by several scandals, many of which involved inappropriate behaviour by founders. Given that India has the world’s third-largest startup ecosystem with more than 1.10 lakh such companies, without proper regulation there could be many more such scandals in future.

The CII said in its recent charter that governance failure at many high-profile startups sparked concerns about significant erosion in the value of shareholders’ stakes. An example that stands out is that of Paytm’s parent firm One97 Communications Ltd. Its public shares, issued at ₹2,150 apiece in November 2021, are currently trading below ₹375, or more than 80% lower. The stock listed at a discount to its issue price before plummeting below ₹600 over the next few months following regulatory action by the Reserve Bank of India (RBI).

Also read: Paytm’s bank is in a state of suspended animation. So, what’s next?

Another notable example is that of Byju’s. Once India’s highest-valued startup with a $22 billion valuation in 2022, it is now valued at less than $1 billion and struggling to stay afloat amid a string of controversies. In April 2023, the Enforcement Directorate (ED) conducted raids on three offices of Byju's in Bengaluru, alleging violations under the Foreign Exchange Management Act (FEMA), and issued a ₹9,362.35-crore FEMA violation notice to the company.

Also read: Byju’s faultlines and the perils of easy money

A communique from the Startup20 Engagement Group at the G20 summit in July 2023 had also noted the crucial role of corporate governance in startups. The startup governance framework designed at the meeting suggested that the key guiding principles should be: enhanced transparency and accountability, improved decision-making, reduced risk, increased access to capital market and partnership, and stronger reputation and trust.

Can’t existing corporate-governance codes ensure good behaviour by startups?

The rules enforced by Sebi through its Listing Obligation and Disclosure Requirements Regulations apply only to listed entities, while rules under the Companies Act, 2013 must be followed by all incorporated entities. This means startups that are corporate entities are required to follow some of the rules but not others. Also, many of these rules are followed only in letter and not in spirit.

The charter published by CII is meant for companies that are incorporated under the Companies Act, 2013. However, a large number of startups are partnerships or sole proprietorships. The CII suggests that entities that are not companies are free to adopt the guidelines outlined in the charter. But that is unlikely to happen. In any case, a charter released by a business chamber cannot be made mandatory.

India’s G20 sherpa and former Niti Aayog CEO Amitabh Kant suggested last year that startups implement high-quality corporate governance and self-regulation practices systematically, with guidance from experienced mentors. The question, however, is whether self-regulation can deliver the desired results.

How will good corporate-governance practices help startups?

Startups depend on investments from venture-capital and angel investors to fund their expansion. These investors are becoming increasingly particular about governance practices at the entities in which they invest. However, many investors still set unrealistic targets for returns on their investment, putting pressure on founders and management to flout the law.

Good corporate-governance practices could help startups attract quality investors who seek realistic returns and allow them to focus on long-term value creation rather than short-term valuations. It is thus widely believed that good corporate-governance practices are necessary for startups to improve the quality of decisions, reduce conflicts of interest, promote long-term strategic thinking, and enhance disclosures relating to predictability in revenue, growth and business planning.

Also read: Startup investors are hunting outside unicorn zone