Backbone of “Make In India” – MSME Sector - Struggling to lay down structure for good Corporate Governance: An indispensable ingredient for long-term

“Corporate Governance means enhancing shareholders value in a company along with the equal and fair treatment to all its investors, stakeholders, customers, employees, vendors and the society” - Mr. Narayan Murthy

 The above phrase by Mr. Murthy, one of India’s most celebrated businessman and entrepreneur, captures the essence of corporate governance succinctly. Implementation of sound corporate governance mechanisms is paramount for the success of any organization and is even more crucial for the growth and sustenance of a young company. Unfortunately, this seems to be taking back seat for many of the companies operating in the Indian MSME space.

The MSME sector has emerged as a mighty contributor to the Indian economy over the last few decades. With India aspiring to be a $5 trillion economy by 2024, MSMEs will be the central backbone of the country. Currently, it is the second largest employment generating sector, after agriculture, and more than 120 million Indians livelihoods are associated with it. There are approximately 63 million MSMEs and they account for a sizeable 6.1% of manufacturing GDP and 24.7% of GDP from service activities[1]. Not only do they play a big role of providing employment at comparatively lower capital cost, they also help in the industrialization of rural India and therefore reduce the regional imbalances and contribute to inclusive growth. This sector has the potential to boost the growth and industrial output for India and must be nurtured appropriately.

Most of the successful organizations attribute their success to strong corporate governance. While this is ingrained in many of the large successful organizations, this doesn’t form part of the priority list for startups and small companies. Day to day survival is more important for such organizations than anything else. For startups, funding, growth, and hiring take up owner’s bandwidth and hence corporate governance takes a back seat. None the less, there are ethical, legal, and fiduciary responsibilities for organizations of any size. The relevance of corporate governance increases proportionally with the magnitude of the business and the number of shareholders. As these organization grows, they realize that they have obligation to both its investors, employee’s, statue and the environment.

Another aspect of the Indian MSME sector is that many of the companies are family owned businesses. Members of a family may develop; biased views of non-family members controlling the business and hence restrict the amount of control that is available. A successful, growing, privately held business will question the value of a truly independent board and instead resort to compromised board. The risk here is that when multiple roles are executed by the family members, division of responsibility and power becomes difficult as different generations join the business.

 What accounts for good corporate governance?

In very simple words, corporate governance concerns a company’s system of management and control. Good governance will lead to internal discipline, accountability, and transparency with its various stakeholders. This helps the company to scale in a more structured format and drive growth in a sustainable manner.

For a public company, or a small one, good corporate governance implies that the board provides an independent perspective by considering the interests of both the shareholders and all stakeholders. The board must be constituted carefully with experienced directors and independent ones whose vision align with that of the company. Very often we find that the board members are tied or linked to the CEO is some way or the other which restricts the freedom of thought. On the other hand, a diverse board, with members from different genders, race, geography, and industries leads to better outcomes. A strong board will be involved with all aspects of the company – financial, strategic, operational – and will be able to guide the management forward in the right direction.  

External and independent directors go a long way in cementing a company’s success. Not only do they provide the management with access to different networks and contacts, but they can also be an invaluable source of experience when it comes to navigating any crisis period by balancing the views of the executives and enabling better strategic decisions.

 Advantages of sound corporate governance

There is enough research and data to prove that well governed companies grow and outperform in the long run. Broadly speaking, there are 5 distinct advantages for a company which follows good practices.

1.      Capital

A proper governance structure will improve the ability to raise capital. In fact, better governance can be used a core value proposition to attract investors. Various funders, ranging from banks, private equity, and venture capitalists, understand that good governance implies more security and therefore the possibility of a better return on their capital. This can also lead to a premium valuation for the SME ensuring better returns for stakeholders.

2.      Effective Management

The company’s management and operations will improve if the roles, responsibilities, processes are clearly defined and delineated. On one hand, the shareholders will be able to better understand the workings of the business and thus contribute towards the strategic objectives, on the other hand this will lead to lesser internal conflicts thus freeing up management time to focus on growth and profitability.

3.      Future Ready

As the SME scales and looks to grow in size, an important step in this journey is to manage stakeholders’ expectations. Preparation of audited financial statements, annual reports, board meetings, budgeting and planning from an early stage sets the right tone from the start and will allow the company to gain respect, trust and financial returns.

 4.      Risk Management

Every business goes through some crisis or transition period at multiple points in its life. Good corporate governance will ensure that risks mitigation plans are in place that are supported by internal controls. This would help the company to quickly take cognizance of any risk, monitor it, and chart the right plan of action required to mitigate it. Such systems support the company to embark any new initiatives such as a new product, geographic expansion, acquisition etc. in a confident manner. More importantly, future bankruptcies will be prevented from happening.  

5.      Reputation

The fallout of a governance failure is disastrous for any organization. Enough examples are there in India and abroad where large conglomerates have sunk. One such instance, there is no going back, and the damage is irreversible. Companies with good corporate governance are less likely to suffer such failure and reputational damage. Effective organization stable governance over time enhances Brand equity, Employer Equity, and steadily strengthens financials.

In summary, corporate governance will be the key for success of today’s young MSME sector, looking to scale and grow. With the increasing number of SMEs in India, it is important that they are aware of the benefits that good governance structures can provide. There is no doubt that these structures lead to better business outcomes and will help the SMEs of today become the large corporates of India tomorrow.

[1] CII Report https://www.cii.in/Sectors.aspx?enc=prvePUj2bdMtgTmvPwvisYH+5EnGjyGXO9hLECvTuNuXK6QP3tp4gPGuPr/xpT2f