CORPORATE GOVERNANCE IN INDIAN STARTUPS
Alpha Partners
Recognised Indian corporate commercial law firm based in Delhi NCR and Dubai
Introduction
The legal dispute between Ashneer Grover and BharatPe has been finally settled amicably on 30 September 2024. The settlement provisions require Mr. Grover to adhere to several conditions, including severing ties with BharatPe and a mandatory prohibition on holding any shares in the company. This dispute has cemented the need for effective and robust corporate governance structure in any business especially startups so that any conflicts and dispute can be resolved efficiently.
On this our managing partner, Akshat Pande commented “This case underscores the importance of robust corporate governance measures in any business and how the investor’s ignore such issues when the times are good.
Highlighting the Issues In the dynamic landscape of Indian startups, various corporate governance challenges can arise, often hindering the growth and stability of these emerging businesses. It's essential for investors and promoters to address these issues proactively to foster a healthier investment environment.
Following are some critical areas of concern that warrant legislative attention:
1. Overstated Financial Metrics: Many startups tend to overstate their revenue, profit, and EBITDA figures, creating an illusion of success that can mislead investors.
2. Lack of Internal Controls: There is often a notable absence of internal controls and policies, which are vital for effective governance and operational integrity.
3. Improper Policy Application: Essential policies, including those related to intellectual property (IP), employment, ethics, governance, and accounting, are frequently either incorrectly implemented or ignored entirely.
4. Neglect of Related Party Transactions: Startups often fail to review related party transactions as required by law, leading to a lack of transparency and potential conflicts of interest.
5. Transparency in Vendor Management: There is often insufficient transparency in the selection and management of vendors, particularly for companies dependent on networks or franchise members.
6. Loan Policies: Many startups lack clear policies regarding loans to employees and third parties, leading to potential financial mismanagement.
7. Inaction on Delinquencies: Companies may hesitate to address breaches or delinquencies by employees or third parties due to fears of losing business or creating conflict.
8. Inventory Management: Poor inventory management practices can lead to inefficiencies and financial discrepancies.
9. Investor Board Representation: Investors frequently lack adequate representation on the boards of startups, which can result in governance disconnects.
10. Formal Meetings: Many startups do not conduct genuine board and shareholder meetings, relying instead on "paper meetings" that lack substantive discussion.
11. Reporting Issues: Inadequate reporting to investors can hinder transparency and accountability.
Proposed Solutions
In order to address the prevalent corporate governance issues and foster a culture of accountability, startups can implement a series of strategic actions. These measures aim to enhance oversight, establish clear policies, and ensure that all stakeholders operate within a framework of transparency and integrity.
Following are some key actions that startups can undertake to strengthen their governance structures:
1. Appointment of Observers: Mandating the compulsory appointment of an observer (if not a director) to the board to ensure oversight and accountability.
2. Written Policies: Developing and approving written policies for each of the identified corporate governance issues, with regular monitoring of their implementation.
3. Internal Control Reviews: Conducting comprehensive reviews of internal control systems to ensure compliance with established policies throughout the organization.
4. Consultant Supervision: Appointment of an investor-nominated consultant as a supervisor. The consultant would be responsible for checking policy implementation, reviewing accounts, managing related party transactions, and ensuring effective board and shareholder meetings.
5. Litigation Policy: Implementing a litigation policy to address breaches of policies or contracts. This ensures that appropriate actions are taken to mitigate any damages effectively.
6. Rights in Shareholders Agreement: Ensuring that the shareholders agreement grants investors sufficient rights to take necessary actions if founders are uncooperative, including the right to withdraw investments or gain control of the company.
7. Preferred Accountants and Auditors: Specifying preferred accountants and auditors in the shareholders agreement to ensure quality financial oversight.
Conclusion
It is important to recognize that many of these governance issues are typically not the result of intentional misconduct by founders. Often, they stem from a focus on business development and sales, with governance matters left to outsourced agencies like chartered accountants. Educating founders about the importance of maintaining good governance practices to protect investor interests ensures significant enhancement of corporate governance in Indian startups. Further the implementation of these measures can create a more transparent and accountable framework that not only attracts investment but also fosters sustainable growth within the Indian startup ecosystem.