Disruptive startups need better governance. A new form of decentralized ESG (dESG) could help
Case studies: Theranos, FTX, and other startup governance failures
"Hopefully things can find a way to recover. Hopefully this can bring some amount of transparency, trust, and governance to them." –Sam Bankman-Fried, former CEO of FTX, 11/11/2022
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”—John J. Ray III, newly appointed CEO of FTX, 11/17/2022
FTX, Theranos, Robinhood, and other high-profile startups became vulnerable to poor management decisions when growth and funding imperatives got ahead of good governance and customer and employee care.
Company boards rarely intervene when founders appear to be creating rapid growth, rising market value, or media praise. However, if you’re a stakeholder in a disruptive startup you should demand a say in its governance to ensure that the company succeeds and also does no harm. The goal of all stakeholders, including investors, employees, and users, should be sustainable growth and socially responsible business—not just scale, as is too often the case for VC-funded startups.
Potential damage from complacent governance can devastate startups and their investors. It can result in fines, user abandonment, sanctions, reputational damage, or even prison sentences for overly emboldened and naive founders. When disruption goes wrong, everyone loses. Recent startup disasters have made that all too clear.
Good governance mechanisms are relatively simple. So why have investors, regulators, employees and customers so often been failed or defrauded by fast growth, high-visibility startups?
?A new, decentralized approach to ESG could help startups grow faster and more responsibly ?
?ESG (environment, social and governance) frameworks seek to remedy socially harmful or corruptive corporate behavior and to mitigate stakeholder risk by imposing centralized standards of disclosure, behavior and governance. Unfortunately ESG has become controversial for its regulatory overreach, politicization, and usurpation of authority over businesses and markets. Even with the best of intentions, traditional ESG can be impractical for startups and SMEs due to the high cost and growth inhibitors of adoption and compliance.
These drawbacks create the opportunity for a new form of decentralized ESG governance that we call dESG. dESG embodies many of the aspirations of traditional ESG—trust, inclusion, authentic social and environmental responsibility, transparency, and oversight—but its authority rests in stakeholder consensus and oversight rather than external standards or coercive regulation.
What is dESG?
dESG is a form of democratic self-governance whereby an organization’s stakeholders are networked and incentivized—potentially through product discounts, early releases, equity/tokens, or just greater social participation—to provide feedback, consensus, and oversight on social, environmental, and governance matters. As with traditional ESG, dESG can be used to set environmental, social or governance policies and goals, but it offers unique applications for startups by attracting early adopters and talent as well as by engaging stakeholders to help collectively manage and propel rapid, but responsible, growth and industry disruption.
Governance, in essence, is about accountability—asking pertinent questions and getting honest and actionable answers. When this process is obstructed, as in our case studies of Theranos and FTX below, things go wrong. The solution is to remove any potential obstruction of open communication and accountability between management and the other stakeholders. This is the goal of dESG.
?How it works
Under dESG protocols the organization establishes a network or a constellation of sub-networks where solutions to ESG (or commercial) issues can be crowdsourced from stakeholders. Consensus is rendered by vote of the constituent stakeholder networks on blockchain or web mechanisms. The organization decides how consensus is applied—as a full DAO, on an advisory basis, or with partial/full discretion on select matters.
Networks can be empowered to engage with and inform the board, regulators, and other stakeholders. Topics for consensus or oversight can be determined by the organization, the networks, or a combination of both. The goal is to make collaborative decisions with more inclusive and organic input.
For example, a startup might adopt separate sub-networks for engineers, marketing teams, risk management/compliance, shareholders, or customers. Each sub-network can be invited to share in decision-making or oversight relevant to their roles in the organization. Sub-networks can render consensus independently or in combination with other sub-networks, e.g. employee networks might join customer networks to address wage vs. price decisions. This consensus can be conveyed to the board for final consideration and execution. This process is particularly effective for setting milestones and communicating those to investors and board members.
Once a dESG network is in place, it can help set ESG priorities, goals, and KPIs for the host organization. It is compatible and synergistic with traditional ESG protocols, but authority stays with stakeholders, making it more democratic, inclusive and user-friendly. That can be very attractive to prospective team members, users, and ESG investors. Importantly, decisions and polices are tailored to the specific needs of the organization rather than to a one-size-fits-all mandate by external standard setters. dESG’s low adoption costs and potential network effects expand its applicability to startups and to the 90% of the world’s businesses that are SMEs.
Beyond compliance
Unlike traditional ESG (which is largely driven by compliance, risk-avoidance, or external pressures) dESG is driven by competitive advantage, growth and network effects. Its advantage derives from collaborative decision-making, stakeholder inclusion, and empowerment. Stakeholders, especially employees and customers, increasingly expect this from the organizations they do business with. And as recent research by FCLTGlobal and Wharton’s ESG Analytics Lab shows, engaging stakeholders leads to better and more stable financial returns.
dESG provides another advantage over traditional ESG models: propagation. Compliance isn’t a good basis for a viral movement and pushback against authoritarian ESG is growing, especially in the USA. In contrast, dESG has the potential to compound virally by simultaneously engaging not just a broader range of businesses, but also their customers and other stakeholders. Since consumers interact with multiple vendors, dESG networks can cross-promote: customers and employees favor providers that grant them a voice in social and environmental decision-making.?
?Better Startup Governance
While much of the focus of traditional ESG has been in addressing climate issues, dESG is uniquely suited for social and governance applications. Its collaborative network approach removes unproductive silos and promotes trust, transparency, and inclusion. It creates an organic and fluid reporting and recommendation process that collects and feeds information and consensus seamlessly throughout any organization. It can also be used along supply chains and counter-party networks to ensure ESG integrity from suppliers and vendors, and to reduce counterparty financial or social/environmental risk.
Let’s simplify ESG and impact investing
dESG would make life considerably easier for ESG and impact investors, who, according to Bloomberg, will soon control some $41 trillion in capital assets.
Evaluating ESG compliant investment targets is a big challenge. It currently requires ongoing diligence, ever-expanding data points, competing standards, and value judgments about diverse and often conflicting corporate behaviors. Greenwashing is rampant. Even the most diligent of businesses can fail on some ESG parameters…just ask Tesla.
This all poses reputational, litigation, and regulatory risk to ESG fund managers and investors.
Insiders know best
?Employees and customers are the ultimate insiders in any business and especially in startups. As Theranos showed, it actually requires extraordinary effort to hide problems from employees and customers. It’s far easier to fool or greenwash regulators or boards than those who work daily within an organization. That makes dESG networks far more efficient in early discovery and mitigation of management or cultural problems within fast growth businesses.
dESG networks also provide significant advantages in environmental applications and monitoring.?More democratic processes in setting KPIs and sustainability policies are likely to result in better buy-in by workers as well as customers and other stakeholders. Measuring materiality and impact of those policies once adopted, is also more efficient. Consensus-based impact reporting would solve one of the biggest challenges of ESG investing by providing clearer and more in-depth views of how adopted policies are actually impacting social and environmental factors in the organization’s orbit.
Investors can save time and reduce risk by simply limiting their investment targets to businesses that adopt or agree to adopt dESG protocols. Furthermore, since most startups and SMEs can’t afford traditional ESG reporting and compliance, dESG adoption greatly expands the universe of investment targets to include smaller and faster growth startups.
Let’s see how applying dESG protocols to Theranos and FTX might have preempted disaster and saved both founders and investors.
领英推荐
THERANOS: Elizabeth Holmes would have hated dESG, but it would have kept her out of prison
Theranos’ Vision:
Disrupt the blood testing oligopoly and democratize healthcare. Founder Elizabeth Holmes’ goal was to empower patients with personalized blood testing and diagnostic tools, allowing more control over personal health data.
What went wrong:
Theranos’ initial technology didn’t work. The company’s culture and governance then failed to allow for accountability and a pivot to more viable applications.
A culture of secrecy, an inexperienced founder, and a complacent/absentee board and investor-base contributed to Theranos’ downfall. Scientists, employees, compliance/legal officers and the board were all siloed to restrict communication and transparency. Strict NDAs and confidentiality protocols allowed management to fudge data and test results so as to keep raising capital at elevating valuations.
Most successfully innovative businesses are already collaborative networks, formally or informally. The founder’s vision guides, but collaboration and debate solve problems and propel accomplishment. Elizabeth Holmes desperately needed guidance, experience, and oversight. Instead, she got adulation, celebrity, and easy money. These fueled misguided policies, deception, and a toxic culture leading to the company’s demise—and to her criminal conviction.
How dESG might have saved Theranos:
dESG imposes network structure and integrity and acts as the heart, conscience, and culture of a business—things Theranos reportedly lacked. Because networked stakeholders have both common and divergent interests, they provide important checks and balances and are far more likely to demand answers—and action—on hard issues.
Presumably, Elizabeth Holmes believed that with enough time and money she could overcome core technology challenges. dESG could have ensured counter-balancing accountability and integrity, thereby removing the kind of wishful thinking that often gets startups into trouble.
More specifically:
?In the end it was whistle-blowers and investigative reporting that exposed the truth about Theranos. A dESG network could have accomplished the same thing, but early enough to have saved, rather than destroyed, the project.
?An honest and productive counterbalance to Holmes’ ambitions via dESG might have tempered the company’s meteoric rise to a $9 billion valuation, but would almost certainly have helped Theranos avoid disaster and possibly find honest and viable applications within the personal health diagnostic space.
?FTX: What governance?
?Sam Bankman-Fried’s FTX and Alameda Research not only didn’t have decentralized governance, they reportedly had no governance at all. No real board. No oversight. And now, no business.
FTX and Theranos shared many similarities that led to their downfalls: complacent, FOMO-juiced investors who never demanded accountability or oversight, and conscientious, early team members who quit when concerns were ignored. Both enjoyed unqualified celebrity praise. And, as with Theranos, it wasn’t regulators or a diligent board who exposed the problems at FTX. It took a competitor (Binance) and a media source (Coinbase) to reveal the truth and catalyze the implosion.
?A dESG protocol could have addressed many of FTX-Alameda’s shortcomings, and possibly prevented investor and depositor losses. dESG promotes trust through transparency and a counterbalancing network authority. It ensures all stakeholders have a voice when concerns arise, as they did at both FTX and Theranos. Input from employees and insiders provides continuous, real-time reporting and safeguards. Networked transparency could have alerted depositors and regulators to the lack of accounting and trading controls.
Regulatory arbitrage and offshore shell games also become far more difficult. Stakeholder networks are global and distributed throughout the organization, without constraint by location or conflicting regulatory authorities.
Would dESG adoption have been possible under SBF?
Unlike Theranos, investors and employees would have had less leverage to impose dESG governance on FTX or Alameda. SBF had already made big money via crypto arbitrage and trading. Investors like Temasek, Sequoia, and SoftBank were in a rush to get in on what seemed like the white hat of the crypto-exchange universe. SBF reportedly responded to investor Chamath Palihapitiya’s suggestion that they create a real governance board with “FU.”
Depositors, on the other hand, had more leverage. FTX needed deposits to fuel growth. Competition for deposits and customer accounts was, and is, highly competitive. As we can see from the post-FTX rush to provide proof of reserves, depositor trust is where the leverage is. A dESG network that included depositors, investors, insiders, and auditors could have prevented comingling and unauthorized hypothecation of customer assets at FTX.
The likely upshot of the FTX disaster will be more regulation, and a move away from centralized control of decentralized assets. FTX should be a wakeup call to U.S. regulators to finally create a less ambiguous regulatory environment for crypto adoption and innovation. A much more powerful force, however, will be depositor and investor demand for governance mechanisms like dESG that can better ensure safety and trust.
There is currently a rush to demonstrate transparency and proof of reserves by the surviving exchanges, Kraken, Coinbase and Binance. That’s driven by depositor concern.??But the default mode for crypto exchanges has always been opacity.??A similar thing happened after the collapse of Mt. Gox, where a temporary reflex to transparency was followed by a return to opacity once deposits flooded back into exchanges.?If/when crypto prices recover, this could happen again due to the short-term memories of investors and depositors.?dESG would provide a more sustainable mode of governance and oversight regardless of what measures registers and exchanges take.?
To the extent that financial intermediaries exist in the future, they will have strong incentives to provide more fault resistant governance to their users and investors.
Early-stage VCs and angel investors should require their startups to adopt dESG networks to ensure good governance and reduced ESG risk.?This would greatly increase transparency and communication while providing guardrails for managing fast growth and disruption.?
?As ESG becomes more ingrained, startups seeking partnerships or supply chain relationships with established businesses (think Walmart or pretty much any EU corporation) will have a big advantage if they can demonstrate an authentic and inclusive dESG network guiding their decisions and oversight.?
Mark Deuitch
This article was edited and fact-checked by a dESG network at https://www.wenetwork.app
In our next issue we will discuss decentralizing Tesla, WeWork and Starbucks through dESG.?
If you're interested in innovation in ESG and governance, you can join our free ESG/Innovation 2023 pitch contest online.