Why Startups fail and the Role of Accounting in Corporate Governance for startups

Lately I have been following stories of startup and their founders. Which led me to read various articles about these startups on different platforms. Over time, I started seeing patterns of startups failing. Mostly after receiving investors' funding. In one of the Harvard business reviews it is stated that two-thirds of start-ups never deliver a positive return to investors.

Recent research shows that around 90% of startups fail over a period of years:

21.5% of startups fail in the first year.

30% fail in the second year.

50% fail in the fifth year.

70% fail in the tenth year.

Here are some of the top reasons why startups fail:

1. Didn’t understand the market.
2. Market conditions changed unexpectedly.
3. Bad timing
4. Cash problems
5. Flawed business plan
6. Didn’t hire the right people.
7. Entered into a bad partnership.
8. Failed to learn from mistakes and make adjustments.
9. Lost the passion to succeed.
10. Unforeseen crisis.

I will be focusing on the cash/finance problems for the purpose of this post. I have been seeing and hearing stories of how founders are using their business as vehicle for just getting VC funding, mismanaging these funds and later now hear of their exit. I won't be calling names, but I guess we have heard stories about them.

For Investors Accountability, Startups are required to give their VCs detailed financial information.?For example, if VCs feel that money is being wasted in unnecessary purchases or elsewhere, they are free to withdraw their investment or vote to formulate a new policy. Accounting gives investors the information they need to make informed decisions and to have their legal say in the policies of a startup. This accountability is generally good for profits, since investors have an interest in the success of the corporation.

This problem led me to start thinking of how accounting can serve as a tool for corporate governance to abate this challenge. We know that some of these startups don't have a structured system for corporate governance in place.

We will be defining corporate governance as the system of rules, practices, and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, which can include investors, management, customers, suppliers, lenders, regulatory authority, etc.

When a business operates under a corporate umbrella, many of the business basics are governed by accounting results and practices. Through accounting, corporations can keep track of their expenditures and income and establish an accurate picture of their overall financial status. Ultimately, accounting helps startups run smoothly on a practical, ethical and legal basis, establishing a foundation for continued growth and success.

Here are specific ways in which accounting contributes to corporate governance in startup environments:

Financial Planning and Budgeting

Strategic Decision-Making: Accounting helps startups create realistic financial plans and budgets, aligning financial strategies with the overall business objectives. This ensures that resources are allocated efficiently and that the startup remains financially sustainable.

Investor Relations:

Attracting Funding: Startups often rely on external funding to fuel their growth. Accounting practices contribute to creating accurate financial statements and reports that attract potential investors. Transparent financial information is crucial during fundraising rounds.

Financial Transparency:

Stakeholder Confidence: Transparent financial reporting through accounting practices builds confidence among stakeholders, including investors, employees, and partners. Clear and accurate financial statements contribute to a positive corporate image.

Cash Flow Management:

Sustainability: Accounting plays a vital role in managing cash flow, a critical aspect for the survival and growth of startups. Effective cash flow management ensures that the company can cover its operational expenses and invest in growth opportunities.

Compliance and Governance:

Regulatory Compliance: Startups must adhere to various regulatory requirements, and accounting practices help ensure compliance with tax laws, financial reporting standards, and other regulations.

Internal Controls: Implementing internal controls is crucial for preventing fraud and ensuring the accuracy of financial reporting. Accounting helps establish and maintain these controls to enhance corporate governance.

Risk Management:

Identification and Mitigation: Accounting contributes to risk management by identifying financial risks and uncertainties. This includes monitoring burn rates, assessing financial stability, and implementing measures to mitigate potential risks.

Equity Management:

Stock Option Plans: Many startups use stock options as a key component of employee compensation. Accounting is essential for managing equity-related matters, including stock option plans, to align employee incentives with overall corporate goals.

Due Diligence:

Mergers and Acquisitions: In the case of mergers, acquisitions, or partnerships, accounting practices play a crucial role in due diligence. Accurate financial records facilitate a smoother process and contribute to the overall success of such transactions.

Performance Metrics:

Key Performance Indicators (KPIs): Accounting metrics are often used as KPIs to measure the startup's financial health and performance. These indicators help stakeholders assess the company's progress and make informed decisions.

In summary, accounting in startups goes beyond mere financial record-keeping, the role of accounting in corporate governance is essential for establishing financial discipline, ensuring transparency, and facilitating informed decision-making.