Start-ups need to beef-up governance

For almost a decade, generally, good things have been said about the Indian start-up atmosphere. Many start-ups have turned unicorns – a status that is quantified by valuation (which is done purely on assumptions and estimates) and not old-world metrics such as profits or assets. Some have established a global presence (Byjus), some are providing unique services in the domestic market (Dunzo) and some are still starting small. There are start-ups in every conceivable space -- fintech, edtech, cryptos, Web 3, Defi, etc. Over the last few months, however, the lack of robust corporate governance practices in start-ups has come into focus.

Issues in accounting and governance practices have been raised in Bharatpe, Trell, Zilingo, Zetwerk and Infra.market to name a few. This forced a venture capital fund that had invested in most of these start-ups to issue a statement on corporate governance that ran into almost 1,000 words.

At one point, the statement said, “We will continue to respond strongly when we encounter wilful misconduct or fraud. When whistle-blowers call us to report on issues, we always take them seriously. We know in some cases they may turn out to be baseless – but we still have to look into them as it is a board member’s fiduciary duty. We will continue to have zero tolerance towards proven wrongdoing. We won’t hesitate to act to protect the interest of the company and employees, even if it costs us financially. We will take tough calls where needed in the interest of doing what is right”.

This is the first time a major venture capital fund has put out a statement in the public domain -- an indication that governance issues in start-ups have crossed the tolerance limit.

Wrong side of law

The allegations against the promoters of Bharatpe are too serious to be ignored. It is alleged that they engaged in extensive misappropriation of company funds, including, but not limited to, creating fake vendors through which they siphoned money away from the company’s expense account and grossly abused company expense accounts in order to enrich themselves and fund their lavish lifestyles. The GST Department has launched a couple of investigations into the fake invoice controversy. After the controversy surfaced, everyone at the company is blaming the other for a variety of alleged offences and a lengthy court battle is guaranteed.

The issues at Zilingo came as a surprise to everyone since this was a company that was supposedly the darling of investors. Zilingo is an e-commerce marketplace for small fashion retailers and wholesalers across South-East Asia. Questions have been raised about the method of revenue recognition used by Zilingo -- they were apparently presenting gross revenue, instead of net revenue. There are reports that the promoters could not see eye-to-eye on many issues and one of the promoters had huge differences with the head of the venture capital fund that had invested a lot of money in Zilingo. For the head of the venture capital fund, this was familiar territory -- he had a tiff with the promoter of housing.com some years earlier and had the latter removed.

Meanwhile, suspecting tax evasion, income tax raids have been conducted on the offices of Zetwerk and Infra.market.

Start-up Governance

For all practical purposes, start-ups are unregulated. They would only have to comply with the provisions of the Companies Act if they are registered as a company. The detailed corporate governance practices that are mandatory for public and other companies would not apply to most start-ups. As a result, the focus of the promoters and their team would be on product/service/valuation rather than on proper accounting/compliance/ corporate governance procedures. Investors in start-ups get MIS data every month and pile on the pressure on the promoters if the metrics don’t meet their estimates, forcing the promoters to indulge in dodgy accounting practices.

Considering the issues that are surfacing, start-ups would do well to invest in two resources. A strong finance person who knows the numbers and is prepared to narrate them as they are, and an independent person who can sort of play the role of an independent director. The finance person will ensure that the true picture is presented to all concerned, while the independent director can play the role of the devil’s advocate. The return on these two investments will be immense in the long run.

Considering the frenzied atmosphere in start-ups, there have been suggestions that they should have a whistle-blower policy, though many allegations made by whistle-blowers turn out to be only shots in the dark. Auditors of start-ups have not yet come into the limelight but if there are too many instances of accounting problems reported, even their work can come under scrutiny. Steve Jobs once remarked “stay hungry, stay foolish”. The time has come to add, “stay true.”