Conspicuous lack of norms governing startups ecosystem

By Pratap Venugopal

A startup is generally a small self-funded company in the early stages of operations founded by one or more entrepreneurs, seeking to promote a product or service for which, in their opinion, there is a demand.

 

Funding sources for startups include friends and family, venture capitalists, crowd funding etc.

India, according to the Economic Survey 2021-22, has become the third largest startup eco-system in the world after the USA and China, with the total number of recognised startups exceeding 61,400. As on January 14, 2022, startups in India are expected to grow annually at the rate of 12-15 per cent.

India has 83 unicorns (meaning privately held technology startups with valuation around Rs 7,500 crore or more) with a total value of $277.77 billion (Rs 2,10,92,32,60,65,000), predominantly in the services sector, contributing to over 50 per cent of India's GDP.

Though governance standards for listed companies in India are strict and continue to be tightened, there is a conspicuous lack of norms governing startups.

It is only when a startup has, after successfully achieving its goals that institutional investors seek an exist through listing in the stock market, that governance standards kick in and the listed entity becomes subject to regulation by various regulatory bodies, including the Securities and Exchange Board of India (SEBI).

There is a line of argument that the regulatory framework in India qua the startup eco-system is a complex one. However, that there is a need for sound governance practices is established by the recent happenings in BharatPe, which was co-founded by Ashneer Grover and Shashvat Nakrani in 2018 in New Delhi.

It, at a break-neck speed of three-and-a-half years, became a well-known Indian fintech company catering to small owners and kirana or convenience stores.

However, in January 2022, an external investigation resulted in preliminary findings of financial manipulation and fraud for past periods as a startup, involving the wife of Ashneer Grover and her brother, resulting in a decision of the Board of BharatPe to terminate her services.

Ashneer Grover is now being investigated and has proceeded on leave till April 1, 2022.

The BharatPe experience reiterates the need for proper corporate governance in the startup eco system which would hold responsible management and other personnel and ensure ethical values, conduct and actions of such organisations.

However, it is essential that a balance be struck between excessive control and what the startups seek viz self-regulation.

Proper regulation and corporate governance in the startup eco-system will not only promote growth, but also ensure transparency and ultimately promote listing of a good company adding value to investors in the securities market.

The foundation for an efficient and effective corporation governance framework in the startup eco-system requires clarity in legal requirements to be adopted and followed, authority or authorities responsible for regulation of various functions, transparency by proper disclosure of financial as well as non-financial information to all stakeholders, audit by independent auditors and similar such measures.

Corporate governance requirements for startups should be constantly reviewed and adapted as per the requirements that come up from time to time.

It is only with proper "checks and balances" that mismanagement, misuse of company resources and conflict of interest can be curbed, making startups sustainable in the long-term.

Corporate governance norms play a vital role in enhancing the public image of startups and make them attractive to investors.

A startup at every stage of its growth has different requirements with respect to stake holders and compliances and therefore requires appropriate corporate governance norms.

Corporate governance norms, while at the stage of inception, could be less rigid and more flexible, and as the startup grows and is on road to an initial public 1offering (IPO), corporate governance needs should be made more stringent to ensure protection of the interests of the investing public.

There is definitely a need for startups, especially those with potential for exponential growth and consequently also a potential for disruption of the securities market, to have strong pro-corporate governance, and to formulate and adopt the best practices to avoid situations such as the one that has arisen in the case of BharatPe.

The implementation of good and appropriate corporate governance in the startup eco-system, though not an easy task, is essential and of the utmost importance in the long run and needs to evolve taking into account past experiences and situations that have arisen.

The need for a good corporate governance framework and its implementation in the startup eco-system has also been recognised by SEBI.

SEBI has from time to time considered the issue of corporate governance for startups, setting up a number of committees comprising heads of industry, though regulation by SEBI kicks in only upon listing of startups or in the event alternative investment funds (AIFs) are involved.

SEBI has at the same time eased the listing norms to help startups attract large investors.

The SEBI (AIF) (Second Amendment) Regulations, 2021 has sought to define a startup as a private limited company or a limited liability partnership which fulfils the criteria for startups prescribed by the DPIIT, Ministry of Commerce and Industry, Government of India in notification dated February 19, 2019 or such other policy that may be issued from time to time by the Central government.

It is no doubt true that legal and accounting norms may strictly not be of paramount importance for a bootstrapped startup which suffers from inadequate resources or finances, but as the startup evolves and scales up in size and begins to earn substantial revenue, sound and efficient corporate governance norms would prevent money laundering, bribery, manipulation of accounts, diversion of funds, unfair labour practices and so on.

To sum up, while corporate governance should not be equated with bureaucratic red-tape, it would be essential in promoting the mission as envisioned by the founder(s) of a startup, enhance and endear its image to the investing public with a healthy culture of transparency and focus on efficient corporate structure.

To achieve this purpose, it would be necessary to take a re-look at the roles of regulators and authorities so as to bring startups under their jurisdiction, promoting and ensuring compliance with good and efficient corporate governance practices.

(The writer is an advocate in the Supreme Court of India. The views expressed are personal)

Source: IANS