Is it too soon to emphasize governance at early-stages of companies?
A string of scandals at celebrated start-ups have brought the spotlight on the lack of visibility into the operations of early-stage companies and their founders. Is it time for investors to focus on better governance at start-ups?
Start-up companies and their founders have captured the popular imagination and achieved the rock star status. But, sometimes this celebrity culture masks the dark side of things. A spate of scandals in recent years – Theranos, FTX, WeWork, to name a few – have illuminated the dodgy operations underpinning some of the most sought-after businesses. Many investors have lost a lot of money and some element of criminality cannot be ruled out. However, this also raises the question of whether investors need to start insisting on better governance at early-stage companies to protect their investment.
There are several reasons why start-ups get a long rope from the investors. They often deal with innovative business ideas that may have no precedent, they need to stay focused on their solutions, stay lean and agile, the investment is usually smaller and, generally, the higher risk of business failure is well accepted and even expected. However, this landscape has also changed with the global liquidity glut of the last 15 years. The investment sizes became bigger even in early rounds, investors chased higher returns and their risk appetite grew, there was a fear of missing out and investors were entering segments they didn’t understand well and had to rely on the representations of the founders. At the same time, there has been an exponential increase in the number of entrepreneurs and that has increased the competition among start-ups for funding and visibility.
All of this created an environment where raising ever larger funding rounds itself became a sign of success and the investors were either spread thin or only too eager to go after rock star companies and founders. But eventually when the day of reckoning came, many of these businesses were exposed as mismanaged, misrepresented, misguided or purely fraudulent. While many of the investors can afford to write off these losses and move on, what would it take to create a playing field that provides reasonable assurances to investors?
Good governance is not a luxury of the large, public companies. It needs to be a part of the DNA of every organization. While regulated industries try to ensure that through laws and regulations that create a Compliance burden, businesses of all sizes need to focus on checks and balances for probity. Investors must help instill the proper values in their portfolio companies – tracking of funds, investments and expenses, regular reviews of business results and practices and visibility into the activities and commercial interests of the management teams. For specialized sectors, involving experts would be crucial for critical evaluation of the products and technology. Start-ups at experimental stage or ones that may be at the seed stage may yet dispense with some of this structure as their viability is most uncertain. However, as soon as they take steps towards commercialization or raise significant rounds, they should start building the needed internal controls and proactively work to create visibility into their operations for their investors. Having proactive investors who keep a keen eye on the businesses they support will help reduce the chances of malicious, incompetent or disinterested founders damaging the start-up ecosystem.