Founder-led companies: Are stakeholders set up for corporate governance failure?

A clutch of founders, in their quest for hypergrowth, has pushed the boundaries of governance. Would a seasoned C-suite have helped rein them in?

By Nasrin Sultana

Published: Dec 13, 2024 12:33:24 PM IST

Updated: Dec 13, 2024 12:40:09 PM IST

Companies led by founders have high risks of drifting into founder’s syndrome often leading to financial irregularities, lacking sharp decisions, accountability, transparency, massive resistance to change, missing checks and balances leading to a possible shutdown. Illustration: Chaitanya Dinesh Surpur

For every rise of a startup in India, there are equal or maybe greater number of unsuccessful ventures. If hot money chasing new businesses in India boasts of a successful Zerodha and OfBusiness, there are also controversial entrepreneur-founders like Rahul Yadav, Ashneer Grover and Byju Raveendran in the same ecosystem. Alleged misgovernance by founders like Yadav, Grover and Raveendran have had catastrophic repercussions on the functioning of the company.

Besides the obvious reasons, lack of financial discipline, transparency, accountability and corporate governance issues lead to such massive collapses, not only failing the founders’ vision but also sinking stakeholders’ money along with it. So are creditors and shareholders being set up for corporate governance failure in most founder-led companies? Alternatively, can management-led startups offer better corporate discipline with the ability to cross regulatory and compliance hurdles?

According to Abhijit Joshi, founding and managing partner, Veritas Legal, when viewed from a startup perspective, the answer is different compared to an established set-up. Startups need passion, hard work and belief. Typically, startups can’t afford good management on an employee basis. “Compliance will always be at risk in both these situations, perhaps more with founder-led startups as opposed to management-run startups,” he adds.

For instance, the high flying edtech giant Byju’s is now battling a financial crisis. Byju’s, founded by Byju Raveendran and Divya Gokulnath in 2011, has been embroiled in financial irregularities and litigations from creditors, resulting in insolvency proceedings under the Insolvency and Bankruptcy Code. Lenders have sought repayment of the $1.2 billion loan the founders took in November 2021. Raveendran says the startup investors’ darling, once valued at more than $20 billion, was now “worth zero”.

“Accountability differs significantly; founders are often emotionally invested and more resilient in crises, while management-run firms may exhibit a stronger sense of fiduciary responsibility,” says Anand Mohan Murthy, partner, King Stubb & Kasiva, Advocates and Attorneys.

Growth and Innovation

Joshi explains that startup founders know the worth of compliance, but the intensity of work and risk is so heavy that they may often forget the importance of compliance. Some of them might also be inexperienced, but intelligent enough to get advisors to understand the importance of compliance. “But this again adds cost, which the startups may not be able to afford. Therefore, I think compliance is often ignored for one reason or the other in startups,” he adds.

In the last few years Indian startups have grown in leaps and bounds with disruptive models and technologies. However, the pursuit of this hypergrowth in a short span of time brings a major risk of potential pitfalls associated with various factors such as expense manipulation, undisclosed related-party transactions, deviation from the identified business model and undisclosed liabilities.

According to Vinod PV, partner, IndiaLaw LLP, founder-led companies often out-perform management-led companies due to the founder’s commitment to the purpose of the company, obsession to achieve the purpose and willingness to take risks towards this objective. These traits result in more innovation, creativity and growth. “However, founders often tend to compromise on governance while pushing for growth and profit,” he adds.

Also read: 'Founder mode' or 'manager mode' for your startup? The devil may lie in the details

Set up for failure?

Ritesh Jain, co-founder, FlexiLoans, argues that it’s ultimately about how governance is embedded into the DNA of the organisation. “Both models have unique strengths,” he adds. Founder-led companies excel in the early stages due to the “founder’s mentality”—a deep connection with the business, passion, and a bias for action that drives innovation and agility.

“However, as businesses scale, the introduction of seasoned management can streamline operations, establish systems and ensure consistency,” Jain explains.

Jain says while a lack of experience can contribute to governance challenges, it’s rarely the only factor. Startups operate in a fast-paced, resource-constrained environment, often navigating uncharted territory where governance lapses can arise unintentionally. It’s also essential to note that governance issues are not unique to startups—large corporations with decades of experience also face lapses. “What sets founder-led startups apart is their willingness to learn and adapt,” Jain says.

According to EY, good corporate governance is based on founder mindset, investor mindset and board members. At the same time, a startup must create a culture where independent directors can speak openly and any red flag or word of caution by the auditors is acted upon. “All stakeholders are equally important for a startup and founders must build efficient stakeholder management practices, be it sensibly thinking about diversity and inclusion, climate or even customer complaints for that matter,” EY says.

However, the issue is ridden with complexities. There are multiple instances of CEOs leaving their startups, some even when the companies are in trouble. Founders never abandon a sinking ship. Data compiled by Fintrackr showed that in the first eight months of 2023, nearly 20 startup CEOs left their positions to either join a new firm or continue in the same company in a different role. upGrad’s CEO Arjun Mohan quit after a nearly-three-year stint joining Byju’s to lead its international business. Mohan quit Byju’s in seven months as it consolidated its businesses into three key divisions.

Suhana Islam Murshedd, partner, Aquilaw, explains that management-run startups/new companies have diverse and experienced professionals to manage operations. “Hence, management-led companies are sometimes more structured in terms of operations as well as the compliance framework,” she adds.

At the same time, founder-led startups will often have the founder juggling multiple roles in operations, strategy and sales. In the initial stage, when the founders are trying to establish a business out of an idea, corporate governance and compliance may take a back seat. “Companies that have better access to resources and are at a stable stage of business operations are generally more compliant and disciplined,” she adds.

Balancing act

VCs and investors often bring in a degree of accountability and transparency since they are themselves regulated and have a greater say in the management and company affairs, especially with respect to corporate governance. VCs are often wary of value destruction and understand that compliance and good corporate governance play a key role in ensuring value creation.

“Hence, VCs/investors are also interested stakeholders as they can assist in improving corporate governance levels in companies by incorporating mandatory obligations in terms of governance principles and monthly reporting obligations on the company through shareholder level agreements,” says Murshedd.

Corporate governance becomes all the more critical for companies that are IPO-ready or about to go public. A strong regulatory framework not only offers confidence to public investors but is also a sign of maturity of the founders. “At a listing stage, the company has already reached a particular size and scale and therefore, issues of succession, transparency and cleanliness are more important and therefore a management-run company may get a better response in the public market,” says Joshi.

Raj Khosla, founder and MD, MyMoneyMantra, agrees that management-run companies are perceived well in an IPO process on account of their stability, governance and profitability which enthuse risk-averse institutional investors. “However, founder-led companies can also perform well if the founder is seen as a visionary who drives growth in an evolving industry. Markets encourage founder-led companies that innovate, have a strong growth potential and a have clear path to profitability,” he adds.

Overall, apart from whistleblowers, institutional or proactive investors, Indian startups need to prepare a corporate governance framework.