Corporate Misgovernance In Indian Startups: Who's To Blame?

After a string of corporate misgovernance incidents were highlighted in prominent Indian startups—such as BharatPe, Trell, Zilingo, GoMechanic, and most recently, Byju's and Mojocare—investor sentiment has soured in an already weak funding environment.

Due diligence has become lengthier for founders and closing rounds aren't as easy as 2020 and 2021. But who's to blame for this?

According to Nithin Kamath, founder of Zerodha, corporate governance issues coming to light will only increase going ahead, and while founders will be blamed, the venture capital ecosystem is equally to blame.

The root cause of these issues is the overestimation of the size of Indian markets by founders and VCs, the billionaire founder said. Most venture capital funds have miscalculated this target market and "maybe oversold the India opportunity" to their investors, said Kamath.

"In a small market like ours, with limited merger and acquisition opportunities, large exits within seven years (the lifecycle of a fund within which founders are expected to give exits) are hard," he wrote in a post on social media platforms LinkedIn and Twitter.

Hence, the story that the venture capital ecosystem is selling to their investors has to sync with the one that the founders sell so that they can raise funds. "I have seen so many startups funded with decks that were almost delusional. In an ideal world, VCs should help correct this, not fuel the delusion," he said.

Yagnesh Sanghrajka, founder and chief financial officer at 100X.VC, an early-stage VC fund, agrees with Kamath. "The ease of funding resulting in frothy valuations forces startups to adopt unprofessional practices when the pressure to perform mounts and the next fundraise needs to be at a significant upside to the previous round," he said.

"This mostly happens due to investor pressure on the founders because the fund outcomes/internal rate of return depends on these fundraise by the founders," Sanghrajka said.

Ashish Sharma, managing partner at InnoVen Capital—another venture debt fund—said a few founders got carried away and were obsessed with growing at all costs.

"Investors also need to take part of the blame as red flags were ignored and there was lack of oversight in some cases," Sharma said.

"The investor community realises that this has hurt the India startup narrative. For new investments, investors are spending more time to assess the character of founders in addition to reviewing the business potential," he said.

It's time for startups to move beyond rationalisations such as: “We are too small for governance", "Rules make us inflexible" and "It is better to ask for forgiveness than permission from investors" and instill corporate governance when organisations are small, according to Gaganpreet Puri, managing director at Alvarez & Marsal, a global professional services firm. Puri leads the risk and regulatory practice in India.

If startups continue the current trajectory of passing the buck on compliance and business ethics, it would not be surprising if reported cases of corporate governance issues rise, he said.

Kamath, in his post, had said that building a resilient business in India takes time. "I can't think of many who have done it in less than 10 years. If VC funds have seven-year lifecycles and push startups for exits within seven years, how can anyone build a good business? Maybe the fund lifecycles for India should be longer."