Founders are founders. They are really special. But there is no doubt that the current hype about venture capital (VC) firms and their investees is based on the false premise that no founder can do anything wrong. Unfortunately, some can, and some will. Don’t forget that we live in a time when, on a totally different plane, the central government just threatened, last week, to take action against the most powerful state-employed “chief executives” (Administrative Services officers of India and allied services). , for falsifying balance sheets of state governments. So we shouldn’t be completely morally crooked when US-based venture capital firm Sequoia Capital and some of its major peers attract some unwelcome attention in India.
A handful of the startups they have invested in as global investors are now under the scanner of the funds themselves for alleged financial irregularities. The charges they face include misappropriation of funds, dubious accounting practices and tax evasion. In at least one case, the startup’s CEO has been suspended pending an investigation. People in the VC ecosystem are restless. Are venture capital firms being penalized for pushing for greater accountability and better governance?
The allegation that this is a witch hunt against the founders is unfounded. Big venture capital firms have no interest in kicking out founders. But they fear a loss of value if they can’t straighten out the management of the companies they invest in. The failure could mean massive losses of the expected levels.
If we go to what I would call a ‘purity premium’, are we beginning the process of cleaning up India’s startup ecosystem? Of the 400 companies that have large venture capital investments, the bad eggs are unlikely to number more than half a dozen. This is possible due to two factors: One, the due diligence process is intense and generally yields the essential character of an investor. Second, the performance pressure thereafter ensures that there isn’t enough room for creative accounting “game” or enough fat for fakery.
Fortunately for us, even ‘some’ among those who can, won’t. And that too, simply because they’re worried about getting caught. This is also a good thing. The more they worry about getting caught, the greater the chance that the real founders will benefit from a ‘purity premium’. Which is an even better place to reach the entire startup ecosystem.
Sitting as I do on some select boards of publicly traded companies, it is quite shocking to hear loose and invective statements about the responsibilities of directors. Although the Companies Act mandates them to fulfill their fiduciary responsibility to ensure compliance with all rules and regulations, it is simply impossible to do so all the time. After all, that is why management is established, auditors are appointed, and multiple checks and whistles are instituted. If auditors cannot detect fraud, how can board members be expected to detect it?
Directors and boards find that quarterly board meetings or even annual auditors’ reports are too few and too late. I myself have detected it in some cases. And in the hubbub of adrenaline-fueled, super-funded pressure cookers that founders must necessarily contend with, it’s hard to spot signs of trouble early.
Things may go too far by the time of a formal audit for operations to recover from the damage done, unless a whistleblower is willing to provide the board with early warning. And when it does happen, the board must act in unison, or even as concerned individuals. The recent panic on the part of the board of directors of a well-known startup that claimed it was not acting at the behest of a single investor only diminishes the majesty of the board.
One idea may be to make sure the larger funds really do have a full-time forensic auditor on their side. I would like to see this auditor sequentially visit and spend quality time every month with the internal auditors of the companies we invest in. After all, there is a lot of money at stake here.
Then there is the “minor” problem of statistics on customers, downloads or sales and other technology-related parameters. As far as these are concerned, it is surely feasible for larger funds to run automated checks, independently and randomly, to ensure that there is neither the possibility nor any incentive for founders to attempt to falsify financial figures. Measuring actual growth (or what passes for it) and checking whether targets are being met, etc., is another area where lax governance may require a hands-on, high-tech approach. Any cleaning is painful and the screeching of the guy we’re hearing is par for the course.
Problems can arise elsewhere as well, often in the tangle of countless regulatory checkboxes. These are not really easy to tackle. And this is where I hope the union’s finance ministry and corporate affairs department will make things easier for founders. Filling out forms is a difficult task for startups and founders. Therefore, the heavy lifting associated with meeting regulatory requirements is something that the start-up industry itself must push to reduce. We need compliance obligations to be removed, largely and generously, for at least three years.
I’m not getting away from the fact that founders are very special people who could very well put themselves in harm’s way if we don’t do this. If India is going to meet its goal of becoming a $5 trillion dollar economy soon, then we will need multiple orders of unicorns and omycorns to pave the way. Only they hold the secrets to higher growth, jobs and a bright future. Our tech founders are a very special subset of this breed that we need. By now, hopefully venture capital funds are more mature and better geared to managing the surround sound that allows these unicorns to emerge. If they can crack down on the errant few with pincers, we’ll prevent the bloodshed of the bulldozers.
With a lot of money comes a great responsibility. Good governance is mandatory in a highly globalized sector. Startup corporations will feel the heat, at times, but that’s better than the death throes of an entire ecosystem. Expectations are high on both sides, and now they must be met.
Dilip Cherian is the founder of Perfect Relations. He sits on corporate boards and is a member of HNI’s investment committees.