Don’t bother VCs for stray startups
Founders Founders. They are really special. But there is no doubt that the current hype about venture capital (VC) firms and the companies investing in them is based on the faulty premise that no founder can do anything wrong. Unfortunately, some can, and some will. Don’t forget that we live in a time, on a completely different level, when, just last week, the central government threatened to take action against the most powerful ‘chief executives’ of state employees (the officers of the Indian Administrative Services and allied services), to rig the balance sheets of the state governments. So we should not be entirely morally alarmed when Sequoia Capital, the US-based venture capital firm, and some of its major peers are attracting some unpleasant interest in India.
A handful of the startups they invested in as global investors are now undergoing scrutiny of the same funds for alleged financial irregularities. The charges they face include embezzlement of funds, deceptive accounting practices and tax evasion. In at least one case, the startup’s CEO has been suspended pending investigation. People in the VC ecosystem are worried. Are venture capital firms penalized for pushing for greater accountability and better governance?
The assumption that it was a witch hunt against the founders is unfounded. Big VCs don’t care about excluding founders. But they fear losing value if they cannot evaluate the management of the companies in which they invest. Failure may result in huge losses from the expected levels.
If we go to what I call the “purity premium”, shall we begin the process of cleaning up the startup ecosystem in India? Of the 400 companies with significant venture capital investments, bad eggs are unlikely to be more than half a dozen. This is possible due to two factors: First, the due diligence process is intensive and usually brings out the core personality of the investor. Second, the pressure to perform afterward ensures that there isn’t enough room for creative accounting “play” or enough fat for rigging.
Fortunately for us, even “some” of those who can, won’t. And that too, just because they’re worried about getting caught. This is also a good thing. The more worried they are about being captured, the more chances that the true founders with a “purity premium” will benefit. And it’s a better place to get to for the entire startup ecosystem.
As I do on a few select boards of listed companies, it is shocking to hear loose and sore statements about the responsibilities of directors. While corporate law has already commanded them to fulfill their fiduciary responsibility to ensure that all rules and regulations are adhered to, it is impossible to do so all the time. After all, that is why there is management, appointing auditors and making many checks and whistles. If auditors can’t detect fraud, how are board members expected to catch it?
Directors and boards find quarterly board meetings or even annual auditors’ reports too little and too late. I’ve spotted this myself in some cases. And in the case of the heavily funded, adrenaline-driven pressure cooker buzz that founders necessarily have to contend with, it’s hard to spot signs of trouble early on.
Things can go too far by the time of a formal audit of operations to be able to recover from the damage done, unless the whistleblower is willing to provide the board of directors with early warning. And when that happens, the board of directors must act in unison, or even as individuals involved. The recent panic that afflicted the board of directors of a well-known startup company, which confirmed that it was not acting on the order of only one investor to diminish the majesty of the board.
One idea might be to make sure that the larger funds actually have a full-time forensic auditor on their side. I would like to see this auditor visit and spend quality time every month with the internal auditors of the investee companies. There is a lot of money playing here, after all.
Then there’s the “minor” issue with customer statistics, downloads, or sales, and other technology-related parameters. When it comes to these matters, it is certainly possible for larger funds to run automated checks, both independently and randomly, to ensure that there is no possibility or any incentive for founders to attempt to manipulate the financial numbers. Measuring real growth (or what it is going through), checking whether goals have been achieved etc. is another area where lax management may require a heavy technical approach. Any painful cleaning and squealing of the sort we hear is just par for the course.
Problems may appear elsewhere as well, often in a forest of countless regulatory checkboxes. This is not really easy to treat. This is where I hope the Federation’s Ministry of Finance and Corporate Affairs will make things easier for the founders. Filling out forms is a chore for startups and founders. So, grunge work related to meeting regulatory requirements is something the startup industry itself needs to push to reduce. We need to eliminate compliance obligations, largely and generously, for at least three years.
I’m not getting rid of the fact that the founders are really very special people and could be compromised if we don’t. If India is to achieve its goal of becoming a $5 trillion economy soon, we will need multiple orders from unicorns and umicorns to clear the way. Only they hold the secrets to greater growth, employment, and a bright future. Our tech founders are a very special subset of this strain that we need. For now, we hope that venture capital funds are more mature and more geared to managing the surround sound that allows these monos to emerge. If they can eliminate the stray few with pincers, we will avoid the bloodshed of the bulldozers.
With big money comes great responsibility. Good governance is mandatory in a highly globalized sector. Baby companies will feel the heat, at times, but that’s better than the throes of death for an entire ecosystem. Expectations are high on both sides, and they now need to be met.
Dilip Cherian is the founder of Perfect Relationships. He is a member of corporate boards and a member of the investment committees of HNI.