From Startup to Scaleup: The Critical Role of Governance in Managing Growth

Viju George Mela Ventures

Viju George, Partner, Mela Ventuers

Mela Ventures Startup Governance

It is natural for founders to first prioritize product-market fit to establish the legitimacy of the business model. Matters such as governance often seem a distraction at this stage. We firmly believe that it is never too early for founders and boards to institute exemplary governance norms. At Mela Ventures, we champion the early and unwavering adoption of robust governance standards. We urge founders, regardless of their start-up’s size or stage, to prioritize governance as seriously as their product and business. Doing so can significantly reduce the risk of governance-related failures and, importantly, positively impact the industry’s health. The governance shortcomings in prominent companies highlight a missed opportunity; these pitfalls could have been sidestepped with a foundational commitment to governance. Founders need to understand that proactively embracing governance is much more than ticking boxes; it’s about embedding it into their company’s culture.

Why is Governance Important?

The quality of governance mirrors the quality of value systems of the founding team and the start-up. A PwC study highlights that companies with frail governance are 80% likelier to encounter financial turmoil than those with robust governance structures. Startups can significantly diminish the risk of such predicaments by taking the initiative in governance matters. Besides, robust governance acts as a powerful indicator to prospective investors, greatly aiding fundraising efforts, assuming all other factors remain constant. It’s important to note that not every founder naturally possesses a governance mindset from inception. For instance, fresh out of academia and diving into entrepreneurship, young founders often require education in governance principles due to their inexperience in formal corporate environments. This isn’t a criticism but rather an observation of their limited governance exposure. Conversely, seasoned founders with corporate experience are expected to bring a preliminary grasp of governance, informed by their practical understanding of the essentials and pitfalls to avoid. Here is the bottom line:

Ignorance and lack of exposure is no excuse for bad governance, irrespective of the founder’s experience.

What aspects of governance should start-ups and their founding teams be mindful of?

Here are some hard and soft factors. Common hard factors include

  • Compensation philosophy of founders – at the early stage, founders would do well to demonstrate skin in the game by voluntarily embracing deferred compensation principles – this includes acceptance of well-below-market pay; furthermore, this extends to the management team (typically business heads one level below the founding team).
  • Clean capital structure – A transparent and orderly capital structure is a hallmark of foresight among founders. Addressing any complexities early and making judicious allocations to MSOPs and ESOPs demonstrates prudence. Equity parity/comparability within the founding team is generally favorable, as excessive disparity in ownership can be a red flag.
  • Risk mitigation – It is not uncommon to see hasty, ill-informed decisions being made unilaterally. A board of directors equipped with a roles matrix clearly defines decision-making responsibilities, reducing the likelihood of such decisions.
  • Regular financial audits and budgets, as part of a robust governance framework, can identify potential (unintended) issues early on. The audit covers the quality of financial reporting, among other things.
  • Internal controls and audits, including third-party audits. Internal and external audits are vital for ensuring the efficiency and reliability of financial and operational processes from an early stage. Founders should actively engage external experts to scrutinize operations, finances, and regulatory compliance.
  • Regular board meetings: It is essential that board meetings are regularly held and meeting minutes are properly documented for accountability.
  • Transparent reporting and disclosures: As investors, we look for protocols for open and timely sharing of the start-up’s financials and other critical data. Where such protocols are inadequate/absent, we help frame them.
  • Employee training on ethics and governance: Governance is not just for founders but for the org. In keeping with this, ethics and compliance training keeps employees updated on best practices and expected behaviour. In a start-up, even an individual contributor’s mistakes due to the knowledge- and awareness gap can prove costly. Training may help bridge this.
  • Proactive benchmarking of parameters vs the best in the business. This will likely include a mix of both quantitative and qualitative factors.

In addition to the hard factors listed above, there are other qualitative aspects that founders and start-ups should embrace. Some of them include

  • Proactively sharing the not-so-good news with stakeholders
  • Nurturing a culture of collegial questioning
  • Counterbalancing the CEO, especially if he/she is the dominant decision-maker to whom others tend to defer
  • Leading by example – for example, how defensible would it be for founders to continue to draw the regular salaries if the organization is restructuring/rationalizing its workforce?
  • Balancing interests between different stakeholders when in conflict. For example, how do founders balance investors’ and employees’ interests in tough times? Or for that matter, how do founders proactively protect the interests of early-stage investors when later-stage investors bringing in bigger cheques might call the shots?

Summing up, the importance of proactive governance for founders and start-ups cannot be overstated in the context of high-profile failures that we have witnessed. It is never too early to have the right governance systems and culture. The earlier governance norms are established, the better it is as feedback loops to correct this tend to be longer as the start-up scales up. Moreover, generally speaking, bad/misguided governance once institutionalized is hard to reverse. Why not get it right early into the start-up’s journey?