Corporate Governance for Startups

• 06 May 2024

For Prelims: Corporate Governance, SEBI, Confederation of Indian Industry (CII), Startups.

For Mains: Corporate Governance, Issues related to Business in India, Indian Startup Ecosystem, Challenges and Opportunities.

Source: ET

Why in News?

Recently, Confederation of Indian Industry (CII) has launched a corporate governance charter for startups, including a self-evaluative scorecard.

• This occurs during a period when companies like Byju’s, BharatPe, and Zilingo have expressed worries about governance norms in the last 12-18 months.

What are the Key Provisions of the Charter?

• Charter will provide suggestions on Corporate Governance tailored for Startups and offer guidelines suitable for different stages of a startup which is aiming to enhance governance practices.
  • Corporate Governance in India is a set of rules, practices and processes by which a company is guided and controlled.
• Self Evaluative Governance Scorecard:
  • The charter includes an online self-evaluative governance scorecard that startups can use to evaluate their current governance status and its improvement over time.
    • It will allow startups to measure their governance progress, with score changes indicating improvements in governance practices as assessed against the scorecard from time to time.
• 4 key Stages of Guidance to Startups:
  • At the Inception stage: The focus of Startup will be on:
    • Board formation,
    • Compliance monitoring,
    • Accounting, Finance, External audit, Policies for related-party transactions, and
    • Conflict resolution mechanisms.
  • In the Progression stage: A startup may additionally focus on:
    • Monitoring key business metrics,
    • Maintaining internal controls,
    • Defining a hierarchy of decision-making, and
    • Setting up an audit committee.
  • For the Growth stage: The focus will be on:
    • Building stakeholder awareness towards the vision, mission, code of conduct, culture, and ethics of an organisation,
    • Ensure diversity and inclusion on the board and
    • Fulfilling statutory requirements, according to the Companies Act 2013 and other applicable laws and regulations.
  • At the Going Public stage: The Focus of the startup will be on:
    • Expanding its governance in terms of monitoring the functioning of various committees,
    • Focus on fraud prevention and detection,
    • Minimise information asymmetry,
    • Evaluating board performance.
• Valuation: The valuations of businesses should be kept as realistic as possible.
  • Startups may strive for long-term value creation rather than short-term valuations.
• Long-Term Goals: The needs of the business entity should be separated from the personal needs of its founder(s), but at the same time, the goals and needs of the founders, promoters, and initial investors should be aligned with the long-term goals of the business.
• Separate Legal Entity: The startup should be maintained as a separate legal entity with the organisation’s assets distinct from the founders’ assets.

What is a Startup?

• About:
  • According to (Department for Promotion of Industry and Internal Trade) DPIIT, to be considered eligible for recognition, a Startup must meet these criteria:
    • Have been in operation for no more than 10 years since its incorporation.
    • Be registered as a Private Limited Company, a Registered Partnership Firm, or a Limited Liability Partnership.
    • Have an annual turnover not exceeding Rs. 100 crore for any financial year since its incorporation.
    • Not have been formed by splitting up or reconstructing an already existing business.
• Scenario of Startup in India:
  • India has the 3^rd largest startup ecosystem in the world and is expected to witness Year-on-Year growth of consistent annual growth of 12-15%
  • India ranks 2nd in innovation quality with top positions in the quality of scientific publications and the quality of its universities among middle-income economies.
  • As of May 2023, India is home to 108 Unicorns with a total valuation of USD 340.80 bn.

What is Corporate Governance?

• About:
  • Corporate governance, which refers to the system of rules, practices, and processes by which a company is directed and controlled, plays a crucial role in ensuring that businesses are run ethically and in the best interests of their stakeholders.
  • It enforces strong ethical standards and holds individuals accountable for their actions.
• Principles of Corporate Governance:
  • Fairness: The board of directors should treat shareholders, employees, vendors, and communities with fairness and equal consideration.
  • Accountability: The board is required to explain the purpose of the company's activities and report on its conduct.
  • Transparency: The board should ensure that timely, accurate, and clear information is provided about financial performance, conflicts of interest, and risks to shareholders and other stakeholders.
  • Risk Management: The board and management are responsible for identifying and controlling various risks.
    • They should take action based on recommendations to manage these risks and inform relevant parties about their existence and status.
  • Corporate Social Responsibility (CSR): It involves integrating environmental, social, and governance (ESG) considerations into business strategy and operations, and contributing positively to society and the environment.
• Regulatory Framework in India:
  • The Companies Act, 2013
  • Securities and Exchange Board of India (SEBI)
  • Institute of Chartered Accountants of India (ICAI)
  • Institute of Company Secretaries of India (ICSI): It issues secretarial standards as per the provision of the Companies Act, 2013.
• Committees Related to Corporate Governance:
  • Confederation of Indian Industry (CII) National Task Force on Corporate Governance (1996):
    • The task force, chaired by Rahul Bajaj, developed a voluntary code of conduct for Indian companies.
  • Kumar Mangalam Birla Committee (1999):
    • This committee was set up by the SEBI to develop a mandatory code of corporate governance for listed companies.
    • The committee's recommendations addressed issues such as board composition, independent directors, audit committees, and risk management.
  • Naresh Chandra Committee (2002):
    • This committee, constituted by the Department of Company Affairs (DCA), examined various corporate governance issues related to statutory audits, the independence of auditors, and the role of independent directors.
    • Its recommendations led to significant changes in the Companies Act.
  • Narayana Murthy Committee (2003): This SEBI-constituted committee reviewed the implementation of the corporate governance code by listed companies.
    • The committee's recommendations helped strengthen the code and improve its effectiveness.
• Importance of Corporate Governance:
  • Strengthens Investors Confidence: Strong corporate governance maintains investors’ confidence in the financial market, as a result of which companies can raise capital efficiently and effectively.
  • International Flows of Capital: It enables companies to reap the benefits of the global capital markets which will contribute to economic growth.
  • Increased Productivity: It also minimises wastages, corruption, risks and mismanagement.
  • Brand Image: It helps in brand formation and development of a company. It ultimately increases capital flows from foreign institutional investors (FII) and foreign direct investment (FDI).
• Challenges:
  • Ensuring Objective Board: It is a widespread practice in India for the associates and relatives of company owners to be selected as board members.
  • Performance Evaluation of Directors: Corporate firms sometimes do not share the results of performance evaluations to avoid public scrutiny and negative feedback.
  • Removal of Independent Directors: Sometimes, Independent directors are easily removed from their positions by the promoters if they do not side with promoters’ decisions.
  • Founders Control and Succession Planning: In India, founders’ ability to control the affairs of the company has the potential of derailing the entire corporate governance system.
    • Unlike developed economies, in India, the identity of the founder and the company is often merged.

How to Improve Corporate Governance in India?

• Strengthen Regulatory Framework: Continuously update and enforce corporate governance regulations to align with international best practices.
• Independent Directors and Diversity in Board Composition: It ensures their autonomy and effectiveness and brings a broader range of perspectives and expertise to decision-making processes.
• Transparency and Disclosure: Mandate comprehensive and timely disclosure of financial information, ownership structures, related-party transactions, and corporate governance practices.
• Shareholder Rights and Activism: Enhance shareholder rights, including voting rights, information access, and participation in key decisions.
  • Foster constructive dialogue and engagement with all stakeholders.
• Continuous Evaluation and Improvement: Establishing mechanisms for ongoing evaluation and benchmarking of corporate governance practices.
  • Regularly solicit feedback from stakeholders and adapt policies and procedures accordingly.

Drishti Mains Question:

What is Corporate Governance? What is the need of a regulatory framework for corporate governance in India? Suggest measures to improve Corporate Governance in India.

UPSC Civil Services Examination Previous Year Question (PYQ)

Prelims:

Q. What does venture capital mean? (2014)

(a) A short-term capital provided to industries
(b) A long-term start-up capital provided to new entrepreneurs
(c) Funds provided to industries at times of incurring losses
(d) Funds provided for replacement and renovation of industries

Ans: (b)

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Mains:

Q1. In the light of the Satyam Scandal (2009), discuss the changes brought in corporate governance to ensure transparency and accountability. (2015)

Q2. What do you understand by the terms ‘governance’, ‘good governance’ and ‘ethical governance’? (2016)