Theme: Law | How can corporate governance aid start-up valuations?

India’s start-up ecosystem has experienced exponential growth over the past decade, emerging as the third largest globally.  India today has over 100 unicorns among the over 1 lakh registered start-ups in the country. This burgeoning sector, while promising, confronts numerous challenges, particularly in the realm of governance. There have been several high profile governance lapses that caught the attention of global investing community, leading to sharp fall in valuations of few mature start-ups and compelled the government and policymakers to rethink the governance structures and standards.  The governance framework for Indian start-ups is often characterised by nascent, if not rudimentary, structures. Many start-ups, initially family-owned or tightly-held, lack robust governance mechanisms typically seen in more mature corporations. This includes limited oversight roles, underdeveloped compliance procedures, and an absence of independent board members.  Consequently, the governance in these entities sometimes struggles to keep pace with rapid growth, scaling, and the complexities of larger operations and broader investor pools. Challenges  The primary challenge lies in balancing agility with accountability. Startups are naturally inclined towards rapid decision-making and less bureaucratic frameworks which, while beneficial for growth and innovation, may compromise governance. Issues such as conflicts of interest, lack of transparency, financial mismanagement, and regulatory compliance are prevalent. The absence of stringent governance practices can deter global venture capital (VC) and private equity (PE) firms, who see governance as critical to investment security and operational sustainability. Another significant challenge is the alignment of interests among founders, investors, and other stakeholders. Misalignments can lead to power struggles and strategic misdirection, affecting long-term growth and stability. Regulatory Reforms Needed To improve outcomes, India needs targeted regulatory reforms that reinforce start-up governance without stifling innovation.  Some of the suggestions worth contemplating include Introducing requirements for independent directors and audit committees in start-ups that reach a certain size or investment level could ensure better oversight. Start-ups should also be encouraged, if not mandated, to adopt higher levels of disclosure about financials, board decisions, and investor relations to build trust and accountability. The government could consider incentives like tax breaks or funding support for start-ups demonstrating robust governance frameworks. Global VC and PE Perception Globally, VC and PE investors regard governance standards as a litmus test for investment decisions. The perception of India's start-up governance standards is mixed. While the market potential and the high rate of innovation attract investment, concerns about transparency, financial disclosures, and board integrity can deter it. Establishing clearer, enforced governance frameworks could not only attract more foreign investment but also improve the valuation of start-ups. In conclusion, while India's start-up ecosystem thrives on its vibrant entrepreneurial spirit, strengthening governance standards is crucial to sustaining growth and attracting global investment. Regulatory reforms tailored to the unique needs of start-ups will play a pivotal role in shaping a more resilient and globally competitive landscape. To get a deep dive on the governance issues around start-ups and what can be done to improve the situation, businessline spoke to Nikhil Bedi, Partner and Leader—Forensic, Financial Advisory, Deloitte India.  Bedi, who has over 20 years of experience in fraud investigations, FCPA diligence, business intelligence and transaction diligence, has advised large private equity clients in the region on pre/post investment and operational risk mitigation strategies from a reputational perspective.