Don’t Flay Vc Firms For Errant Startups

A handful of the startups that 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 fund misappropriation, dodgy accounting practices and tax evasion. In at least one instance, the startup’s chief executive officer (CEO) has been suspended pending an inquiry. People in the VC ecosystem are restless. Are VC firms being penalized for pushing for greater accountability and better governance?

The imputation that it’s a witch-hunt against founders is unfounded. Big VC companies have no interest whatsoever in ousting founders. But they fear a loss of value if they are unable to straighten out the management of firms they invest in. Failure could mean massive losses from expected levels.

If we move to what I’d call a ‘purity premium’, are we beginning the process of cleaning up India’s startup ecosystem? Out of 400 companies that have large VC investments, the bad eggs are unlikely to be more than half a dozen. This is possible on account of two factors: one, the due diligence process is intense and usually throws up the essential character of an investor. Secondly, the pressure of performance thereafter ensures that there is not enough room for the ‘play’ of creative accounting or enough fat for falsification.

Fortunately for us, even the ‘some’ among those who can, won’t. And that too, simply because they worry about being caught. This too is a good thing. The more they worry about being caught, the better the chances that true founders with a ‘purity premium’ will benefit. Which is an even better place to arrive at for the entire startup ecosystem.

Sitting as I do on a few select boards of listed companies, it is quite shocking to hear loose statements and invective about the responsibilities of directors. While indeed they are enjoined by the Companies Act to fulfil their fiduciary responsibility of ensuring adherence to all rules and regulations, it is simply impossible to do it all the time. After all, that is why a management is put in place, auditors are appointed and multiple checks and whistles instituted. If auditors cannot catch fraud, how can board members be expected to catch it?

Directors and boards find that quarterly board meetings or even annual auditor reports are too little, too late. I have spotted this myself in some cases. And in the hurly-burly of the super-funded adrenaline-driven pressure cookers that founders must necessarily wrestle with, it’s difficult to spot signs of trouble early.

Things can go too far by the time of a formal audit for operations to be able to recover from the damage done, unless a whistleblower is willing to provide the board with an early warning. And when it happens, the board must act in unison, or even as concerned individuals. The recent panic by a well-known startup’s board that averred it wasn’t acting at the behest of only one investor just diminishes the board’s majesty.

One idea may be to ensure that the bigger funds actually have a full-time forensic auditor on their side. I’d like to see this auditor sequentially visit and spend quality time every month with the internal auditors of investee companies. There’s a lot of money at play here, after all.

Then there’s the ‘minor’ issue of statistics on customers, downloads or sales and other tech-related parameters. Where these are concerned, surely it is feasible for the bigger funds to run automated checks, independently and randomly, to ensure that there is neither the possibility nor any incentive for founders to try and fudge financial figures. Measuring real growth (or what passes for it) and checking if targets etcetera are being met is another area where governance laxity may require a heavy tech hand-on-heart approach. Any clean-up is painful and squeals of the kind we are hearing are just par for the course.

Issues may crop up elsewhere too, often in the thicket of innumerable regulatory check boxes. These aren’t really easy to tackle. And this is where I hope that the Union finance ministry and department of corporate affairs make things easier for founders. Filling formats is a chore for startups and founders. So, grunge work related to meeting regulatory requirements is something that the startup industry itself needs to lobby for a reduction in. We need compliance must-dos eliminated, largely and generously, at least for three years.

I’m not getting away from the fact that founders are indeed very special people who could well become endangered if we don’t do this. If India is to meet its target of becoming a $5 trillion-dollar economy soon, then we will need multiple orders of unicorns and omicorns to pave the way. Only they hold the secrets to greater growth, employment and a bright future. Our technology founders are a very special subset of this breed we need. By now, VC funds hopefully are more mature and better geared to manage the surround sound that allows these unicorns to emerge. If they can crack down on the errant few with pincers, we’ll avoid the bloodshed of bulldozers.

With big money comes big responsibility. Good governance is mandatory in a highly globalized sector. Fledgling corporations will feel the heat, on occasion, but that is better than the death throes of an entire ecosystem. Expectations are high on both sides, and they now need to be met.

Dilip Cherian is founder of Perfect Relations. He sits on corporate boards and is a member of HNI investment committees.