Cleaning up the startup ecosystem is necessary. Likewise, establish a governance charter

The original culture, founder mindset, and ongoing governance of these fledgling enterprises are greatly influenced by the early investors. Additionally, in order to close acquisitions or increase their “founder friendliness,” investors have recently permitted founders to become accustomed to truly skewed incentives.

The urgent need is for a governance charter that links the fundamental motivations of founders and investors to the startup’s success.

While there have been many mistakes made in the startup industry, conventional recommendations for corporate governance have focused on compliance and audits, a POSH (protection of women from sexual harassment at work) policy, or a whistleblower policy—things that are crucial but come after the fact. A huge set-up is required for a company planning an IPO (initial public offering), including a chief financial officer (CFO), an extremely vigilant board, and several internal and external checks.

However, many of these issues start far earlier. The issues we see are just a manifestation of founders and early investors who had the best of intentions but were corrupted by twisted incentives. According to Charlie Munger, if your incentive system is stupid, your results will also be stupid. The poor incentives of the bankers were to blame for the entire banking disaster, which occurred despite extensive governance and controls. The original culture, founder mindset, and ongoing governance of these fledgling enterprises are greatly influenced by the early investors. Additionally, contrary to conventional wisdom, investors have recently permitted founders to become accustomed to seriously warped incentives in order to close acquisitions or increase their founder “friendliness.” For instance, if a founder invests a lot of money in a two-year-old high-burn business solely because it can raise a lot of money, the major motive will be to raise money and take some of it out. Furthermore, falsifying data is justified because it makes it possible to raise more money. This also enhances the reputation of investors in the near term, up until the issues are exposed.

entrepreneurial opportunities in an economic recovery
entrepreneurial opportunities in an economic recovery

We require a governance charter that links the underlying motivations of the startup’s founders and investors. Therefore, before establishing a formal governance and compliance framework, we suggest including a founder- and investor-centric governance approach. Remember that incentives are reciprocal; while founders have recently come under fire for poor governance, we think investors are partly at blame for sowing the seeds of unruly behaviour.

The following are our unique suggestions, and we are confident that every investor and creator will personalise the framework in their own way. We advise the founders to:

1. Compensation: Employees’ cash compensation cannot be listed among the top three salaries on the corporate payroll roster. shall not, during a fresh round, enter into any side agreements that might benefit the MSOP (management stock option plan) at the detriment of current shareholders.

2. Benefits: Must disclose to the board non-cash compensation like as use of a company vehicle, long-term housing, learning and development expenditures paid for them, opulent travel, etc. through a disclosure form.

3. Secondaries: For the first five years, there are no secondaries. Not more than $2 million once every three years after five years.

4. Angel investment: In the first five years of the business, there may be a maximum of ten angel investments. Each investment and its amount must be declared to the board in the quarterly update, together with a justification and an explanation of any potential conflicts. Every time an angel investment is made, an equivalent amount must be made by the founder in the business.

5. Important managerial figures: shall keep a list of “key management” people on file and, on a quarterly basis, reveal the addition and removal of key management personnel from this list. Every fiscal year, founders and the board must agree on the definition of key management.

6. linked party transactions: linked party transactions are disclosed quarterly. The board shall have the right, at its discretion, to annually audit these related party transactions. Any personal relationships not covered by the word ‘related party’ are also to be disclosed.

7. Cash flow and reconciliation: In addition to the pre-agreed MIS, the board should be provided with quarterly bank statements for all of the company’s accounts as well as reports on the cash balance, liquid assets, liabilities (including legal obligations), monthly cash burn, and cash runway guidance.

Investors should consider the following:

* Conflicting and competing investments: On a quarterly basis, they must inform their portfolio firms that they have not made any such investments. If a case is made for investing in a potential conflicting or rival firm, they must also obtain permission from the company’s founders.

* Goal alignment: If an investor stands to benefit professionally from an up-round, exit, or other similar event, the founder should be informed. 

*Fair to early investors: Shall not pressure early investors to sell exploiting the knowledge asymmetry. 

* ESOPs: Dilute equally with founders and make further ESOP a board decision, not a matter of veto. Due to this, entrepreneurs start to neglect the equality of and duty to all shareholders.

* Affiliate mergers: Founders should not be subjected to undue pressure to merge with another affiliate or a different portfolio firm.

* Consultants, agencies, and lawyers: They should refrain from pressuring founders to hire outside counsel for a certain position or to collaborate with another portfolio firm. If there are any such suggestions, they must be presented in front of the entire board.

* Angel investing in a portfolio: Must respect founders’ time, refrain from pressuring them to make angel investments with them, and ensure that the founders receive any deal flow. They should also practise the strictest restraint when approaching founders without permission.

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