ETtech Opinion: The way we evaluate startups needs to change

There has been plenty of news lately about corporate governance issues at a few high-profile startups. Social media is full of views on whose responsibility it is to run the governance function. As Info Edge founder Sanjeev Bikchandani said, maintaining the highest degree of governance and transparency
is the fundamental responsibility of founders. At startups, the culture of the company is that of the founders.

Startups raise venture capital on a regular basis. In addition to providing capital, VC firms also attach their credentials to the company they invest in. In these times, the amount of money and the brand name that invests in the company is seen as a measure of success on all parameters, including that the company is well-run.

Hence, VCs must share the responsibility of ensuring good corporate governance at their companies – even more so when many VCs position themselves as company builders and not just asset managers. By lending their names to unknown companies, they signal not only that the company has huge potential but also that it has sound governance and transparency.

However, there are some funny dynamics related to follow-on rounds. Subsequent VCs take confidence from the pedigree of the VCs that invested before them, and so on. This makes diligence a half-baked process. Add to this the pressure to conclude deals quickly and you soon end up in a situation where deals are done without much diligence at all.

Then comes the work after investing. Typically, VCs take board seats in a company. However, the same VCs are also busy fundraising and finding new firms to invest in and may not be able to dedicate enough time to governance.

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The single parameter of success for a company is whether it raises a new round of financing. The higher the markup, the more likely it is that the company will be perceived as well-run on all parameters, including governance. A higher markup is the result of rapid growth, so founders are incentivised to chase growth at any cost. Some founders will step over the red line in this quest for growth, and with it, the next round of financing.

Finally, there is the phenomenon of alpha male founders, who do not take criticism from their board or investors. In today’s ecosystem, if a company crosses a Series C or D round, the founder is a rockstar no matter how high the losses or how poor the work culture.

This needs to change.

The ecosystem needs to start valuing revenues and profitability. VCs must stand up and deliver tough messages to erring founders early on, not after things go haywire. Finally, it is the founders’ responsibility to have high standards of ethics and governance. They also need to learn to take criticism from their board members.

– The author is cofounder and CEO of Fisdom.