Not every Bill Gates currently sitting in his parent's garage actively thinks about corporate governance, board structure or shareholder interests. This often leads to corporate governance being relegated to the background, a subject left for later. Often startups are focused on getting funding, staffing, and generating a product-market fit. As startups have limited access to resources, they are often occupied with trying to gain market traction,1 thus pushing corporate governance best practices down the priority list.
The lacuna in the corporate governance structure of these startups become apparent when they need funding from angel investors and venture capital firms. However, where startups create a solid foundation for success with good corporate governance, more often than not they become even more desirable to lucrative investors.2
This article seeks to discuss how corporate governance practices can be adopted by startups in each stage of their growth.
CORPORATE GOVERNANCE AND STARTUPS
Corporate governance simply put, is the system of rules, practices, and processes by which a firm is directed and controlled.3 It is the framework that allows a company to thrive by balancing and addressing the vested interests of various stakeholders including shareholders, employees, and customers.
Thus Corporate governance structure for startups should identify roles, authority, and timing in key business decisions between shareholders, directors, and the CEO.4 Additionally, adoption and implementation of corporate governance practices foster company culture built on standards of integrity, accountability, transparency, fairness, responsibility and performance.5 Where this foundation is put in place early, the flexibility necessary for the management to fully focus on innovation, top-notch service delivering and expansion of the company would be a part of the company's daily process. As earlier stated, it is natural for startups to begin to think about corporate governance structure when they require funding. And it would be unrealistic for the most advanced governance standards to become a priority when the company is just a little more than an idea. Governance implementation can however take place gradually and become more sophisticated throughout the process, as each stage of the growth process represents a favorable moment for adoption or improvement of certain governance practices.6
GOVERNANCE CONSIDERATIONS IN STARTUP STAGES
There are four stages in a startup's evolution to maturity, success, and eventual scale up. These distinct stages compose of different priorities and characteristics, which means that the governance structure and considerations required in each stage differ. The stages include the:
1. Ideation Stage:
This phase consists of the pre-seed and seed stages. This is where market analysis is done, and ideas are conceived. Thus, it is the stage of conception and union between people who connect around a defined purpose and begin to develop what could become a company in the future.7
At this stage, it is important to define aspects related to corporate governance to avoid problems and expand future opportunities. This is because decisions made at this stage (or the lack thereof) will have future consequences for the company. Certain governance practices can help start off on the right foot by laying the foundations on stable ground.
Governance focus at the ideation stage should be on:
- Roles, expectations, and contribution of partners:
The monetary or intellectual contributions of partners at this stage should be specified at this stage. And this contribution should be commensurate to the needs of the company at this stage. - Definition of equity interests:
At this stage, good governance practice would be to establish in advance the requirements or conditions to be met by each partner to receive his equity interest. This is important from the beginning as certain partners may feel they have contributed more to the company than others. - Establishing rules for joining and withdrawal from the
company:
It is important to gather individuals dedicated and in alignment with the goals of the company. - Ownership of the company's intellectual property:
At the ideation stage, the company should focus on establishing that all products created by the partners belong to the company. Also, the duty of confidentiality among partners should be established, to avoid misuse of trade secrets.
The most important document at this stage is the founders' agreement which will encompass all considerations highlighted above. The founders' agreement is a contract that elucidates the rights, roles, responsibilities, and obligations of each founder. It is a legally binding document, which aims to safeguard the interests of each founder while forestalling any possible conflict that may arise.8
2. The Early Stage:
The early stage also referred to as the 'validation stage', indicates the beginning of a phase in which the idea is left to evolve, until it becomes a product or service in the market.9 In this stage, the startup's product i.e., the Minimum Viable Product (MVP)10, market and business model are undergoing testing and experimentation of propositions made during the ideation stage.
Furthermore, at this stage the company is formalized, already has a team, and can receive the first round of investments.
Governance focus at the early stage should be on:
- Company set-up and organizing rules regarding the rights and duties of the partners
- Organizing practices regarding potential key employees
- Relationship with customers and strategic partners
- New Partners and Investors:
As stated earlier, at this stage the company can receive its first round of investments. It is pertinent that founders map out how these new partners and investors would come into the company. Usually, investors require an equity stake in the company and where proper care, attention and structure are not put in place, founders risk losing most of their interest just to accommodate a new round of investors. It is advised that the negotiation be conducted carefully. As the founders need to take into account that this situation will repeat itself in each round of investment. If, for every fundraising, founders extend new rights to investors in the current round and those from previous rounds, they will end up giving up some of their own rights or equity interests on a continuous and cumulative basis. - Means of resolving disputes:
At this stage it is important that the startup decides on the dispute resolution mechanism to employ in the event of a conflict. Where the startup decides to opt for arbitration or mediation, this must be expressly provided for in the articles of association and/or the partnership agreement. - Intellectual Property Protection:
At this stage, ensuring confidentiality and protection of trade secrets is of utmost importance. The startup is to focus on registration of intellectual property, and to ensure ownership of brand names, domains, software, patents, and trademarks to protect the company's value.
3. Growth Stage:
Also referred to as the Product Market Fit (PMF) or the traction stage, is the stage where the product being tested at the previous stage has been validated. Thus, the focus of the startup is on getting new customers, getting new employees and revenue generation. Profitability at this stage is paramount as this stage has the highest failure rate.
Governance focus at the growth stage should be on:
- Establishing a Board Structure:
At this growth stage, establishing a board structure for strategic support and deliberation is of most importance. This could be an advisory board or a board of directors. - Defining hierarchical levels for decision making:
In this regard, a company structure/organogram should be drafted to highlight roles, responsibilities, and hierarchy in the company. This clear attribution of competencies will avoid an instance of overlapping issues, confusion, and conflicts. - Evolving business and control practices:
Here the startup should focus on scaling company culture and mapping out the resources available, goals to be met and responsibilities of each partner and employee. This is to have a structured system where all employees are aware of the company's goals and what needs to be done to meet or exceed them.
4. Expansion Stage:
This is the growth/scale up stage which marks the distinct phase of a company's growth.11 At this stage, the company is already well established and ready to move at a faster pace, hire more staff, put out more products in the market and expand to other locations.
Governance focus at the expansion stage should be on:
- consolidating governance practices that can help the business
succeed and achieve the desired continuity.
Governance practices that should be consolidated include: -
- Implementing Policies - policies that regulate transactions with related parties, practices of donations, communication, prevention, and detection of acts of illegal nature should also be implemented.
- Ethics and Codes - this is setting down principles that promote
the integrity of the company.
Ethical decisions are those in which the decision made involves, at all stages, not only the identity of the organization, but also analysis of the impacts of each decision on all stakeholders, society in general, and the environment.
Codes of Conduct represent the formalization of expectations regarding the behavior and conduct of partners, administrators, employees, suppliers, and other stakeholders. - Succession Plan - as most companies at the expansion stage are concerned about longevity, a succession plan then becomes necessary.
- Improvement of shareholder and investor relations - at this stage, formalizing and optimizing the relationship and communications with shareholders and investors is of priority. Such communication is to reflect accountability, transparency, and inclusivity.
- Improvement of internal control and management - this can be achieved when the board creates committees to address the growing complexities of the company. These committees will take on a check and balancing structure and examples of such committees include the audit committee, risk management committee, strategy committee, governance committee and the likes. These committees are created tailor-specific to the needs of the company.
CONCLUSION
The purpose of this paper is to highlight how corporate governance practices can be integrated in the ideation, early, growth and expansion stages of every startup, to show how early integration of these practices can boost productivity and attract investors. From the objects to be focused on listed under each stage, it is obvious that corporate governance practices integrated from the onset is of more advantage, than leaving it to when it is too late and messy. With all that has been highlighted in the body of the paper, we hope to have contributed to ensuring that corporate governance is considered from the conception of the startup, until its transformation into a benchmark for the market and for society.
Footnotes
1. Chin Hooi Yen, Should Startups Bother with Corporate Governance?, Board Room Matters Vol II, http://www.sid.org.sg/images/PDFS/Publications/BoardroomMatters/Vii/5.%20Boardroom%20Matters%20Vol%20II-Should%20Startups%20Bother%20With%20CG.pdf accessed 4th January 2022.
2. The Unbridled Unicorn and a Quest for Corporate Governance Structure, Govenda https://www.govenda.com/blog/corporate-governance-structure/ accessed 5th January, 2022
3. James Chen, Corporate Governance, Investopedia, https://www.investopedia.com/terms/c/corporategovernance.asp , accessed 4th January 2022.
4. Govenda, supra
5. Betsy Atkins, 'Why Startups Are Increasingly Prioritizing Corporate Governance As Their Businesses Scale'(2021), Forbes https://www.forbes.com/sites/betsyatkins/2021/04/12/why-startups-are-increasingly-prioritizing-corporate-governance-as-their-businesses-scale/?sh=69505a585900 accessed 5th January, 2022.
6. Corporate Governance for Startups & Scale-Ups, IBC Segmentos (2020), https://idbinvest.org/sites/default/files/2021-04/IBGC%20Segmentos%20-%20Corporate%20Governance%20for%20Startups%20%26%20Scale-Ups.pdf accessed 6th January, 2022.
7. IBC Segmentos, supra.
8. Chinazom Arinzechukwu, ' Why You Badly Need A Founders' Agreement For Your Startup', Mondaq (2020), https://www.mondaq.com/nigeria/executive-remuneration/898268/why-you-badly-need-a-founders39-agreement-for-your-startup accessed 7th January 2022.
9. What are the six stages of a startup?, Cemex Ventures (2021), https://www.cemexventures.com/startup-stages-phases/ accessed 7th January, 2022.
10. The minimum viable product is a model that does not have its full functions, making the test less complex. It is released as a first version, with the results and information being collected. After its release it should be analyzed to evaluate if it meets the needs of customers; if not, improvements are made with new versions that try to satisfy the user. See Cemex Ventures, supra.
11. Angela Logan, 'What is a Scale Up?' , Tech Nation (2019), https://technation.io/news/what-is-a-scaleup/ accessed 8th January, 2022.
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