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As the entrepreneurial landscape evolves, startups and emerging companies are increasingly recognized as key innovation and economic growth drivers. These dynamic and rapidly evolving entities face unique challenges that differ significantly from those of established corporations. In this context, one of the pivotal aspects of governance is the role of independent directors—experienced professionals brought in to provide oversight, strategic guidance, and ensure robust governance practices.
Independent directors have traditionally been associated with larger, established companies whose role primarily revolves around ensuring compliance with regulations and safeguarding shareholder interests. However, as startups and emerging companies grow, they encounter complex governance issues that necessitate the involvement of seasoned independent directors. These directors can offer invaluable perspectives, help navigate scaling challenges, and contribute to the establishment of sound governance frameworks tailored to the specific needs of high-growth environments.
Startups, characterized by their rapid growth, innovative business models, and often limited initial resources, present a distinctive set of governance challenges. Unlike firms with extensive structures and established practices, startups may operate with fluid and less formalized systems. Introducing independent directors in such environments requires a careful balance between providing strategic oversight and adapting governance practices to fit the startup’s agile and evolving nature.
Emerging companies, particularly those scaling up or preparing for significant funding rounds, face additional complexities such as regulatory compliance, investor relations, and succession planning. Independent directors can play a crucial role in these areas by offering guidance on best practices, facilitating connections with potential investors, and helping craft strategies that align with short-term and long-term sustainability goals.
In this context, the adaptation of governance practices to meet the needs of growing businesses involves several key considerations:
Tailoring Governance Structures: Startups often operate with lean teams and fluid organizational structures. Independent directors need to help shape governance frameworks that are scalable and flexible enough to accommodate rapid growth while ensuring effective oversight and strategic guidance.
Navigating Regulatory Challenges: As startups and emerging companies evolve, they must comply with increasingly complex regulatory requirements. Independent directors with expertise in legal and regulatory matters can provide critical support in ensuring that the company adheres to applicable laws and best practices.
Supporting Strategic Growth: Independent directors can offer valuable insights into scaling strategies, market-entry, and competitive positioning. Their experience can help startups navigate growth and expansion challenges while focusing on sustainable business practices.
Facilitating Investor Relations: For startups and emerging companies seeking funding, independent directors can play a key role in building relationships with investors, understanding investor expectations, and ensuring transparent communication.
Enhancing Credibility and Trust: Independent directors can enhance a company’s credibility with stakeholders, including potential investors, partners, and customers. Their involvement signals a commitment to governance and transparency, which can be crucial for attracting investment and building trust.
The role of independent directors in startups and emerging companies is thus multifaceted, blending traditional governance responsibilities with the need for agility and adaptability. By integrating independent directors into their governance structures, startups and emerging companies can benefit from seasoned expertise, strategic insight, and enhanced credibility, all essential for navigating the complexities of growth and achieving long-term success.
Startups' Corporate Governance
In the context of startups, corporate governance refers to the set of values, norms, and procedures that guide, manage and oversee a company. It includes the framework that enables founders, investors, and other stakeholders to guarantee the company's goals are achieved while encouraging openness, responsibility, and moral decision-making procedures to support the startup's long-term development and prosperity. This includes following legal and regulatory standards, upholding financial transparency and identifying the roles and duties of important persons. The objective is to cultivate a culture of responsible corporate conduct within the dynamic and innovative startup environment, attract investment, and build stakeholder confidence.
Why corporate governance is important for startups
According to the Economic Survey 2021–2022, India boasts 70,000 startups, more than any other country globally (the US and China being the top two). Many of those firms have gone on to become industry unicorns. Strong corporate governance is needed in Indian companies, though, given the rise of frauds like BharatPe, hazardous workplaces, and cybercrimes. A healthy balance between the interests of promoters, customers, employees, and investors is upheld by good corporate governance. Transparency, accountability, responsibility, and honesty are the four pillars of corporate governance that support improved management and control in startups. The following are the top 10 problems and obstacles that startups experience and good corporate governance can help.
Founder-driven decision-making: This promotes organised decision-making while balancing the founders' individuality.
Openness: In financial reporting and decision-making processes, always make sure there is open communication and openness.
Board composition: Assists in assembling a knowledgeable and varied board to offer strategic direction.
Conflict of interest: Assists in reducing conflicts of interest between investors and entrepreneurs.
Compliance: The employee assists in following legal and regulatory regulations to stay out of trouble with the law and keep money coming in.
Planning for succession: Assist in creating strategies for changing leadership to maintain continuity.
Ethical business practices: Encourages moral behaviour and conscientious company operations.
Risk management: Assists in locating and reducing operational hazards.
Shareholder rights: By putting policies and shareholder agreements into effect, shareholders' rights are defined and safeguarded.
Adaptability and innovation: Facilitates the integration of governance procedures that support adaptability and innovation.
The Indian government and new ventures
The Indian government launched the Startup India program to encourage entrepreneurs to create jobs and wealth. Instead of focussing on job seekers, this program seeks to integrate India as a nation that creates jobs. The Department for Industrial Policy and Promotion (DPIIT) is in charge of overseeing this program.
The advantages offered to a startup under DPIIT are as follows.
Self-certification: With a straightforward online process, companies may easily certify their compliance with three environmental regulations and six labour rules. Regarding environmental legislation, startups will be placed in the "white category," only self-certified businesses will undergo sporadic inspections.
Handholding and simplification: streamlined compliance procedures, expedited patent application processing, legal assistance, and exit strategies for unsuccessful firms.
Finance and Rewards: Section 56 and 80 IAC provide exemptions from capital gains and income taxes for qualifying startups.
Incubation and Industry-University Collaborations: Seed Funds give entrepreneurs 20 lakhs and 50 lakhs to demonstrate their prototypes and go to market.
The state of corporate governance for Indian startups at the moment
By 2024, the Indian startup scene will better understand the significance of corporate governance. Although many startups are advancing in the adoption of governance techniques, obstacles, including differing levels of maturity and complex regulations, still exist. During investment rounds, investors are placing increasing focus on governance, which is an indication of a healthy trend towards a more rigorous approach.
The following are the top 10 dangers that startups in India are facing due to forthcoming challenges and issues; these risks can only be reduced by putting solid corporate governance and management practices in place.
Founder resistance: Adopting successful governance may be hampered by aversion to giving up power.
Lack of resources: New businesses may find it difficult to set up and keep up governance procedures due to a lack of funding.
Challenges associated with rapid expansion: Implementing good governance and adjusting to growth may become more difficult when a business grows quickly.
Negative alterations to legislation could affect the startup's daily operations and governance framework.
Expectations from investors: Handling varying expectations about governance processes from investors, customers, and founders.
Cybersecurity concerns: Startups are susceptible to cybersecurity hazards because they use the Internet and sophisticated technologies.
Talent retention: To thrive in the current market conditions, sound policies and HR procedures are essential.
Financial instability: In a highly unpredictable and turbulent market, startups must have enough cash and share capital to maintain their operations.
Worldwide expansion: Developing abroad creates additional governance difficulties and roadblocks for future plans.
Brand and goodwill: Inadequate corporate governance can cause a company's goodwill and brand name to suffer over time.
Provisions and provisions established by the Indian government for startups
The Companies Act of 2013 established regulations about sound corporate governance for new businesses in India. Startups must abide by the following articles and conditions of this regulation for successful governance:
Section 149: Defines the minimum number of directors, the presence of independent directors, and the required directors appointments.
Section 177: Indicates that an Audit Committee is required to supervise compliance and disclosures in financial statements.
Section 188 requires companies to monitor related party transactions, shareholder consent, and onboarding approval.
Section 203: Key managerial persons (KMPs), such as the CEO, CFO, company secretary, and managing directors, must be appointed by startups.
Government restrictions and compliance are mandatory for startups in India.
In India, all new businesses must abide by the Companies Act of 2013, certain Income Tax Department demands, and directives from the Central Government and the ROC, among other requirements. Ensuring good corporate governance and streamlining operations are two benefits of these compliances for startups.
Guidelines from the Companies Act of 2013
From a regulatory perspective, the Companies Act of 2013 establishes precise guidelines for corporate governance in startups.
Choosing directors: New businesses must choose directors, ensuring a mix of independent, non-executive, and executive directors.
Audit committee: For financial reporting and compliance, startups need an audit committee.
Board meetings: Startups need to hold regular board meetings to address strategy, performance, and risk management.
Disclosure and openness: Startups must be open and honest, providing timely disclosures of all pertinent information and accurate financial reporting.
Related party transactions: Startups must maintain transparency and approval processes for such important transactions, as rules frequently restrict transactions between the firm and its related parties, such as founders or key management people.
CSR committee: New businesses are required to establish a CSR committee and provide funding if needed.
Guidelines issued by the Income Tax Department
Startups must adhere to certain necessary compliances the Income Tax Department sets forth. The following are some of the conditions that are specified:
On-time return filing: Startups must file their income tax returns before the deadline to stay in compliance.
Documented transactions: Startups must maintain thorough records of all financial transactions to be eligible for a tax assessment.
Tax law compliance: New businesses need to adhere to all applicable tax regulations regarding their operations.
Corporate governance and independent directors:
Independent directors are crucial since they are supposed to act in the shareholders' best interests and be unbiased towards the company's management. They must be aware of corporate events and speak up when necessary. A series of regulations referenced under Schedule IV of the Companies Act of 2013 describes its function. These guidelines outline the responsibilities of independent directors, including safeguarding the interests of all parties involved. Regarding minority shareholders, these directors assist in resolving conflicts of interest, assess the management's performance, and mediate disagreements between the management and shareholders. Attending corporate meetings and keeping up with company developments is another requirement for independent directors.
Attendance at board meetings
According to Section 173(2) of the Companies Act of 2013, directors may participate in board meetings in person, by video conference, or by using a similar technology. These techniques need to be able to keep track of who attended and what was discussed at the meeting, together with the time and date. On the other hand, the government may designate specific subjects that are off-limits during video conferences or other comparable gatherings.
Independent directors and board committees
The Companies Act of 2013 mandates that independent directors be a part of the following committees:
Corporate Social Responsibility (CSR) Committee:
Under Section 135 of the Act, businesses that reach certain revenue levels are required to set up a CSR committee. Three or more directors, including at least one independent, are required for this committee. Only two directors may establish the CSR committee, and private or unlisted public businesses are not required to recruit independent directors.
Under the Companies (Corporate Social Responsibility Policy) Rules, 2014, foreign businesses are required to establish a CSR committee consisting of a minimum of two members: a person designated under Section 380(1)(d) and another person the company nominates. A resident of India who has been granted permission to accept legal documents on behalf of the corporation is considered one of the persons named under 380(1)(d).
Committee on Nominations and Remuneration
Certain businesses must establish a Nomination and Remuneration Committee (NRC) by the Businesses Act of 2013. Every listed business and some prescribed businesses must establish an NRC following Section 178. Three or more non-executive directors are required, with at least half of them being independent. Whether executive or non-executive, the corporate chairman may serve as a member but not as the NRC's chairman. The NRC chairperson ought to be an independent director.
The function of independent directors
In their official capacity, independent directors are responsible for carrying out a range of duties. Among these important functions are:
Regarding stakeholders and shareholders
Independent directors oversee the company's operations to provide clarity and transparency. They use their knowledge to advise shareholders specifically. When the company's management or board makes choices that could negatively impact these parties, independent directors defend the interests of shareholders, creditors, and employees. To protect stakeholders' interests, they additionally monitor transactions between the business and affiliated parties and encourage systems like whistleblower rules that aid in exposing any wrongdoing.
In the direction of the board
The independent director is responsible for ensuring that the board of directors appropriately addresses significant matters to the organisation. The executive directors' and independent directors' goals and responsibilities are identical. However, the independent director's time commitment, expertise, and care for the company are far lower than those of the executive directors.
Independent directors' obligations to uphold sound corporate governance
An independent director has essential obligations. Their duties as board member are substantially the same as those of any other director. The independent directors will work with the risk management committee to identify potential issues and develop solutions for them. They must share their opinions and apply their expertise to better comprehend these issues without taking a side. Additionally, since open communication between the business and its stakeholders fosters credibility and confidence in the eyes of the public, independent directors must maintain this line of communication. Independent directors are essential to a corporation in this sense. For example, following the 2008 financial crisis, organisations such as JP Morgan increased the number of these guardians to keep a closer eye on things. These directors offer advice as well because they are well-versed in business. Another example is Sheryl Sandberg, who assisted Walt Disney with its Internet and digital initiatives preparations.
Ensuring that the corporation acts in the best interests of its owners the shareholders is another crucial responsibility of the independent directors. Occasionally, it also entails making difficult choices. An experienced and well-versed business professional typically serves as an excellent independent director. They must be independent thinkers, truthful, and not overly swayed by others. An excellent illustration of a capable independent director is Susan Decker. Her employment included positions at Yahoo! and Berkshire Hathaway. She contributed a wealth of knowledge to Intel's board and assisted the corporation in making wise decisions.
The obligations and behaviour of an impartial director
The obligations of the independent directors are numerous. The following responsibilities are listed in Section 166 of the Companies Act of 2013 for all directors, including independent directors. It consists of the subsequent items:
The principles and regulations outlined in the articles of association of the firm must be adhered to by directors.
Directors ought to make choices that advance the objectives of the business, safeguard the environment, and serve the needs of the community, workers, and shareholders. They ought to behave honourably and truthfully at all times.
The care, competence, and diligence demanded of someone in a director's position must be applied to the performance of their tasks. They ought to make thoughtful choices and take appropriate action to learn about the business's operations and difficulties.
When their interests and the company's interests collide, directors should steer clear of the issue. They must return any unauthorised gains to the company if they utilise their position for personal benefit or profit.
Directors cannot assign their responsibilities to another person. Any effort to do so is ineffective.
Under Section 166(7) of the Companies Act of 2013, a director may be penalised between one lakh and five lakh rupees for violating any of these responsibilities.
Directors must, in short, always act honourably and in the interests of the firm and its stakeholders. Among the general responsibilities and behaviours of these independent directors are:
Independent directors must maintain ethical norms by being truthful in all circumstances.
They must carry out their duties responsibly and impartially.
They must take the time to thoroughly comprehend challenges to make judgements that will advance the company's growth. Future choices must be made with the company's best interests, not yours or anyone else's.
Gain an understanding of the business and its operation by attending training and remaining current.
Make an effort to attend the board of directors, committee meetings, and the company's general meetings.
Possess sufficient understanding of the business and the sector in which it works.
Notify the company of any unethical activity, fraud, or regulation violations that they observe.
Protect the interests of the business, its shareholders, and its employees by using their authority.
Refrain from impeding the board committees' or the company's advancement.
Participate in the committees of the board as a member or chair.
They cannot disclose private information unless the board authorises it or the law demands it.
Ensure that there is a mechanism for individuals to report problems without fear of repercussions.
Independent directors are comprised of different committees within the corporation. As they do not belong to the company's executive team, they exchange objective viewpoints.
The Role of Independent Directors in Growing Businesses
1. Tailoring Governance Structures
Startups and emerging companies often begin with minimal formal structures, focusing primarily on rapid growth and innovation. As these businesses scale, there’s a need to establish more robust governance frameworks without stifling the entrepreneurial spirit that drives their success. Independent directors can guide the development of governance structures that are both scalable and flexible. This might involve creating advisory boards, establishing clear reporting lines, or implementing formal risk management processes that can evolve with the company.
For instance, while an early-stage startup may operate with a small, close-knit team and informal decision-making processes, growth often necessitates the introduction of formal committees, such as audit, compensation, and governance committees. Independent directors can help design these structures to ensure they meet regulatory requirements and best practices while remaining adaptable to the company’s changing needs.
2. Navigating Regulatory Challenges
As startups and emerging companies grow, they encounter increasingly complex regulatory environments. Compliance with legal and regulatory requirements becomes more critical and more challenging. Independent directors, particularly those with expertise in legal and regulatory matters, can offer invaluable support in navigating these complexities.
For example, startups preparing for initial public offerings (IPOs) or significant funding rounds must comply with stringent disclosure and reporting requirements. Independent directors can help ensure that the company meets these requirements, mitigating risks and avoiding potential legal pitfalls. They can also assist in implementing internal controls and auditing processes to maintain compliance and enhance transparency.
3. Supporting Strategic Growth
Independent directors bring a wealth of experience in strategic planning and business development. They can provide valuable insights into scaling strategies, market expansion, and competitive positioning. Their experience can help startups and emerging companies develop and execute strategies aligning with short-term and long-term objectives.
Consider a tech startup looking to expand its product line or enter new markets. Independent directors with industry-specific expertise can offer strategic advice on product development, market entry strategies, and competitive analysis. They can also assist in evaluating potential partnerships or acquisitions, helping the company make informed decisions that support sustainable growth.
4. Facilitating Investor Relations
Securing funding is a critical aspect of many startups and emerging companies' growth journeys. Independent directors can play a key role in building and maintaining investor relationships. Their involvement can lend credibility to the company, making it more attractive to potential investors.
Independent directors often have extensive networks and experience in investor relations. They can assist in crafting compelling pitches, negotiating investment terms, and managing investor expectations. Independent directors can help build investor confidence and secure the necessary capital for growth by ensuring transparent communication and demonstrating a commitment to sound governance practices.
5. Enhancing Credibility and Trust
The presence of independent directors on a startup or emerging company’s board can significantly enhance its credibility with stakeholders. Independent directors are viewed as impartial overseers who bring an added layer of scrutiny and expertise to the governance process.
This enhanced credibility can be particularly valuable when dealing with customers, partners, and potential investors. It signals that the company is committed to high standards of governance and is serious about its long-term success. This can be a decisive factor in attracting investment, forming strategic partnerships, and building a positive reputation in the market.
Adapting Governance Practices for Startups
1. Balancing Formality and Flexibility
One key challenge for independent directors in startups is balancing the need for formal governance practices with the company’s inherent need for flexibility and agility. While formal governance structures are important, they must be implemented in a way that does not impede the company’s ability to innovate and respond quickly to market changes.
Independent directors can help strike this balance by recommending governance practices that are scalable and adaptable. For example, they might suggest phased implementations of formal committees or reporting processes that align with the company’s growth trajectory.
2. Addressing Cultural Differences
Startups and emerging companies often have unique cultures and operating styles that differ from those of established corporations. Independent directors must understand and respect these cultural nuances while providing effective oversight.
Cultural sensitivity is important when introducing new governance practices. Independent directors should collaborate with the startup’s leadership to ensure that governance frameworks are tailored to the company’s culture and values, fostering an environment where innovation and compliance can thrive.
3. Emphasizing Strategic Guidance
In addition to their governance role, independent directors in startups should focus on providing strategic guidance. This involves overseeing compliance and risk management and actively participating in the company’s strategic planning and decision-making processes.
Independent directors can offer valuable insights into market trends, competitive dynamics, and growth opportunities. By engaging in strategic discussions and providing expert advice, they can help guide the company through critical growth phases and position it for long-term success.
Conclusion
Independent directors play a crucial role in the governance of startups and emerging companies, offering expertise, oversight, and strategic guidance essential for navigating growth complexities. By adapting governance practices to the unique needs of growing businesses, independent directors can help startups build robust, scalable frameworks while maintaining the agility and innovation that drive their success.
Integrating independent directors into the governance structures of startups and emerging companies enhances credibility and compliance and supports strategic growth and investor relations. As these companies continue to evolve, the role of independent directors will remain integral to ensuring sound governance and achieving sustainable success in a rapidly changing business environment.
Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out efficiently, helping you make a significant contribution to the board and raise corporate governance standards within the organization.
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