OPINION | Startup Challenges: Is it the VC who should be hung?

By Dr. Jaijit Bhattacharya

In the last few months, we have seen startups being embroiled in corporate governance issues, typically involving their founders. We have seen promising startups such as BharatPe, Zilingo, Infra.market, Trell etc. running into problems of corporate governance. This comes in the backdrop of India having blazed from being almost nowhere in the global startup pecking order about seven years ago to becoming the 3rd largest ecosystem for start-ups in the world, right behind US and China. India now has over 61,400 start-ups, with over 95 of them having achieved ‘unicorn’ status. That is, they have a valuation of over USD 1 billion.

This is stupendous growth for any economy, and it has been possible to a large extent because of the venture capitalists or VC’s providing unflinching financial backing to these hordes of startups. Unlike banks or traditional providers of capital for an enterprise, Venture Capitalists (VC’s) do not take any collateral and bet their money on the founding team and their idea. It involves a lot of risks and, hopefully, a very significant return that justifies the risk. So in the success of the startups, lies the success of the VC’s.

To understand the issue, one has to understand the business of a Venture Capitalist. Being a VC is expensive. A typical VC firm would require a certain number of people to be on their team in order to sift through the various investment opportunities, do the due diligence and eventually make the investment, adhering to a host of local regulations and ensuring that the investee companies sign on to adhere to the law of the land and to uphold the interests of the investors. In order to support such a large internal team and to keep its overall risks low, a VC typically breaks its total investments into a large number of smaller investments and invests in multiple startups. This also means that the VC’s would be extremely challenged in providing oversight to each company, as the companies themselves go through break-neck growth, fuelled by the idea, the entrepreneurial spirit, the market and the backing of the VC capital.

In such a context, is it really fair to zero-in on the VC’s for breaches in corporate governance of these fast-growing startups? If the leadership of the startups do not bring up the issues to the board, or the auditors are not able to catch a break in the pattern in the accounts as the startups are new and do not really have much of a history to detect a pattern and are by definition, creating a new sub-industry that does not have precedences to fall back upon, is it realistically feasible for VC’s, whose core expertise is to fund startups and not to run startups, to be able to catch slippages in corporate governance? It does seem to be a herculean task.

If we look at this issue from the context of traditional corporates, is it justified to hold banks responsible for the failure of large corporates such as Enron or Arthur Andersen or Satyam etc? The job of the banks is to fund the corporates. They sometimes also get a board seat which helps them ensure that their investments are safe. But does it mean that the banks are solely responsible for the failure of these corporate bodies? Clearly no. There are many other factors that lead to slippages in corporate governance staying undetected, and having a board seat does not ensure that one is able to detect such slippages.

Indian corporates as a whole seem to be having a large number of cases of inappropriate corporate governance. This is probably the right time to bring in fundamental changes in the oversight of companies and to strengthen them in order to propel India into the top three economies by the end of this decade. However, it would be unwise to shoot the funder, the banker or the VC who helps in providing the fuel to the entrepreneurial energies of this country, for issues that they may not be responsible for.

This article first appeared in India Today, https://www.indiatoday.in/opinion-columns/story/startup-challenges-venture-capitalists-1942599-2022-04-27