2023's start-up lessons: The imperative role of investors in corporate governance
/Investors, as key stakeholders, bear significant responsibility in ensuring strong corporate governance. The role of investors involves active engagement with companies, utilisation of voting rights, and attendance at shareholder meetings.[1]
Despite aligned interests, conflicts may arise due to differing timeframes for desired outcomes. In 2023, global start-ups faced challenges as instances of corporate mismanagement tarnished the sector's resilience, causing a sharp decline in investors’ interest in investing in startups - some even faltered under the pressure of the so-called tech winter.
The need for robust corporate governance became evident, with well-funded companies grappling with layoffs, restructuring, and a series of mismanagement allegations. The collapse of these start-ups underscored the dangers of prioritising short-term gains over long-term vision.
There are also instances where the two values between investors and the startups they are investing in don’t really match.
OpenAI's unique governance structure, for instance, played a pivotal role in the abrupt ousting of CEO Sam Altman. The structure limits investor returns to 100x of the first-round investment, exemplifying the nonprofit's mission to achieve artificial general intelligence (AGI) rather than prioritising profit.[2]
The board has discretionary power to determine AGI achievement, exempting it from commercial licensing agreements with current customers. The company, however, eventually transitioned to a "capped-profit" corporation in 2019. This dual, mission-driven approach, inspired by effective altruism, surprised investors and employees alike.
Handling transitions
Michael Peregrine, a partner at McDermott Will & Emery law firm and senior contributor for Forbes, wrote that the corporate world can learn a thing or two from football coaching legends Bill Belichick, Nick Saban, and Pete Carroll.[3]
Key considerations include a proactive approach to CEO and director succession, addressing concerns about entrenchment, managing executive retention, balancing age discrimination concerns, and navigating leadership transitions gracefully.
In the startup ecosystem, CEO turnover is a common occurrence, reminiscent of the situations faced by iconic coaches in football. This inevitability underscores the importance of having a standing board CEO search and succession committee as a best practice. In startups, the dynamics of CEO turnover can be driven by various factors, such as investors ousting executives or executives making way for incoming investors, often to pursue new ventures.
This phenomenon is exemplified by cases like Twitter after the departure of CEO Jack Dorsey and instances involving figures like Sam Altman.
However, the unique culture within startups can create a scenario where CEOs become central figures, almost cult-like, within the organisation. The startup culture's inclination to elevate CEOs to cult status can complicate succession, often driving great resignation among corporate experts.
Hence, these investors must navigate potential transitions carefully, transparently, and effectively communicate to maintain stability and trust within the organisation.
Bridging values
An EY report published in December 2023, "Start-up Governance Navigator," offers insights into challenges faced by investors during diligence and portfolio oversight. Effective governance in the VC ecosystem relies on the founder mindset, investor mindset, and board members. Establishing trust is paramount for start-ups, and a robust corporate governance framework is vital for ethical standards and sustainable growth.[4]
Corporate governance, encompassing legal compliance, transparency, and ethical operations, is an essential long-term investment. A scalable startup governance model is crucial, emphasising the need for ethics and compliance. Start-ups can build integrity by focusing on prevention, detection, and early risk response.
Effective corporate governance necessitates transparent financial reporting, consistent communication, and well-defined roles within the boardroom. Boards are critical in providing strategic advice, ensuring alignment with stakeholder interests, and acting as a vital check and balance for significant company decisions.
However, the dynamic in the boardroom often changes towards negative tension after investors arrive due to differences. Despite the different values, investors must reconcile these differences through transparency, effective communication, and alignment of interests, focusing on growth. A proactive approach to addressing risks and issues and regular communication between boards, management, and shareholders contributes to a more robust and resilient ecosystem.
Transparency, consistent regulatory compliance monitoring, and objective decision-making are crucial for responsible investing. Long-term commitment to value creation and adherence to ethical practices are vital for the sustainable growth of start-ups and the returns of investors.
Ultimately, navigating the complexities of corporate governance in startups requires a strategic and ethical approach, with investors playing a central role in fostering stability and sustainable growth.
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This information is not intended to serve as an exhaustive review of all legal and practical developments, nor does it encompass every aspect of the matters referenced. Readers are strongly advised to seek professional legal counsel before applying this information to address specific issues or transactions.
References:
[1] Napur Garg, "Start-Ups and Corporate Governance: Here’s Why Buck Stops with the Investors," Business TodayJan 13, 2024. https://www.businesstoday.in/latest/corporate/story/start-ups-and-corporate-governance-heres-why-buck-stops-with-the-investors-413124-2024-01-13.
[2] Devin Coldewey, "OpenAI Shifts from Nonprofit to ‘capped-Profit’ to Attract Capital," TechCrunchMar 11, 2019. https://techcrunch.com/2019/03/11/openai-shifts-from-nonprofit-to-capped-profit-to-attract-capital/.; Kyle Wiggers, "Investors are Souring on OpenAI’s Nonprofit Governance Model," TechCrunch, Nov 20, 2023. https://techcrunch.com/2023/11/20/openai-governance-model-investors/.
[3] Michael Peregrine, "Belichick, Saban, Carroll and their Impact on Corporate Governance," Forbes.ComJan 13, 2024. https://www.forbes.com/sites/michaelperegrine/2024/01/13/belichick-saban-carroll-and-their-impact-on-corporate-governance.
[4] EY and IVCA, Start-Up Governance NegotiatorEY - Ernst & Young, IVC Association,[2023]).
