Good Governance Lies Between Founders’ Hubris And Overvaluation: Mohandas Pai

The relationship between a publicly listed company and its shareholders is based on many important fiduciary obligations. For the company to fulfil these obligations, a certain standard of corporate governance is required. In the recent past, we have seen many new-age start-ups failing to meet these governance standards, which resulted in souring of shareholders’ sentiments and markets reacting accordingly.

The reaction of the market has hit the respective companies’ valuations, bringing the issue of corporate governance back into discussion. In the light of these events, it seems that many start-up founders need to revisit some fundamental facts.

When someone puts money into any company, no matter the amount, the investment is an act of trust as well as faith. It is an act of trust because the investor believes that the enterprise will use the money for its promised objectives and execute it well. Faith comes into the picture because the investor expects the management and the controlling shareholders to exercise their fiduciary obligations responsibly.

Once a company is up for public shareholding, it does not belong to the promoters or founders anymore. Its management has to act as a fiduciary agent which works for every investor equally. The obligations of such a company include running the enterprise for common benefits, not using the company assets for personal use, not having any related party transactions without proper disclosure, releasing financial details on time and so on.

To put it simply, the company should not do anything that puts the interests of its investors in jeopardy. This has to be scrupulously followed, irrespective of whether the company is listed or not. It is also important to have a good, independent board of directors who are well qualified to advise on business matters. Such a board will act as a sounding board for management to run the business, give timely advice and ensure that public confidence in the enterprise remains high.

An independent board whose members are free to speak their minds and can question the management provides the best learning for any management to improve its enterprise. Any start-up that wishes to grow organically should have such a board and be open to the suggestions brought forward by the board. The independent nature of the board will also ensure that the company does not turn complacent and lose track of its main objectives.

The primary aim of any business is to earn profits and generate great returns for investors. This takes place in a competitive environment where, sometimes, the business goes after market domination by spending more in advance. This can lead to momentary losses, but continuous losses are not a sign of a good enterprise. There should be an urgency to earn positive cash flows. After all, the value of an enterprise is the net present value of its future stream of free cash flows. While talking about creating positive cash flow, it is also crucial to remember that initial success is not a guarantee of anything.

We have seen many start-ups blow up in recent times because of bad corporate governance practices. This is driven by the hubris and arrogance of the founders who tasted success in running their first enterprise and believe that they owe the success to just themselves and not to anything else. It must be remembered that the economy and the market are above any individual. The market is the sum total of the feeling and emotions of thousands of investors who coalesce to create value for everybody.

Once a start-up enters the public market, it must subscribe to a higher level of corporate governance because a large number of public shareholders join the cap table. As the participation of public shareholders is limited to looking at the enterprise when it discloses results, it is the duty of a listed company to issue its earnings on time. The company has the onus to prove that it is worthy of the trust and faith of investors in it. There is no room for shoddy management here.

It is disappointing to see many recently listed new-age companies overvalue themselves, forgetting the fact that the IPO valuation is not as important as the valuation post listing. They need to ensure that new investors can see decent returns and the value for existing investors is protected. Overvaluing means that new investors lose and the resultant loss of confidence hurts existing investors who see their value reduce. As listing percentage is less than the existing holding, it hits old investors the hardest. Good companies understand this well. The market is showing declining confidence in such companies because the narrative from its founders and management has been poor. They fail to issue their earnings on time and, consequently, do not enjoy good relations with their shareholders. If the company does not take it upon itself to set high standards of governance, disclosure and investor relations and subscribe to the highest levels of ethics and values, it will lose the respect of the market.

To be fair, it is not easy to be a listed company. Once listed, the company is open to increased scrutiny and the impact of economic uncertainties on an almost daily basis. This brings about an added responsibility, as well as an opportunity, on the founders and company management. This responsibility should be discharged fully in a diligent manner if the business has to create value. The management should step up to the task and demonstrate to the public why the company is trustworthy. Good corporate governance delivers great value for companies and ensures that the business remains competitive. It also ensures the longevity of the business and earns respect for the company and its management in the market.