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Wherever Valuation Exceeds Value, It Leads To Friction Within The Start-Up System, Says Fireside Ventures' Partner Dipanjan Basu 

With growing number of corporate governance issues, Basu explains the need to differentiate between intentional fraud and misgovernance arising out of mistakes

Wherever Valuation Exceeds Value, It Leads To Friction Within The Start-Up System, Says Fireside Ventures' Partner Dipanjan Basu 
Dipanjan Basu, partner and chief financial officer of Fireside Ventures
POSTED ON May 03, 2023 11:43 AM

The Enforcement Directorate's ongoing money laundering investigation against Byju's, with raids at its offices last weekend, has again fixed the spotlight on the gaping corporate governance issues plaguing Indian start-ups. The edtech start-up allegedly did not prepare its financial statements since FY21 or get these accounts audited, despite these being mandatory practices. 

Dipanjan Basu, partner and chief financial officer (CFO) of Fireside Ventures, opines that such lapses result from the growth-at-all-costs approach that founders and investors espoused when funding was readily available. The narrowing of the capital runway, coupled with slowing business, compelled them to have tough conversations about this attitude and the pertinence of due diligence.  

An erstwhile Myntra CFO who has worked with leading IT services companies, including Wipro, Basu tells Outlook Start-Up that it is unfair to paint all start-ups with the same brush. He maintains that stronger checks and balances will become the de facto standard as the ecosystem matures and companies eye the global market.

Edited excerpts: 

How has corporate governance evolved globally and in India? 

In the 90s, when IT services were big, SEC-listed US companies did not consider India a country with great accounting standards. Corporate America had over 50 years of experience in corporate governance, learning it the hard way, driven by some of the largest debacles like Enron and insider trading.   

When Indian IT companies started listing in the US stock markets, they had to adhere to similar strict standards. Indian accounting standards underwent a journey embracing processes like anti-fraud mechanisms, the Foreign Corrupt Practices Act, etc, and are today amongst the most well-governed companies from the standpoint of the standard. This continuum has moved to start-ups, like ecommerce, to fintech entities, in the Indian context and is continuing with the newer unicorns.  

Governance as a standard has withstood the test of time, and one should not paint it as a start-up issue alone. Instead, one should look at it in the context of how India is growing after understanding how capital markets work.  

SEBI is tightening the guidelines in how Indian companies aspire for IPOs, and the top investors, be it Tiger Global, Softbank or Sequoia, are governed by robust US regulations of how they should look at governance worldwide. It is a question of understanding and implementing frameworks from governing bodies like SEBI and SEC, and how high a bar one should apply.  

Then why are so many instances of corporate misgovernance coming out now? 

Looking at the global history of venture capital (VC), wherever valuation exceeds value—where the company's growth is X, but the valuation growth is X plus—leads to inherent friction within the start-up system. Without commenting on a particular fund, this is a human tendency when the country's GDP is growing at breakneck speed.  

When the US registered 7 to 8 per cent GDP growth between the 70s and the 90s, they lacked the right frameworks for corporate governance. But companies learnt from it, and we are using that learning in the context of a high-growth country like India.  

Today, we know what has gone right or wrong and how to prevent it. India's start-up economy is at an adolescence stage where investors, regulators and media need to play the role of watchdogs.  

If any company is valued more than expectations, it will face tremendous pressure to show results and growth. This can outweigh various aspects, including corporate governance, sustainability, or even people practices.  

As a CFO yourself, how do you explain the absence of a CFO in several start-ups for months and why it did not set off alarm bells for investors? 

The parent stakeholder should question whether these guardrails or basic hygiene is set up. It is hard to catch an individual fraud, which is also the last step when so many things have gone wrong that you are forced to address a particular issue. However, these stakeholders should look at things like delegation.  

In Fireside Ventures-backed start-ups, we evaluate how much the founder handles himself versus a professional team in areas like finance, tech, supply chain or inventory management. This is because most departments have a handshake between multiple stakeholders, eventually leading to corporate governance.  

The answer is not to have a promoter and a strong CFO; it is to have a founder at the helm, followed by professionals taking independent decisions to achieve the founder's vision. A company with proper delegation without a senior CFO would have already built suitable checks and balances.  

But isn't a lot of power vested in the CEO, who takes carte blanche decisions, be it at VC companies or start-ups? 

True. That is why Fireside Ventures is focusing on building teams much ahead of time and not just when the start-up reaches the unicorn stage. We have good examples of soonicorns like Mamaearth or bOAT that built these teams years ago.  

We place a strong onus on unit economics and the company should be profitable. The only exception could be when they are unit economics-positive but are making losses because the company is building teams ahead of its time.

This is a healthy matrix because it means that when the company grows, it will automatically become profitable because the team cost does not increase linearly. However, when a company is under unreasonable pressure for not being profitable, the easiest thing to cut is people.  

While there are cases of bad apples coming out, there are good ones as well, which should not taint the ecosystem. On the positive side, many professionals are entering the ecosystem compared to five years ago when the founders led the narrative.

One needs to segregate how many corporate misgovernance cases are intention-led frauds and how many are mistakes. The problem is about setting expectations and defining what is unacceptable.  

Do you see things getting worse before they get better? 

VCs play an enormous role in ensuring no sympathy for misdemeanours because that taints the company, ecosystem and country. However, I see lesser instances of these happening.  

While 2021 was the happiest year for fundraising, as an investor, it was a scary one where the valuation exceeded far beyond what one could have imagined. It was because there was significant liquidity in the US and more money creates more expectations, which can break the fabric of what the company is doing.  

That was significantly corrected in 2022 as liquidity tightened. It is not that money is unavailable for good companies, but now people are asking the right questions. Unfortunately, three years ago, no one asked these questions as there was money to deploy. Neither were they asking founders why they felt they could become a $100 million company within a year.  

In a high-growth market, expectations are high, and so is hubris. Could that be the reason for corporate governance issues?  

The buck has to stop with fund managers and investors. The answer is to build a sustainable business. Money does not equal growth; there is a brand, product, customer and growth potential. This is impossible if the founder raised money expecting to get 10x growth. It will create friction on the ground and all the multiple voices within the start-up will be left unheard.  

For instance, if the most dominant voice is about growing 10x or else they will not raise their next round or the investor will not put the next cheque. Other voices talking about corporate governance, people, practice or culture management will be unheard. An investor's role is to hear these voices.  

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