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The clunky phrase "corporate governance" may sound like the antithesis to the freewheeling culture of startups. But with cautionary tales emerging from the West and even at home, startups in South-east Asia are paying more attention to the old-school rules of governance, say industry observers. In recent months, WeWork's botched Initial Public Offering (IPO) has served up a striking example of how governance can get out of hand, notes Stefanie Yuen Thio, joint managing partner at law firm TSMP. For one, the market is all too aware of how WeWork's key investor, Softbank, has "come out to publicly acknowledge corporate governance failures in this high-profile investment", she says.
Amy Zhao, who takes charge of investor and general partner relations at venture firm Openspace Ventures, attests to this: "With the recent WeWork situation, investors are paying more attention to the topic and building it into the investment process, as well as ongoing monitoring."
The WeWork saga itself is something of a "worst hits" compilation of alleged corporate governance lapses, encompassing related-party transactions, weak board oversight, a questionable business model and voting rights concentrated in the hands of the iconoclastic former chief executive Adam Neumann.
Closer to home, the fall of honestbee is perhaps the largest startup crisis to have unfolded in South-east Asia's young ecosystem. Saddled with over US$209 million in debt, the grocery delivery firm has faced scrutiny over how it accumulated some 1,800 creditors in just four years.
Could its board members have done more to prevent the debt situation? And why did the startup not file its annual financial statements with the Accounting and Corporate Regulatory Authority from 2016? Key questions on corporate governance have come to the fore.
Some might pin the blame on startup investors for overlooking lapses amid unbridled optimism. But then again, investors themselves also have limited information, given that startups, as private companies, are not subject to the same rigour of public disclosure as listed companies.
There is a rationale for the less rigid standards - the beauty of startups is said to lie in the chaos of unfettered innovation. South-east Asia has already produced about a dozen unicorns, and hundreds of so-called "soonicorns" on the path to the billion dollar valuation.
But with this maturing crop of tech companies, including many IPO aspirants, corporate governance cannot be an afterthought, contends Mak Yuen Teen, associate professor at the National University of Singapore Business School.
"I think too many fall into the trap of thinking that corporate governance is only important after a company is listed and there are public shareholders. It is true that corporate governance priorities evolve over a company's life cycle but getting the right people in to constructively challenge ideas and provide advice, and putting in place basic policies and controls, should start from an early stage," he says.
The South-east Asian startup ecosystem is flush with capital. According to data from Cento Ventures, the region's tech companies clinched about US$6 billion in funding in the first half of 2019, a 65 per cent rise from the prior six-month period (see chart). Unicorns including Grab, Gojek, Traveloka and Tokopedia continue to attract capital, Cento Ventures said in its report.
But with great money, comes great responsibility. When asked about the biggest corporate governance challenges in South-east Asia, Sai Ranganathan, chief executive and co-founder of energy management startup SensorFlow, points to financial reporting in a fragmented region.
"South-east Asia startups tend to grow really fast and involve massive cross-border operations from their inception. Unlike the US or EU market, (with) a common legal zone, it's very different in South-east Asia...You have to take into account different holding taxes, different ways of importing lease services and so on," he says.
The dizzying array of accounting regimes across the region presents challenges for startups as they scale, agrees Christopher Quek, managing partner of venture firm TRIVE. Sometimes, a founder may also lose direct oversight of local teams, creating risks of financial misreporting.
"Having proper controls can be very difficult during scaling up, as local accounting standards across South-east Asia might not be in sync with IFRS (international financial reporting standards). This might motivate local management to modify figures, which paint a rosier picture than what it is," he says.
How can founders keep all financials kosher, even as they lose some degree of control with rapid regional expansion? Assoc Prof Mak says that hiring an experienced financial team is key.
"Maybe it's the startup culture that you get someone your own age, but I think that may be a mistake when it comes to finance and operations. If you look at Google, the founders hired Eric Schmidt to provide 'adult supervision'," he notes.
For an early-stage company that may not have the resources to make such hires, it boils down to sheer discipline in maintaining accounts.
Rajesh Jaisingh, chief operating officer at fintech startup WeInvest, highlights the importance of meticulousness when it comes to finances.
"Given the transition from the chaos of an early-stage startup, we had to make a significant effort to align all our accounting practices to the demands of being a larger structured entity as we grew and took on additional funding," he says. For instance, coming up with a monthly pack of key metrics for investors also helped the company keep track of its own progress with the financial impact of its product.
One aspect startups should not skimp on is the quality of auditing, adds Reshmi Khurana, managing director and head of South-east Asia at risk consultancy Kroll.
"Startups should also consider getting high-quality external and internal auditors who act as a sounding board for the management and challenge their assumptions, as opposed to relying on representations made by the management," she suggests.
Auditing is also the surest safeguard against financial fraud, which Openspace Ventures attests is present in the region. "This is where we see inappropriate methods used to procure better results or metrics than is actually the case. Sometimes, this is a matter of interpretation; other times, this is clear-cut fraud. The worst cases are where early-stage companies engage in under-the-table payments to secure a leg up," says the firm's general counsel Kelvin Goh.
Ultimately, founders must bear in mind that they must be accountable for money entrusted to them by third-party investors, says Ms Yuen Thio of TSMP. Proper financial controls become an indispensable expense.
"There's a legal obligation to account for the spending, and if the startup hopes to attract even bigger investors at higher valuations, with the possibility of a trade sale or an IPO thereafter, corporate governance is a key indicator of how well-managed it is," she says.
Adults in the room
Another cornerstone of corporate governance is in having a good slate of investors and board of directors to guide growth. This is particularly important in the context of startups, to counter the larger-than-life personality of a founder, notes Associate Professor Lawrence Loh, director at the Centre for Governance, Institutions and Organisations at the NUS Business School.
But in many South-east Asian startups, boards tend to be limited to investors, who double-hat as directors, he points out.
"Maybe more could be done to introduce independent directors who are not major shareholders, who can act as a check and balance," he suggests, particularly for late-stage startups preparing for listings.
Mr Ranganathan of SensorFlow echoes this concern, adding that founders must have the courage to point out potential conflicts of interest a director may have if he is also an investor in the startup. "When serving on the board of directors, they need to always be company-first, but at the same time, if they're an investor, they might also be joining in the next round of investment, which can result in conflicting interests… It is very crucial for founders to be able to point it out early, rather than worry about it in silence," he says.
While welcoming the proverbial adults into the room, founders must also be careful that they are not taken advantage of, says Mr Quek of TRIVE. Some investors may foist unfair terms on startups - such as full-ratchet anti-dilution clauses that disadvantage other investors at a new round of fund-raising.
Another common example is setting an overly-demanding liquidation preference. Expressed as a multiple of the original purchase price per share - such as 1X or 2X - the liquidation preference represents the amount paid to preferred shareholders, before ordinary shareholders, in the event of a liquidation or a defined event such as a trade sale. Overbearing investors may set the liquidation preference at even 3X or higher, to the detriment of founders.
Mr Quek adds: "From 2017 to 2018, there were startup founders who gave up rights when funds were limited. I recall one particular investment term sheet where the investor had a right to dictate excessive control for S$50,000. The founder needed to seek approval from the investor for many operational matters, such as requiring three quotes for any equipment purchase above S$2,000… Any hire required the investor's approval, even an intern."
However, the market has since swung in favour of the founders, Mr Quek says. "If there are startups having very unfriendly terms, they should not hesitate to look around and find friendlier investors," he advises.
Turning away unsavoury individuals is another challenge. For any founder, having a high-quality board of directors is critical and it is important to understand the motivations for a prospective board candidate, says Hari Sivan, chief executive and co-founder of SoCash. In the early days of his four-year-old startup, he was often approached by various individuals offering to sit on the board or be an adviser.
In such instances, he had to make the difficult but necessary move to say 'no' when needed. "We had to turn away many people who seemed to be there for resume-building. And these can be people who may seem powerful, but you need to be able to say no," he says.
It is also important to avoid the temptation of building a "vanity board" - decked with big names who actually add very little value to the governance of the firm.
One infamous example was the disgraced US biotech startup Theranos, where alleged misdemeanour went unnoticed by a board stacked with political luminaries who knew nothing about blood testing.
"Big names make good corporate patrons; many don't add value - like how a lot of Singapore-listed companies used to seek out Members of Parliament to sit on their boards, thinking that they would lend cachet. While some did bring value, others just took up space. Worse, if the VIP was bent on protecting himself, he might not advance the objectives of the company with as much vigour as a non-big name director," says Ms Yuen Thio of TSMP.
With the numerous aspects of corporate governance, just getting started on the journey can seem like an enormous undertaking to a young entrepreneur. How early should corporate governance begin in a startup's life?
From day one, says Assoc Prof Loh of NUS. Rather than instituting rigid protocols, startups need to make corporate governance agile, so that checks and balances keep pace with growth. Failing to do so could jeopardise startups' future fundraises, and even their exit potential.
"It can hinder their ability to scale up their business and also constrain fund-raising, as larger investors in subsequent rounds of fund-raising - Series C and D - may look at these issues very closely… The venture investing industry is a small world and startups should want to stand out for good corporate governance," adds Ms Khurana of Kroll.
Mr Sivan of SoCash suggests that entrepreneurs "not be creative" when it comes to proper corporate governance, but to stick with proper procedures, whether in financial reporting or forming a board.
For Varian Lim, newly-appointed chief operating officer at distressed honestbee, corporate governance is now a core priority. "With a strong focus on financial controls and checks and balances to reduce compliance risks, the company is committed to taking a risk-based approach towards implementation of policies and procedures as it regains its footing," he says.
And ideally, it should not take a calamity for a startup to get its governance in order.
"A lack of financial controls and lack of need for public disclosures are a dangerous combination for startups - they act almost like a vicious circle with one reinforcing another," notes Assoc Prof Loh.
"Good corporate governance will function to break this cycle of doom that impairs many fast-growing startups."